THE INSTITUTE OF CHARTERED

ACCOUNTANTS OF NIGERIA

PATHFINDER
NOVEMBER 2020 DIET
PROFESSIONAL LEVEL EXAMINATIONS
Question Papers

Suggested Solutions

Marking Guides

and

Examiner‘s Reports

162
 FOREWARD

This issue of the PATHFINDER is published principally, in response to a growing

demand for an aid to:

(i) Candidates preparing to write future examinations of the Institute of

Chartered Accountants of Nigeria (ICAN);

(ii) Unsuccessful candidates in the identification of those areas in which they

lost marks and need to improve their knowledge and presentation;

(iii) Lecturers and students interested in acquisition of knowledge in the relevant

subject contained herein; and

(iv) The professional; in improving pre-examinations and screening processes,

and thus the professional performance of candidates.

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

It is hoped that the suggested answers will prove to be of tremendous assistance to

students and those who assist them in their preparations for the Institute‘s
Examinations.

NOTES

Although these suggested solutions have been published under the

Institute‘s name, they do not represent the views of the Council of the
Institute. The suggested solutions are entirely the responsibility of their
authors and the Institute will not enter into any correspondence on them.

1
 TABLE OF CONTENTS

PAGE

FOREWARD

CORPORATE REPORTING 3-31

ADVANCED TAXATION 32 – 72

STRATEGIC FINANCIAL MANAGEMENT 73 – 106

ADVANCED AUDIT AND ASSURANCE 107 – 135

CASE STUDY 136 - 175

2
 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2020
CORPORATE REPORTING
Time Allowed: 31/4 hours (including 15 minutes reading time)

INSTRUCTION: YOU ARE REQUIRED TO ANSWER FOUR OUT OF SIX

QUESTIONS IN THIS PAPER

SECTION A: COMPULSORY QUESTION (40 MARKS)

QUESTION 1

Statements of financial position as at December 31, 2019

Haba Suka Zara
N‘000 N‘000 N‘000
Assets
Non-current assets
Property, plant and equipment 32,000 25,000 20,000
Investments 33,500 - -
65,500 25,000 20,000
Current assets
Cash at bank and in hand 9,500 2,000 4,000
Trade receivables 20,000 8,000 17,000
Inventory 30,000 18,000 18,000
125,000 53,000 59,000
Equity and liabilities
Equity
Share capital 40,000 10,000 15,000
Share premium account 6,500 – –
Retained earnings 55,000 37,000 27,000
101,500 47,000 42,000
Current liabilities 23,500 6,000 17,000
125,000 53,000 59,000

3
 Statement of profit or loss for the year ended December 31, 2019
Haba Suka Zara
N’000 N’000 N’000
Revenue 125,000 117,000 82,000
Cost of sales (65,000) (64,000) (42,000)
Gross profit 60,000 53,000 40,000
Distribution costs (21,000) (14,000) (16,000)
Administrative expenses (14,000) (8,000) (7,000)
Profit before taxation 25,000 31,000 17,000
Income tax expense (10,000) (9,000) (5,000)
Profit after tax 15,000 22,000 12,000

Statement of changes in equity (extract) for the year ended December 31,
2019
Haba Suka Zara
N’000 N’000 N’000
Retained earnings brought forward 40,000 15,000 15,000
Retained profit for the year 15,000 22,000 12,000
———– ———– ———
Retained earnings carried forward 55,000 37,000 27,000

You are given the following additional information:

(i) Haba owns 80% of Suka‘s shares. These were purchased in 2016 for
N20.5 million cash, when the balance on Suka‘s retained earnings stood
at N7million.
(ii) In 2014, Haba purchased 60% of the shares of Zara by the issue of shares
with a nominal value of ₦6.5 million. These shares were issued at a
premium of N6.5 million. At that date the retained earnings of Zara
stood at N3 million and the fair value of the net assets of Zara was N24
million. It was agreed that any undervaluation of the net assets should
be attributed to land. This land was still held at December 31, 2019.
iii) Included in the inventory of Zara and Suka at December 31, 2019 are
goods purchased from Haba for ₦5.2 million and N3.9 million
respectively. Haba aims to earn a profit of 30% on cost. Total sales from
Haba to Zara and to Suka were N8 million and N6 million respectively.
Iv) Haba and Suka each proposed a dividend before the year-end of N2
million and N2.5 million respectively. No accounting entries have yet
been made for these.

(v) Haba has carried out annual impairment tests on goodwill in accordance
with IFRS 3 and IAS 36. The estimated recoverable amount of goodwill at
December 31, 2016 was N5 million and at December 31, 2019 was N4.5
million.

4
You are required to prepare:

a. Consolidated statement of profit or loss for the year ended

December 31, 2019. (10 Marks)
b. Consolidated statement of financial position as at December 31,
2019. (10 Marks)
c. Explain why external users of consolidated financial statements
benefits from inclusion of statement of group cashflows in the
annual report of companies. (10 Marks)
d. At December 31, 2019, Hard plc owned 90% of the shares in Spark
Limited. At this date the carrying amount of the net assets of
Spark in the consolidated financial statements of the Hard Group
was N800 million. None of the assets of Spark are re-valued.
On January 1, 2020, Hard sold 80% of the equity of Spark for N960
million in cash.

The remaining shares in Spark held by Hard are estimated to have

a fair value of N100 million.

Required:
Explain how the disposal of the shares in Spark should be
accounted for in the consolidated financial statements of the Hard
Group.
(10 Marks)
(Total 40 Marks)

5
SECTION B: YOU ARE REQUIRED TO ANSWER ANY THREE OUT OF FIVE
QUESTIONS IN THIS SECTION (60 MARKS)

QUESTION 2

Goodwin plc
Statement of profit or loss extract for the year ended December 31, 2019
N N
Profit before tax 121,900
Less: Taxation (52,900)
69,000
Less: Transfer to general reserve 5,750
Dividends:
Preference shares 1,380
Ordinary shares 2,070
(9,200)
Retained profit 59,800

As at January 1, 2019, the issued share capital of Goodwin plc was 23,000 6%
preference shares of N1 each and 20,700 ordinary shares of N1 each.

Required:
Calculate the basic and diluted earnings per share for the year ended December 31,
2019 under the following circumstances:
a. Where there is no change in the issued share capital. (5 Marks)

b. The company made a bonus issue of one ordinary share for every four shares
in issue at September 30, 2019. (3 Marks)
c. The company made a rights issue of shares on October 1, 2019 in the
proportion of 1 for every 5 shares held at a price of N1.20. The middle
market price for the shares on the last day of quotation cum rights was
N1.80 per share. (8 Marks)
d. Briefly discuss how investors use EPS ratio in investment decision and give
TWO examples of potential ordinary shares under IAS 33. (4 Marks)
(Total 20 Marks)

6
QUESTION 3

Tupe Print plc has just recently acquired 18% of the shareholding in Adowa plc
making it the second largest single shareholder. The majority shareholder has 58%
voting shares while the remainder of the shares are held by ten other shareholders
with none holding more than 5% voting shares. The board of directors of Adowa is
made up of 12 members with TupePrint having 3 members and the majority
shareholder having 7 members. TupePrint was able to negotiate its representation
on the board due to its strategic importance in Adowa‘s operations and expansion
plans. The directors of TupePrint have accounted for its investment in Adowa as an
equity instrument investment. The directors feel Adowa should not be accounted for
as an associate because TupePrint does not have 20% of the voting interest and
thus does not exercise significant influence over Adowa.

Adowa has been making losses for the past three years and has only returned a
taxable profit once in the last five years. The projection is that Adowa will return to
making taxable profits in another five years. As part of the acquisition of shares in
Adowa, deferred tax assets for deductible temporary differences arose. The
directors of TupePrint are unsure of how to account for this deferred tax asset.
TupePrint has an item of equipment which costs N56 million. This item of plant and
equipment currently has a carrying value in the financial statements of N39.2
million. TupePrint expects the operation of the equipment to generate undiscounted
cash flows of N7 million per year for the next five years. TupePrint could generate
immediate cash flow of N40 million if the equipment is disposed today. However, if
the disposal is carried out, it will have to pay a sales commission of 8.5%. The
directors of TupePrint are performing an annual impairment review and
understand that determining the recoverable amount is an important part of this
exercise.
Required:
a. Discuss how the investment in Adowa plc should be accounted for in the
financial statements of TupePrint plc. (7 Marks)
b. Advise the directors of TupePrint how the deferred tax asset that has arisen
should be accounted for. (7 Marks)

c. Assist the directors of TupePrint to determine the recoverable amount of the

equipment. You may assume a discount rate of 10% or five year annuity rate
of 3.791, (if relevant). (6 Marks)
(Total 20 Marks)

7
QUESTION 4

a. There have been many developments in Nigeria that increasingly put

pressure on listed companies to embrace sustainability reporting.

Required:

Discuss any THREE of such developments. (7 Marks)

b. The directors of BETA Company Plc sought your opinion on sustainability

strategies to be included in the company‘s sustainability report in order to
advance their sustainability development in the country.

Required:
Advise the Board of Directors on areas to focus in order to deliver their
sustainable development commitments. (7 Marks)

c. The objective of IAS 24 – Related party disclosure, is to ensure that an

entity‘s financial statements contain sufficient disclosures to draw attention
to the possibility that the entity‘s financial position or profit or loss may have
been affected by the existence of related parties.

Required:
Identify and discuss THREE key areas of disclosures required by a group
companies in their financial statements. (6 Marks)
(Total 20 Marks)

8
QUESTION 5

Muzana Limited owns tractors used for farming purposes and sometimes enters into
lease arrangements with other agricultural companies. A particular tractor when
leased out by Muzana is for 8 years. The useful economic life of each tractor is
estimated at 10 years while the fair value of each tractor is estimated at N26
million. The present value of minimum lease payments in the lease arrangement is
N28 million. Lease payments are made to Muzana by the lessee on a monthly basis
and has purchase option at the end of the lease term to acquire the machine for
N2.2 million. A similar fairly used machine in the market will cost the buyer N2.5
million. Following the transition to IFRS 16, the management of Muzana have
classified this lease as an operating lease in its year-end financial statements.

In order to expand its operations, Muzana accessed the Agricultural Loan Credit
Programme set up by the government of Nigeria. In the year 2016, Muzana was
granted a 5-year interest free loan of N100 million. At year end September 30,
2019, Muzana had been able to set aside N100 million in a special trust to be used
for no other purpose than to pay off the loan in full on its due date in 2020. The
management of Muzana are currently preparing their year-end 2019 financial
statements and have derecognised the loan liability due to the fact that funds have
been set aside in full to satisfy the loan payment in 2020.

Muzana Limited have just concluded a meeting with its tax consultant. The
amounts due to the state tax authorities in the current year is N2.3 million. Muzana
also has a tax credit of N1.8 million due from the Federal government in the current
year. The tax consultant has advised Muzana that these amounts can be offset in
their year-end financial statements to show only a tax liability of N500,000.

Required:

a. Explain how the lease arrangement should be classified in Muzana‘s 2018

year-end financial statements? (7 Marks)
b. Advise the management of Muzana, based on IFRS 9 derecognition rules, if
the loan liability can be recognised in their year-end September 30, 2019
financial statements. (7 Marks)
c. Explain if the advise provided by the tax consultant is consistent with the
offsetting rules under IAS 12 Income Taxes? (6 Marks)
(Total 20 Marks)

9
QUESTION 6

a. KutuKutu plc has a policy in place to pay its employees a performance bonus.
This bonus is to be paid in cash and is unrelated to the movement in its
share price. KutuKutu plc has the choice of settling the bonus in cash or in
equity shares to the value of the cash bonus. Based on bonuses paid in prior
years, KutuKutu has always settled the bonuses to employees that qualify in
shares.

b. KutuKutu plc grants one share option to each of its 50 employees on January
1, 2016. The share options will vest at the end of the 2 years provided that:

(i) The employees remain in KutuKutu plc‘s employment at that date;

and
(ii) The earnings before interest, tax depreciation and amortisation
(EBITDA) of KutuKutu plc for the 2nd year achieves a specified target.

At the grant date, each recipient is required to make a non-refundable cash

payment of N2,000 to KutuKutu plc. This payment amount is based on the
estimated fair value (FV) of the share option which reflects the probability
that the target EBITDA will be achieved in the 2nd year. FV of each option
would be N250 (excluding the effect of the EBITDA condition).

If KutuKutu plc does not achieve the target EBITDA or if an employee leaves
the employment of KutuKutu plc, no shares will be issued and the employee
will not be entitled to a repayment. Accordingly, both service and non-
market vesting condition are deemed to be substantive

Required:
i. Do the transactions entered into under (a) above meet the definition
of equity-settled share based payment transactions within the scope
of IFRS-2? (8 Marks)
ii. How should the transaction in (b) above be accounted for? (12 Marks)
(Total 20 Marks)

10
SOLUTION 1

a.
Haba Group
Consolidated statement of profit or loss and
other comprehensive income for the year ended December 31, 2019

N‘m
Revenue 310.0
cost of sales (159.1)
150.9
Distribution cost (51.0)
Admin expenses (29.0)
70.9
Less: Impairment loss (0.5)
Profit before tax 70.4
Income tax expense (24.0)
Profit after tax 46.4

b.
Haba Group
Consolidated statement of financial position as at December 31, 2019

N‘m N‘m
Assets
Non – current assets
Property, plant and equipment (32 + 25 + 20 + 6) 83
Goodwill (wk3) 4.5
Total non-current assets 87.5

Current assets
Cash at bank and in hand (9.5 + 2 + 4) 15.5
Trade receivables (20 + 8 + 17) 45.0
Inventory (30 + 18 + 18 – 1.2) 63.9 124.4
Total assets 211.9

Equity and liabilities

Equity:
Share capital 40
Share premium 6.5
Retained earnings (wk4) 90.3
Non-controlling interest (NCI) (wk6) 28.6
165.4

Current liabilities (23.5 + 6 + 17) 46.5

Total equity and liabilities 211.9

11
Workings

Wk 1

Haba group structure

80% 60%

Suka Zara
NCI 20% 40%

Wk 2 - Consolidated schedule

Adjustment
Haba Suka Zara Haba Suka Zara P&L
N‘m N‘m N‘m N‘m N‘m N‘m N‘m
Revenue 125 117 82 - (8) (6) 310
Cost of sales (65) (64) (42) 8 6 (157)
Unrealised profit (W 4) - - - - (1.2) (0.9) (2.1)
Gross profit 60 53 40 - (1.2) (0.9) 150.9
Distribution costs (21) (14) (16) (51)
Admin expenses (14) (8) (7) (29)
70.9
Less: Goodwill impairments (0.5) (0.5)
Profit before tax 70.4
Income tax expense (10) (9) (5) 24.0)
Profit after tax 21.5 12 46.4

Profit attributable to: Haba Suka Zara

Parent (Balancing figure) 37.30
Non-controlling Interest 20% 4.3 -
40% - 4.8 9.1
46.4

Wk 3 – Calculation of goodwill

Suka Zara
N‘m N‘m
Purchase consideration 20.5 13
Net assets at acquisition 80% (N17m) 13.6 -
60% (N24m) - (14.4)
Goodwill at acquisition date 6.9 (1.4)
Impairments: 2016 1.9
2019 0.5 2.4 -
Goodwill at reporting date 4.5 (1.4)

12
Wk 4 – Consolidated retained earnings (Group)

N‘m
Parent 55
Gain on bargain purchase (Goodwill – Zara) 1.4
Share of profit – Suka 24
Share of profit – Zara 14.4
Unrealised profit (0.9 + 1.2) (2.1)
Impairment (2.4)
90.3

Wk 5 – Post acquisition profits of subsidiaries

Suka Zara
N‘m N‘m
Retained earnings at acquisition date 7 3
at reporting date 37 27
30 24

Parent Suka 80% (30) 24

NCI 20% (30) 6
30
Zara 60% (24) 14.4
NCI 40% (24) 9.6
24.0

Wk 6 – Non-controlling interest

Suka Zara
N‘m N‘m
At acquisition - 20% (17) 3.4 -
At acquisition - 40% (24) - 9.6
Share of profit (Wk 5) 6 9.6
9.4 19.2
Total NCI (9.4 + 19.2) N28.6m

13
Wk 7 – Net assets of subsidiaries

Suka Zara
N‘m N‘m
At acquisition
Share capital 10 15
Share premium - -
Retained earnings 7 3
Fair value adjustment – Land - 6
17 24
At reporting date
Share capital 10 15
Share premium - -
Retained earnings 37 27
Fair value adjustment – Land - 6
47 48
Post – acquisition profit 30 24

c. Benefits of cash flow statement

i. Cash flow statement refers to a financial statement that provides details

about the amount of cash and cash equivalents of a business.

ii. It is a key report that highlights the changes in a company‘s cash flow
over a specified period.

iii. Investors consider the cash flow statement as a valuable tool because it
helps them to understand how much money an entity is making and
spending, where the money is coming from; and how it is being spent.

iv. Cash flow statement also helps the investors to know the liquidity/actual
cash position of the company which P or L will not show.

v. It provides insights about the liquidity and solvency of an entity, which

is vital for the survival and growth of any organisation.

vi. With a clear liquidity position, cash-flow helps the entity to arrange for
any shortfall or surplus for the growth of the business and even helps in
cash flow forecasting for investment decisions.

vii. Where the company has long-term debt obligations, a cash flow
statement helps the investors to determine the possibility of repayment.

14
 viii. Cash flows can be used to easily predict the timing, amounts, and
uncertainty of future cash flows.

ix. Cash flow assists investors to determine actual cash generated from
operation and understand the working capital management of the entity.

x. Cash flow statement clarifies cash inflows and outflows into operating
activities, investing activities and financing activities.

d. Disposal

N‘m
Purchases consideration
Fair value of retained shares in Spark 960
100
1060
Net assets of Spark at carrying value 800
Less: NCI 10% N800m (80) (720)
Gain on sale of shares 340

i. The standard gives guidance on how entity should account for disposal
of equity interest in a subsidiary where control is lost or retained.

ii. In line with the question, this is a step disposal where parent lost control.

iii. The standard requires that the fair value of the disposal consideration
should be added to the fair value of the remaining equity interest and
compared with the parent‘s percentage shareholding of the subsidiary‘s
consolidated net assets, which include any fair value adjustment and
unimpaired goodwill if any, at the date of disposal.

iv. Any gain or loss arising from the disposal should be credited/debited to
profit or loss if control is lost, otherwise, it should be charged to other
component of equity assuming parent retained control.

v. The total gain of N340 million on disposals of the shares should be

recognised in profit or loss for the period.

vi. Hard Plc will recognise the investment in Spark in its statement of
financial position in accordance with the requirements of IAS 39. At
initial recognition, this investment should be valued at N100 million.

15
Marking Guide
Marks Marks
a. Consolidated statement of profit or loss 4
Group structure 1
Consolidated schedule 5 10
b. Consolidated statement of financial position 4
Computation of goodwill 1
Value of net assets 2
Non-controlling interest in Suka and Zara 1
Group retained earnings 1
Post-acquisition profits of subsidiaries 1 10
c. Benefits to users of inclusion of group cash flows in
annual reports of companies
(any correct 10 points) 10
d. Accounting for disposal of shares in the
consolidated financial statements 6
Explanation of step disposal of Hard plc.
(any correct 4 points) 4 10
Total 40

Examiner’s Report
Parts (a) and (b) of the question test candidates‘ knowledge of group structure,
preparation of consolidated statement of profit or loss and statement of financial
position. Part (c) of the question tests candidates‘ knowledge of the benefits
accrued to external users on inclusion of group cash flows in the annual reports of
companies. Part (d) of the question tests how the disposal of shares are accounted
for in the group consolidated financial statements.

All the candidates attempted the question and their performance was above average.
The commonest pitfalls of the candidates were their inability to calculate correctly
group retained earnings, goodwill, post-acquisition profit of subsidiaries,
computation of the non-controlling interest (NCI) and accounting for disposal of
shares.
Candidates are advised to do in-depth study to understand the basic principles of
consolidating financial statements, practise more questions and use ICAN study
texts for better performance in future examinations.

16
SOLUTION 2

(a) This question requires the calculation of basic and diluted earnings per share
which are the main requirements of IAS 33.

IAS 33 requires entities to calculate:

 the basic earnings per share on its continuing operations
 the diluted earnings per share on its continuing operations.

Diluted EPS and basic EPS will usually differ when there are potential
ordinary shares in existence.

Without a change in the issued share capital and no potential ordinary shares,
Basic and Diluted EPS will be the same.

The Formula is:

Net profit or loss attributable to ordinary shareholders during a period

𝐁𝐚𝐬𝐢𝐜 𝐄𝐏𝐒 =
Weighted average number of shares in issue during the period (WANOS)
Total earnings
Or Simply Basic EPS =
(WANOS)

The total earnings to use will be the profit or loss from continuing operations
after deducting tax and preference dividends (and in the case of consolidated
financial statements, after excluding the earnings attributable to non-
controlling interests or minority interests). Total earnings include any income
from associates (i.e. any share of profits or losses of associates).

PAT− Preference dividend N69,000 − N1,380

Calculation for Godwin Plc Basic EPS = =
(WANOS) 20,700)

= N327k or N3.27k

(b) With bonus issue on September 30, 2019, WANOS will change but no
potential ordinary shares and so Basic and Diluted EPS are still the same.

Existing number of shares before bonus issue = 20,700

Bonus issue is 20,700/4 (1 for every 4) = 5,175
Total Shares = 25,875
N69,000 − N1,380
Basic EPS = = 261k or N2,61k
25,875

17
(c) With right issue on October 1, 2019
N69,000 − N1,380
Basic EPS = = 299k or N2.99
22,648

Calculation of WANOS
Theoretical ex-right price (TERP) will be calculated to derive the new WANOS.
Theoretical ex-right price (TERP) is the weighted average price of the share
immediately after the right issue. With the middle market price of N1.8 and right
issue price of N1.2, TERP will be calculated thus:
Existing shares 5 x 1.8 = 9
Right issue 1 x 1.2 = 1.2
6 10.2 TERP = 10.2/6 = 1.7

Calculation of WANOS
Bonus element of issue increases shares to 20,700 x 1.8/1.7 = 21,918
Full price element of issue increases shares to 20,700 x 6/5 = 24,840
WANOS is therefore: 21,918 x 9/12 = 16,438
plus 24,840 x 3/12 = 6,210
22, 648

(d) Uses of EPS ratio by investors

i. Investors use EPS as a measure of performance to assess the
companies in which they invest or might possibly invest.
ii. These investors are usually interested in changes in a company‘s
EPS over time (trends)
iii. They are also interested in the size of EPS relative to the current
market price of the company‘s shares which is referred to as the
Price earnings ratio (P/E)
iv. They use calculated EPS to reliably compare different companies
through evaluation of the EPS and P/E ratios of different companies.

Examples of potential ordinary shares under IAS 33

A potential ordinary share is a financial instrument or other contract that may
entitle its holder to ordinary shares at some time in the future.

IAS 33 gives the following examples of potential ordinary shares:

 financial liabilities or equity instruments that are convertible into new
ordinary shares at some time in the future (convertible debentures,
convertible preference shares);
 share options and warrants. Options and warrants are financial instruments
18
 that give the holder the right (but not the obligation) to purchase new
ordinary shares at some time in the future, at a fixed price;

 shares that will be issued if certain contractual conditions are met, such as
contractual conditions relating to the purchase of a business.

Marking Guide
Marks Marks
a. General requirement of IAS 33 1
Reasons why there is no difference between basic and 1
diluted EPS
Formula for basic EPS 1
Definition of total earnings 1
Calculation of basic EPS for Goodwin Plc. 1 5
b. No difference between basic and diluted EPS 1
Calculation of new total no of shares with Bonus issue 1
Calculation of new basic EPS with bonus issue 1 3

c. Calculation of basic EPS 1

Calculation of TERP 2½
Calculation of WANOS 4½ 8
d. Uses of EPS ratio by investors 2
Examples of potential ordinary shares 2 4
Total 20

Examiner’s Report
The question tests candidates‘ knowledge of calculation of basic and diluted
earnings per share (EPS) in accordance with the requirement of IAS 33- Earnings
Per Share.

Majority of the candidates attempted the question and their performance was above
average.

The commonest pitfall of the candidates was their inability to differentiate between
calculation of basic and diluted earnings per share.

Candidates are advised to improve their level of preparation to cover all areas of
the syllabus and to pay more attention to relevant accounting standards at this
level of the Institute‘s examinations.

19
SOLUTION 3
a. The standard gives guidance on when an investor is said to have gained
significant influence. If an entity holds 20% - 50% of the equity interest in an
investee, it will be presumed the investor has significant influence unless it
can be clearly proved that this is not the case. If the holding is less than 20%,
the entity will be presumed not to have significant influence unless such
influence can be clearly demonstrated.

The existence of significant influence by an entity is usually evidenced in one

or more of the following ways:
 Acquisition of 20% - 50% of the share capital of an investee;
 Material transactions between the two entities;
 An inter-change of management personnel between the two entities; or
 The provision of essential technical information by one entity to the other;
 Representation on the board of directors or equivalent governing body of
the investee; and
 Participation in the policy-making process, including participation in
decisions about dividends or other distributions.

Since Tupeprint has three (3) board members out of twelve (12) representing
25% and the majority shareholder have seven (7) members representing 58%,
this qualifies Tupeprint to participate in the policy-making process thus gain
significant influence.

Consequently, the investment in Adowa should be accounted for in line with

IAS 28 using the equity method as follows:

N
Cost of investment X
Plus/(minus) parent‘s share of profit/(loss) X
Plus/(minus) parent‘s share of OCI X
Minus share of impairment (x)
Less Dividend (x)
Cost of investment in Associate (x)

The director should be aware that percentage of interest is not the only basis
of determining associate or subsidiary other factors stated above should
always be considered.

b. Deferred tax assets are Items on a company's statement of financial position that
may be used to reduce taxable income in the future. They are created by deductible
temporary difference (Deferred Tax Asset (DTA).

(DTA = Deductible temporary different x Tax rate).

The standard requires that DTA can only be recognised as a non-current
asset if the following conditions are satisfied;

20
 (i) If it is recalculated and reconfirmed;
(ii) If the entity can proof that there will be future profit where it
intends to utilise it; and
(iii) If the amount can be reliably measured and are not to be
discounted.

Supposed the above mentioned conditions are met, then the Directors of
Tupeprint should account for the DTA as follows:

DR Deferred tax asset

CR Profit or loss

Based on constant loss in the past, current year profit may not demonstrate
or serves as basis for future profits except if certain projections and
conditions that will enhance future profits existed.

c. In line with the relevant standard, an asset is said to be impaired if the

carrying amount (CA) of the asset or cash generating unit is higher than the
recoverable amount (RA).

Recoverable amount is the higher of the fair value less cost to sell and value
in use.

Value in use is the present value of all the net future cash flows associated
with the use of the assets including the residual value discounted at the cost
of capital.

Impairment is the amount by which the carrying amount is higher than the
recoverable amount.

This is applied in the determination of the recoverable amount of the asset as

follows:
N‗m
Cost 56
Acc. Depreciation 16.8
Carrying amount 39.2

Value in use (V.I.U)

Year Cashflow Annuity factor at 10% Present value
1-5 N7m 3.791 N26.537m

21
 Fair value less cost to sell (FVLCTS) N‗m
Fair value 40
Cost to sell 8.5% x 40 (3.4)
FVLCTS 36.8
The Recoverable amount (RA) is 36.6 (the higher of V.I.U of 26.537 and FVLCTS of 36.6)

The impairment: N‗m

Carrying amount 39.2
Recoverable amount 36.6
Impairment 2.6
TupePrint should recognise the impairment by passing below accounting entry
Dr Profit or loss N2.6 million
Cr Plant and equipment N2.6 million

Marking Guide
Marks Marks
a. Introduction of the guidance of the accounting
standard 1
Points to illustrate existence of significance
influence ( any correct 4 points) 2
Explanation of Tupeprint significance influence 2
Investment in Adowa using equity method 2 7
b. Definition of deferred tax asset 1
Recognition of deferred tax asset 4
Advise to the Directors of Tupeprint 2 7
c. Determination of the recoverable amount 3
Computation of value in use 2
Calculation and accounting treatment of impairment
1 6
Total 20

Examiner’s Report
Parts (a) and (b) of the question test candidates‘ understanding of the principle of
significance influence on entity‘s financial statement, while part (c) tests
candidates‘ knowledge of computation of recoverable amount of a non-current
asset.

Few candidates attempted the question and their performance was poor.

The commonest pitfall of the candidates was their inability to deduce that
significant influence is not limited to percentage of shares holdings alone, but on
the basis of some other factors enunciated under IAS 28- Associates and Joint
Ventures.

22
Candidates should pay special attention to this area of the syllabus for better
performance in the Institute‘s future examinations.

SOLUTION 4

a. Listed companies in Nigeria just like their counterparts across the World
embrace and develop more interest in sustainability reporting. Increased
interest in sustainable reporting has come from several sources and based
on recent developments such as:
(i) A broader understanding and acceptance of the links between
economic activities and global sustainability issues by companies and
other stakeholders;
(ii) A recognition of the risk-management and economic benefits that
organisations can gain from integrating sustainability into their
strategies;
(iii) A growing demand from stakeholders, including investors, customers,
employees and NGOs, for organisations to manage their operations in
a more sustainable manner;
(iv) Government‘s concerned about the implications for society of
environmental damage and loss of natural resources. This has led
some governments and regulators to request companies to report on
their environmental and social impacts;
(v) Investors, many of whom now consider the ethical, social and
environmental implications of the investments they make (socially
responsible investment (SRI);
(vi) Companies themselves, who may identify business opportunities –
developing new products or reducing costs, in environmental friendly
initiatives; and
(vii) Companies have come to realise that they can enhance their value by
developing an understanding about the connections between
sustainability and business and communicating this to their
stakeholders. Thus, driving improvement and innovation.

(b) Sustainability Reporting is the disclosure and communication of

environmental, social, and governance (ESG) goals as well as a company‘s
progress towards them.

There are many ways to build sustainability reporting into corporate social
responsibility programme. Sustainability indexes provide corporate
organisations with typical sustainability strategies and areas to focus in order
to achieve whatever sustainability development commitments an organisation
may seek to achieve.

23
 Sustainability indexes are based on analysis of economic; environmental; and
social performance generally and specifically assessing the following issues:
 corporate governance;
 risk management;
 branding,;
 climate change mitigation;
 supply chain standards;
 labor practices; and
 industry-specific sustainability criteria

Therefore, BETA Company Plc is advised to consider any of the areas above to
include them in the Company‘s sustainability report.

(c) Disclosure requirements on related party transactions

IAS 24 is a disclosure standard calling for specified disclosures of:
i. related party relationships; and
ii. related party transactions.

Provisions and requirements of IAS 24 are:

i. IAS 24 requires disclosure in the notes to the financial statements of the
following, whether or not transactions have taken place between those
related parties;
 the name of the entity‘s parent; and
 if different, the name of the ultimate controlling entity.
ii. Where transactions have taken place between the related parties,
irrespective of whether a price was charged, the following should be
disclosed:
 the nature of the related party relationship;
 the amount of the transactions;
 in respect of outstanding balances;
- the amount;
- their terms and conditions;
- any guarantees given or received; and
- any provision for doubtful/irrecoverable debts.
 The expense recognised in the period in respect of irrecoverable
debts due from related parties.

The above disclosures should be given separately for each of the

following
categories of related party:
 the parent;
 entities with joint control or significant influence over the entity
 subsidiaries;
 associates;
 joint ventures in which the entity is a venture;
 key management personnel of the entity or its parent; and

24
  other related parties

iii. In addition, IAS 24 requires disclosure of compensation to key

management personnel, in total, and for each of the following
categories:
 short-term employee benefits;
 post-employment benefits;
 other long-term benefits;
 termination benefits; and
 share-based payments

Marking Guide
Marks Marks
a. Introduction 1
Identification of the developments 3
Discussion on each for maximum of 3 points 3 7
b. Any seven (7) areas of focus for sustainability reporting 7
c. Identification of the disclosure requirements of IAS 24 3
Discussion on any 3 of the disclosure areas 3 6
Total 20

Examiner’s Report
Parts (a) and (b) of the question test candidates‘ knowledge of the current
development in sustainability reporting, while part (c) of the question tests the
objectives of IAS 24- Related Party Disclosures on group companies financial
statements.

Majority of the candidates attempted the question and their performance was above
average. They also displayed good understanding of the question using local
environment in parts (a) and (b). However, their performance in part (c) was poor.

The commonest pitfall of the candidates in part (c) of the question was their
inability to separately identify the disclosure requirements of the parent,
subsidiaries, associates and joint ventures.

Candidates are advised to have adequate knowledge of contemporary issues

beyond financial reporting as well as the basic principles of disclosures relating to
group financial statements for better performance in future examinations

25
SOLUTION 5

a. Classification of lease arrangement

According to IFRS 16 Leases, the lessor must classify all lease contracts into
finance lease or operating lease.

The lessor should classify the lease as a finance lease if:

i. the lessor substantially transfers the risks and rewards associated with
leased asset to the lessee;
ii. the lessor will likely transfers ownership of the leased asset to lessee
after the end of the lease period;
iii. the lessee is responsible for the maintenance and servicing of the leased
asset;
iv. the present value of minimum lease payment is greater or substantially
equal to the fair value of the leased assets;
v. the lease term or period forms a substantial part of the useful life of the
leased assets even if title is not transferred;
vi. the lease contract is a non-cancellable lease agreement; and
vii. the lease contract contains a bargain purchase option.

The lessor should classify the lease as an operating lease if:

i. the lessor substantially retains the risks and rewards associated with
leased assets;
ii. the lessor is responsible for the maintenance and servicing of the leased
asset;
iii. the present value of minimum lease payment forms an insignificant part
of the fair value of the leased assets;
iv. the lease term or period forms an insignificant part of the useful life of
the leased assets even if the title is not transferred;
v. the lease contract is a cancellable lease agreement; and
vi. the lease contract does not contain a bargain purchase option.

Based on the above position of IFRS 16, Muzana should classify the lease
arrangement as a finance lease in the financial statement for 2018 year-end
for the following reasons:
 the present value of minimum lease payment of N28 million is greater
than the fair value of the leased asset of N26 million;
 the lease term of 8 years forms a substantial part of the useful life of the
leased asset of 10 years even if the title is not transferred;
 the lease contract is a non-cancellable lease agreement; and
 the lease contract gives the lessee an option to purchase the leased asset
at the end of the lease period and the option, is under condition,

26
 favourable to the lessee. The lessee will be required to pay N2.2 million
while a similar asset actually cost N2.5 million.

A contract contains a lease, if it conveys the right to control the use of an asset
for a period of time in exchange for consideration. Control is conveyed where
the customer has both the right to direct the identified assets use and to obtain
subsequently all the economic benefits from the use of the assets.

In the case under review, all the aforementioned conditions are met, hence the
lease assets and corresponding liability of the same amount would be
recognised at the inception of the lease.

An operating lease would still have been capitalised by the lessee under IFRS
16, if it conveys the right to control the use of an asset. Invariably, almost all
form of lease are classified under IFRS 16, however, where a supplier has a
substantive right of substitution throughout the period of use, a lessee does not
have a right to use an identified assets, hence it is not capitalised.

b.
i. IFRS 9 -Financial Instruments, Recognition and measurement is the
relevant standard that deals with the derecognition of financial liability.
ii. Derecognition is the removal of previously recognised financial liability
from an entity‘s statement of financial position.
iii. A financial liability is derecognised when and only when, it is
extinguished.
iv. By extinguishment of financial liability, it means the financial liability
has been discharged, cancelled or expired.
v. This is when the obligation specified in the contract is fully discharged.

Based on the foregoing, Muzana limited loan is still effective and running as
at year-end 2019
 Though full provision have been made for the repayment of the loan, this
will not become due until year-end 2020.
 We have no information that Musana Limited was contemplating or
ready to discharged the loan before its maturity in 2020.
 Therefore, the management of Muzana Limited cannot derecognised the
loan until it is fully discharged at its maturity in 2020.

c. Offsetting of current tax asset and current tax liability

The advice provided by the tax consultant is not consistent with the offsetting
rules under IAS 12-Income taxes. According to IAS 12, an entity can only
offset current tax asset and current tax liability if the following two conditions
are met:

27
 i. The entity has a legally enforceable right to offset the recognised
amount; and
ii. The entity intend to settle the amount on net basis (or intend to realise
the current tax asset and settle the current tax liability at the same time).

Based on the above position of IAS 12, the management of Muzana should
not offset the current tax asset and the current tax liability. That is, the
current tax asset should be separately recognised under current assets while
the current tax liability should also be recognised separately under current
liabilities.

Marking Guide
Marks Marks
a. Explanation on classification of lease arrangement
in the financial statement 5
Classification of Muzana lease based on IFRS 16 2 7
b. IFRS 9 derecognition rules as stated in the 3
standard
Advice to the management of Muzana limited on 4 7
their loan liability
c. Offsetting rules under IAS 12- Income taxes 3
Explanation of the advice to the management of
Muzana limited by the tax consultant 3 6
Total 20

Examiner’s Report
Part (a) of the question tests candidates‘ knowledge of the application of IFRS 16-
Leases on classification of lease arrangement and conditions thereto. The (b) part
of the question tests candidates‘ knowledge of the derecognition rules of financial
liability under IFRS 9 on financial instruments, while the (c) part of the question
examines the application of the offsetting rules of current tax asset and current tax
liability under IAS 12-Income Taxes.

Majority of the candidates attempted the question and their performance was
average in parts (a) and (b) but very poor in part (c) of the question.

The commonest pitfall of the candidates was lack of understanding of the

provisions of IFRS 16 to solve practical problems.

Candidates are advised to pay more attention to the application of the provisions of
various accounting standards to real life situations for better performance in future
examinations.

28
SOLUTION 6

a.

i. The relevant standard is IFRS 2-Share-Based Payment.

A share-based payment is a transaction in which the entity:
 receives goods or services as consideration for its equity instruments; or
 incurring liabilities for amounts based on the price of the
entity's shares or other equity instruments of the entity.

ii. IFRS 2 identifies two types of share-based payment transactions:

 Equity-settled share-based payment transactions. This is where the

entity pays for goods or services by issuing the entity instruments
including shares and share options.
 Cash-settled Share-Based Payment Transaction. This is where the entity‘s
receives goods or services as consideration for cash payment that is
based on the share price.

iii. Since Kutukutu pays its employees a performance bonus in cash which is
unrelated to the movement in its share price, and has always been settled to
employees that qualified in shares; these transactions meet the definition of
equity-settled share-based payment and therefore fall under IFRS 2.

b. The relevant standard is IFRS 2 Share-Based Payment as described above.

The standard requires that full provision based on the number of staff that
will remain at the vesting date should be made, even if it is not probable
that the conditions attached will be met. The provision should be spread
over the vesting period using the fair value of share option at grant date.
However, the provision will be based on the movement in the share price if
share appreciation rights (SARS) are granted.

The accounting requirement for Initial recognition will be:

For equity-settled share-based Payment

DR Profit or Loss
CR Share option

For cash-settled – share based payment

DR Profit or Loss
CR Liability

Subsequently, only the incremental provision is accounted for.

29
This is applied as follows:

Number of staff remaining x share option x share price at grant date x

year/vesting period
N Equity
2016 (Year 1)
Expected outcome (at grant date value)
50 x 1 x 250 x ½ 6,250

2017(Year 2)
Expected outcome
50 x 1 x 250 x 2/2 12,500
(6,250)
6,250

Accumulated equity for the 2 years 12,500

Journal entries

2016 (Year 1)

Dr. Profit or loss 6,250

Cr. Equity 6,250
Share – based equity expended in Year 1

2017 (Year 2)

Dr. Profit or Loss 6,250

Cr. Equity 6,250
Share – based equity expended in Year 2

Non – refundable cash payment

50 staff x N2,000 = N100,000

Dr. Other receivables 100,000

Cr. Profit or loss 100,000
Non – refundable cash payment in respect of share-based equity for staff

30
 Marking Guide
Marks Marks
a. Definition of equity-settled share based payment
transactions according to IFRS 2 2
Identification of types of share-based payments
transaction 2
Explanation on the policy of Kutukutu to meet
definition of equity-settled share based payment 4 8
b. Accounting for transactions in Kutukutu plc. 2
Accounting requirements for initial recognition 2
Accounting for subsequent incremental provisions 4½
Journal entries to record the transactions for 2
years 3½ 12
Total 20

Examiner’s Report

The question tests candidates‘ knowledge of IFRS 2- Share-Based Payment on

application of the standard to a case study, types, recognition, treatment,
presentation and accounting for transactions under the standard.
Few candidates attempted the question and their performance was below average.

The commonest pitfall of the candidates was their inability to correctly apply the
provisions of the standard to the scenario presented in the question.

Candidates are advised not only to concentrate on the provisions of accounting

standards but to also understand their applications to real life situations for better
performance in future examinations.

31
 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA

PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2020

ADVANCED TAXATION
Time Allowed: 31/4 hours (including 15 minutes reading time)

INSTRUCTION: YOU ARE REQUIRED TO ANSWER FOUR OUT OF SIX QUESTIONS

IN THIS PAPER

SECTION A: COMPULSORY QUESTION (40 MARKS)

QUESTION 1

The recent trade tariff war on goods exported between United States and China, has
opened vista for corporate players in the two countries and their allies to venture
into new areas considered to be business-friendly.
Sunchi Limited, Shanghai, is a computer accessories company that was
incorporated in China in 2003. The company established its subsidiary outlet,
Sunchi West Africa Holdings, in Ibadan, Nigeria, on January 1, 2018. The Nigerian
company adopted December 31, annually (same as the parent company) as its end
of financial year.
The first set of consolidated accounts was audited by a reputable audit firm based
in China. Taxes for both business operations were also paid in China.
The Nigerian tax inspectors from the Federal Inland Revenue Service demanded for
annual returns and tax computations from the subsidiary company but the General
Manager of the company claimed that the company had paid personal income tax
of its employees and directors, value added tax on imported equipment and
relevant custom duties. Furthermore, since the parent company is not registered in
Nigeria, there is no reason why it should be liable to companies income tax. The
issue is yet to be resolved.
The Managing Director of the subsidiary company in Nigeria, with the permission
of the head office in China, appointed you as the company‘s tax consultant to help
unravel the issue of payment of companies income tax by resident and non-resident
companies operating in Nigeria. He also submitted to you the statement of profit or
loss for the year ended December 31, 2018, after conversion of the transactions in
head office‘s Chinese currency (Yuan) to Nigerian Naira.

32
 China Nigeria Total
N’000 N’000 N’000
Turnover 1,982,210 455,600 2,437,810
Miscellaneous income 36,010 8,200 44,210
Total income 2,018,220 463,800 2,482,020
Less: Direct cost of production 777,190 120,700 897,890
Gross profit 1,241,030 343,100 1,584,130
Expenses:
Personnel costs 288,650 101,220 389,870
Electricity and rates 3,550 6,830 10,380
Legal expenses 12,000 4,200 16,200
Share of head office expenses 50,000 25,000 75,000
Depreciation 26,300 9,900 36,200
Allowance for doubtful debts 18,240 10,650 28,890
Income tax paid in China 55,880 - 55,880
Value added tax on essentials - 2,500 2,500
Entertainment 2,400 3,400 5,800
Transport and travelling 10,200 1,340 11,540
Printing and stationery 15,770 2,640 18,410
Telephone, telex and postage 3,890 1,730 5,620
Motor vehicle running expenses 18,520 900 19,420
Foreign exchange loss provision - 1,750 1,750
Debenture interests - 1,000 1,000
Loss on revaluation of non-current assets - 1,490 1,490
Repairs and maintenance 90,600 3,440 94,040
Audit and accountancy fees 12,250 - 12,250
Administrative expenses 125,100 44,600 169,700
Total expenses 733,350 222,590 955,940

Net profit 507,680 120,510 628,190

For the Nigerian company, the following additional information is also relevant:
(i) Miscellaneous income:
This consists of income realised from sale of component parts to head office.
The transaction was made at open market price.
(ii) Legal expenses comprise:
N‘000
Debt collection 800
Preliminary expenses 2,100
Land acquisition 550
Retainership fee 750
4,200

33
(iii) Allowance for doubtful debts are made up of:
N‘000
Allowance for doubtful debts 5,820
Specific allowance for doubtful debts 3,300
Bad debts written off during the year 1,530
10,650
(iv) Repairs and maintenance include:
N‘000
Improvement to office building 2,250
Repairs of plant and machinery 1,190
3,440
(v) Administrative expenses include:
N‘000
Court fine 600
Office expenses 42,750
Subscription to Nigeria-China Trade Mission 250
Provision of Chinese books to public secondary school in Oyo
State 1,000
44,600
(vi) Schedule of qualifying capital expenditure is as follows:
Item Date of acquisition Amount
N‗000
Factory building January 1, 2018 20,200
Office building January 1, 2018 12,450
Plant and machinery February 3, 2018 25,000
Motor vehicles March 10, 2018 16,120
Furniture and fittings January 1, 2018 4,700
Office equipment February 13, 2018 4,000

Required:
As the company‘s tax consultant, you are to prepare a report to management of
Sunchi Limited taking into consideration the following:
a. Resident and non-resident companies (4 Marks)
b. Circumstances under which profit of a non-resident company
will be liable to tax in Nigeria. (10 Marks)
c. Relationship between a:
- Nigeria branch and the parent company (3 Marks)
- Nigeria subsidiary and the parent company (3 Marks)
d. Overseas branch of a Nigerian company (3 Marks)
e. Overseas subsidiary of a Nigerian company (3 Marks)
f. Advise on, if any, the companies income tax payable by the two
business operations in Nigeria. (14 Marks)
(Total 40 Marks)

34
SECTION B: YOU ARE REQUIRED TO ANSWER ANY THREE OUT OF FIVE
QUESTIONS IN THIS SECTION (60 MARKS)

QUESTION 2

Sunny Oil Producing Nigeria Limited is engaged in petroleum exploration in the

deep sea off the coast of Bight of Benin in the Niger delta region since 2005. It is
involved in a production sharing contract with the Nigerian National Petroleum
Corporation. In order to consolidate its position in the Nigerian oil and gas sector,
the company intends to diversify its operations into the ocean going oil tanker
transportation business in the next few months.
The company submitted its annual returns and statement of tax computation in
respect of the year ended December 31, 2018 to the Federal Inland Revenue Service
office in April 2019 but there was a disagreement between the amount raised by
the tax office and that of the company. A check by the financial accountant of the
company revealed that capital allowances on plant and equipment acquired for
N120.5 million during the year as well as donation of N50 million made to an
institution of higher learning were not taken into consideration in the
determination of assessable profit. A letter explaining this discrepancy was written
by the Managing Director to the FIRS but instead of the issue to be resolved, a
notice, giving the company, date and time for hearing before the Tax Appeal
Tribunal was received.
In order for the company to be properly guided in the pursuit of the case before the
tribunal, it was resolved that a competent firm of Chartered Accountants with bias
in oil and gas accounting and taxation should be engaged.
Your firm has been appointed as the company‘s tax consultants with the mandate
of representing the company at the sittings of the Tax Appeal Tribunal. Relevant
documents in respect of the acquisition of the plant and equipment and donation
were made available to you.
The extract from the books of accounts of the company for the year ended
December 31, 2018 revealed the following:
(i) Export sales:
Bonny light 150,000 barrels exported at 370API
Forcados 100,000 barrels exported at 360API
Bonny medium 90,000 barrels exported at 350API

Price per barrel at 360API:

Bonny Light $63.03
Forcados $65.00
Bonny medium $64.53

(ii) Actual realised price is arrived at after adjusting for the variance in API. For
every API, $0.03 is the variance in price at 360.
(iii) Domestic sales: 80,000 barrels at N720 per barrel.

35
(iv) Expenses incurred include:
N’000
Operating expenses 255,000
Production and exploration 1,100,600
Intangible drilling cost 420,800
Administrative expenses 225,500
Non-productive rent 80,700
Bad debts written off 20,150
Repairs and renewals 92,600
Transportation and traveling 73,200
Royalties 222,900
Miscellaneous expenses 63,800
Salaries and wages 830,700
Pension fund contribution 74,450
Customs duty (non-essentials) 10,400
Habour dues 3,300
Stamp duties on debenture 2,500
Interest on loan 52,350
Cost of 3 appraisal wells 120,000
Income tax provision 750,000
Transfer to special reserves 255,000

Additional information:
(i) Production and exploration include N80 million incurred on tangible drilling
operation and depreciation of N200.2 million.
(ii) Royalties include amount of N22.5 million in respect of royalties on domestic
sales.
(iii) Miscellaneous expenses include, among others, N12.75 million spent on
obtaining information on the existence of oil in the Middle-Belt and N50
million donation to a public university in one of the states in the Niger delta
region.
(iv) The Joint Tax Board gave approval for the operation of pension fund
contribution in the company.
(v) Interest on loan includes N12.3 million paid to a subsidiary company. The
transaction was made at the prevailing market rate.
(vi) The company entered into a gas contract with the following:
Company Load factor Amount
N‘000
Akin Gas Limited 660 220,000
Bollah Limited 710 350,000

36
(vii) Schedule of qualifying capital expenditure:

Asset Date of Location Amount

acquisition N’000
Plant February 28, 2018 Off-shore operation in territorial
waters and continental shelf
area of 80 metres water depth 120,500
Pipeline and May 1, 2018 Off-shore operation in territorial
storage tank waters and continental shelf
area of 120 metres water depth 85,300
Motor vehicle March 30, 2017 On-shore operation 40,600
Building February 13, 2016 On-shore operation 50,800

(viii) Unutilised capital allowance and loss brought forward from the previous
year were N12.5 million and N750 million, respectively.
(ix) Capital allowance as agreed with the relevant tax authority was N130.25
million.
(x) The amount stated in respect of transfer to special reserves was approved by
the company‘s Board of Directors to be utilised for future investment
opportunities.
(xi) Assume N305 is equivalent to US $1.
(xii) Profits from petroleum exported or sold domestically are taxable at 85%.

Required:
a. As the company‘s tax consultant, you are to draft a report to the Managing
Director explaining the following:
i. The preparation which you and the company should make
before the commencement of the proceedings at the tribunal. (2 Marks)
ii. Steps to be taken by the company if the decision of the
tribunal is not acceptable to it. (2 Marks)
iii. The tax implication of the company‘s proposed transportation
business. (1 Mark)

b. Re-computing the following:

i. Assessable profit (8 Marks)
ii. Chargeable profit (3 Marks)
iii. Assessable tax (1 Mark)
iv. Chargeable tax (1 Mark)
v. Total tax payable (2 Marks)
(Total 20 Marks)

37
QUESTION 3

Larry Limited, Lagos, is a manufacturing company that has been producing

household utensils successfully for several years. The company is planning to enter
the international market but the management team has little or no information in
respect of regional economic integration and trade blocs around the world.
The Managing Director of the company has just engaged your professional
accounting firm to provide advice on some salient issues in this respect.

Required:
As the Desk Officer in charge of international tax matters in the professional
accounting firm, you are to present a report to your principal partner, for his review
before sending it to the firm‘s client. Your report should cover the following areas:

a. Distinction between regional economic integration and trade blocs. (4 Marks)

b. Objectives of regional integration. (5 Marks)
c. Benefits of regional economic integration and trade blocs. (4 Marks)
d. Disadvantages of regional economic integration and trade blocs. (3 Marks)
e. Common market and economic union as major types of regional
economic integration. (4 Marks)
(Total 20 Marks)

QUESTION 4

The quest by various governments in Nigeria since 1990s to use tax incentives to
change the narrative of being a mono-product foreign exchange earner has
attracted interests from both local and foreign investors to the hitherto forgotten
non-oil sector. However, some of the foreign investors are not conversant with these
tax incentives available to investors in the manufacturing, mining and
telecommunication industries.
You have been appointed as a tax consultant to a Mexican billionaire through his
agent in Nigeria, IBK Associates, with interests in many sectors such as agriculture,
aviation, manufacturing and telecommunication in the Latin American region. He
intends to explore the Nigerian business environment within the next six months.

Required:
You are to write a report to the Mexican through his agent in Nigeria highlighting
the following areas:
a. Objectives of Nigerian tax incentives (4 Marks)
b. Forms of tax incentives (2 Marks)
c. Various tax incentives available to operators in the:
i. Manufacturing sector (6 Marks)

38
 ii. Agriculture (2 Marks)
iii. Telecommunications (2 Marks)

d. Other non-tax factors foreign investors consider in determining

a jurisdiction as investment destination. (4 Marks)
(Total 20 Marks)

QUESTION 5

Tax haven is a state, country or territory where certain taxes are levied at a low rate
or not at all. This has created problems for other countries as their products and
services are no longer competitive in international markets. However, various
international organisations, governments and other stakeholders are still
handicapped in mitigating or totally eliminating this malaise that is threatening
competitive global market.

You have been invited by a manufacturing outfit to help explain certain issues
regarding tax haven in practice.

Required:
a. From the perspective of the Organisation for Economic Co-operation and
Development (OECD), explain THREE key factors in deciding
whether a jurisdiction is a tax haven or not. (6 Marks)

b. How can a country use its tax jurisdiction to address the issue of
competition from a tax haven? (5 Marks)

c. Explain the advantages of and provide the criticisms against tax

haven. (9 Marks)
(Total 20 Marks)

QUESTION 6

a. Ms. Lilian Abu is a Nigerian born with a British mother. She grew up and
schooled in the UK after which she took up a job with Her Majesty Revenue
and Customs (HMRC) as a revenue officer. She has been selected to join a
team of international reviewers visiting Nigeria in the coming months under a
project funded by the World Bank.

Lilian has contacted you as part of her initial research to understand the tax
system in Nigeria ahead of her visit.

39
 Required:
i. Discuss the structure of the tax administration system in Nigeria. (4 Marks)
ii. Discuss the functions of any TWO organs of tax administration
in Nigeria. (8 Marks)
b. Lilian informed you that based on her Google searches, she had seen a lot of
concerns being expressed by Nigerian taxpayers over multiple taxation.

Required:
Explain the concerns by Nigerian taxpayers over multiple taxation and outline
the causes and possible solutions of multiple taxation in Nigeria. (8 Marks)
(Total 20 Marks)

NIGERIAN TAX RATES

1. CAPITAL ALLOWANCES
Initial % Annual %
Building Expenditure 15 10
Industrial Building Expenditure 15 10
Mining Expenditure 95 Nil
Plant Expenditure (excluding Furniture & Fittings) 50 25
Manufacturing Industrial Plant Expenditure 50 Nil
Construction Plant expenditure (excluding Furniture
and Fittings) 50 Nil
Public Transportation Motor Vehicle 95 Nil
Ranching and Plantation Expenditure 30 50
Plantation Equipment Expenditure 95 Nil
Research and Development Expenditure 95 Nil
Housing Estate Expenditure 50 25
Motor Vehicle Expenditure 50 25
Agricultural Plant Expenditure 95 Nil
Furniture and Fittings Expenditure 25 20
2. INVESTMENT ALLOWANCE 10%
3. RATES OF PERSONAL INCOME TAX
Graduated tax rates with consolidated relief allowance of N200,000 or 1% of
Gross Income whichever is higher + 20% of Gross Income.
Taxable Income Rate of Tax
(N) (%)
First 300,000 7
Next 300,000 11
Next 500,000 15
Next 500,000 19
Next 1,600,000 21
Over 3,200,000 24

40
 After the relief allowance and exemption had been granted, the balance of
income shall be taxed as specified in the tax table above.
4. COMPANIES INCOME TAX RATE 30%
5. TERTIARY EDUCATION TAX (2% of Assessable Profit)
6. CAPITAL GAINS TAX 10%
7. VALUE ADDED TAX 5%

SOLUTION 1

ABC & CO. (Tax Consultants)

ABC Avenue, Lagos.

April 10, 2020

The Managing Director

Sunchi West Africa Holdings
Ibadan

Dear Sir,

RE: TAXATION OF RESIDENT AND NON-RESIDENT COMPANIES IN NIGERIA

I refer to your mail of April 5, 2020 on the above subject, requesting us to unravel
the issue of payment of companies income tax by resident and non-resident
companies operating in Nigeria.

Please find below relevant issues that will facilitate your understanding of the
situation:

a) Resident company

A company is resident in Nigeria under the extant law, if it is incorporated or

registered in Nigeria. This means that the taxpayer is liable to tax on the
income or profits accruing in, derived from, brought into, or received in
Nigeria

Non-resident company

This is a company that is not registered or incorporated in Nigeria, but which

derives income or profits from Nigeria.

A non-resident corporation or individual is liable to tax only on the profit or

income deemed to be derived from Nigeria.

41
b) Circumstances under which a non-resident company will be liable to tax
in Nigeria

These include:

 Fixed base of business: If a non-resident company has a ―fixed base‖

from which it carries on its business or trade in Nigeria, the profits from
such activities would be deemed to be derived from Nigeria;

 Agency operation: Where a non-resident company does not have a fixed

base but habitually operates a trade or business through a person in
Nigeria who:

- is authorised to conclude contracts on its behalf or on behalf of some

other companies controlled by it or which has controlling interest in
them or

- habitually maintains a stock or goods or merchandise in Nigeria from

which deliveries are regularly made by a person on behalf of the
company, then an agency arrangement is deemed to have arisen.

The profit deemed to have been derived from Nigeria is the profit
attributable to the business or trade or activities carried on through the
agent.

 Turnkey projects: This is a trade or business or activity which involves a

single contract for the surveys, deliveries, installations or construction.
For Nigerian income tax purposes, the profit from such a tunkey project is
considered as derived from Nigeria and this will be liable to tax.
 Income derived by non-resident company from professional consultancy,
management and technical services rendered in Nigeria.
 Income derived from supervisory activity that lasts more than three (3)
months.
 Income derived by a non-resident company from investment, such as
dividend, interest, rent and royalties. The withholding tax deducted from
these incomes is taken as the final tax.
 Income derived from a contract awarded to a Nigerian company, but sub-
contracted to a non-resident company.

42
c i) Relationship between a Nigerian branch and a foreign parent company

 Under the Companies Income Tax Act Cap C21 LFN 2004 (as amended)
citizens of other countries, that are foreign nationals can incorporate a
company or corporation (other than a corporation sole). This is regarded
as a resident company that is a Nigerian company.
 However, a Nigerian branch of a foreign company is treated as a
corporate entity. Income or profits derived by such company in Nigeria is
taxable in Nigeria.
The conditions under which such a Nigerian company will not be liable to
Nigerian tax are where:
 The branch of the foreign company is used solely for the storage or
display of goods or merchandise; and
 The branch is used for collection of information.

c ii) Nigerian subsidiary and a foreign parent company

 Under the Nigerian tax laws, the subsidiary of the foreign parent
company must be incorporated in Nigeria.
 The foreign equity participation may be 100% (wholly-owned) or less
than 100% (partly owned), this will not affect the residence status in
Nigeria.
 Dividends distributed by the Nigerian subsidiary of the parent company
is a franked investment income and shall be exempted from tax in the
hands of the parent company. But it will be subjected to withholding tax
of 7.5% in Nigeria.

d) Overseas branch of a Nigerian company

 For tax purposes, the profit of an overseas branch of a Nigerian company
is deemed to be derived in Nigeria and is therefore fully liable to tax in
Nigeria.
 It is essential to know that the foreign tax suffered is allowable as a
deduction in determining the overseas profits.
 Assets in such a branch are eligible for capital allowances claim in
Nigeria.
 Losses incurred can be set off against profit in Nigeria provided such
losses were incurred from the same source.
 Double Taxation Relief (DTA) is available for any foreign tax suffered.

43
e) Overseas subsidiary of a Nigerian company
 For tax purposes, the profit of an overseas subsidiary is not deemed to be
derived in Nigeria and will therefore not be liable to tax in Nigeria.
 It is only dividend received from such overseas subsidiary that will be
considered for Nigerian tax purposes.
 Technical and management fees paid to the Nigerian company by the
overseas subsidiary will be subjected to tax in Nigeria.
 Capital allowances will not be claimable on the assets of the overseas
subsidiary.

f) Computation of companies income tax payable by the Nigerian

subsidiary
The companies income tax payable by the Nigerian subsidiary is
N31,415,100, while the tertiary education tax is N2,899,400 (See Appendix
I). The China operation is not liable to Nigerian tax, hence no computation of
adjusted/assessable profit.

We have commented on areas deemed necessary. Nevertheless, if you should still

need further clarification(s), please do not hesitate to contact us.
Yours faithfully,

Chukwu, A. O
Senior Consultant

44
 APPENDIX I

Sunchi West Africa Holdings

Computation of adjusted profit

For the year ended December 31, 2018

N‘000 N‘000
Net profit as per accounts 120,510
Add back: Disallowable expenses:
Depreciation 9,900
Loss on revaluation of non-current assets 1,490
Legal expenses:
Preliminary expenses 2,100
Land acquisition 550
Allowance for doubtful debts (General prov) 5,820
Repairs and maintenance:
Improvement on office building 2,250
Administrative expenses (court fine) 600
Foreign exchange loss provision 1,750 24,460
Adjusted profit/Assessable profit 144,970

Computation of companies income tax for 2018 year of assessment

N’000
Adjusted/assessable profit 144,970
Deduct: Capital allowances (w1) 40,253
Total profit 104,717
Companies income tax @ 30% of total profit 31,415.1
Tertiary Education Tax @ 2% of assessable profit 2,899.4
Total tax payable 34,314.5

45
Workings
(1) Capital allowances computation

Factory Office Plant Motor Furniture Office Total

Building Building Machinery Vehicle Fittings Equip. Capital
Allow.
1A 15 15 50 50 25 50
AA 10 10 25 25 20 25
N‘000 N‘000 N‘000 N‘000 N‘000 N‘000 N‘000
2018 Y/A

Cost 20,200 12.450 25,000 16,120 4,700 4,000

1A (3,030) (1,868) (12,500) (8,060) (1,175) (2,000) 28,633
AA (1,717) (1,058) (3,125) (2,015) (705) (500) 9,120
Inv. All. ______ ______ (2,500) _______ ______ ______ 2,500
40,253
2019 Y/A
TWDV c/f
to 2019 Y/A 15,453 9,524 9,635 6,381 2,820 1,542

(2) Annual allowances for 2018 in N‘000

Factory building

N20,200 − N3,030
AA =
10
= N1.717

Office building
N12,450 − N1,868
AA =
10
= N1,058.25
= N1.058

Plant & machinery

N25,000 − N12,500
AA =
4
= N3,125

Motor vehicle
N16,120 − N8,060
AA =
4
= N2,015

46
 Furniture & fittings

N4,700 − N1,175
AA =
4
= N705

Office equipment
N4,000 − N2,000
AA =
4
= N500

Marking Guide

Marks Marks
a) Heading ½
Address ½
Correct definition of resident company 1
Tax implication of resident company ½
Correct definition of non-resident company 1
Tax implication of non-resident company ½ 4
b) 2 marks for each description of circumstances
which income or profit of a non-resident
company will be assessable to tax subject to a 10
maximum 5 points
c i) 1 mark for each correct description of the
relationship between a Nigerian branch and a
foreign parent company subject to a maximum of 3 3
points
ii) 1 mark for each correct description of the
relationship between Nigerian subsidiary and a
foreign parent company subject to a maximum of 3 3
points
d) 1 mark for each correct description of overseas
branch of a Nigerian company subject to a maximum
of 3 points 3
e) 1 mark for each correct description of overseas
subsidiary of a Nigerian company subject to a
maximum of 3 points 3
f) Heading ½
Net profit as per accounts ½

47
 Depreciation ½
Loss on revaluation of asset ½
Preliminary expenses ½
Land acquisition ½
General provision for doubtful debt ½
Improvement to office building ½
Court fine ½
Foreign exchange loss provision ½
Adjusted profit ½
Tax liability:
Adjusted profit ½
Capital allowance ½
Total profit ½
Companies income tax ½
Tertiary education tax ½
Total tax payable ½
8½
Capital allowances (18 ticks x /4 mark each)
1
4½
That is:
2018 Y/A (1 tick)
IA (6 ticks)
AA (6 ticks)
Investment allowance (1 tick)
Total capital allowance (4 ticks)
Conclusion (memo) 1 14
Total 40

Examiner’s Report
The question tests the candidates‘ understanding of the principles relating to
taxation of resident and non-resident companies.

Being a compulsory question, almost all the candidates attempted the question.
Candidates demonstrated a fair understanding of the question, especially in
companies income tax computations; and performance was average.

The commonest pitfall was the inability of the candidates to differentiate between
overseas branch and a Nigerian company.

Candidates should endeavour to read extensively the Institute‘s Study Text and
other relevant textbooks.

48
SOLUTION 2

XYZ & Co (Chartered Accountants)

Port Harcourt

Date ----

The Managing Director

Sunny Oil Producing Nigeria Limited
Niger Delta Region

Dear Sir,

RE: TAX APPEALS AND THE TAX IMPLICATION OF THE COMPANY‘S PROPOSED
TRANSPORTATION BUSINESS

Having concluded our assignment, we are pleased to report as follows:

ai. Preparation to be made before the commencement of the proceedings at the

tribunal

These include:

 All the relevant documents for the plant and equipment acquired and
donation made would be collated and reviewed;
 All such documents would be photocopied and marked for easy reference;
and
 Adequate provisions of the law that back the claim of capital allowances
on the plant and equipment and donation as allowable expenses would
be documented.

ii. Steps to be taken by the company if the decision of the Tribunal is not
acceptable to it

These include:

 Any person dissatisfied with a decision of the Tribunal may appeal

against such decision on a point of law to the Federal High Court;
 The appeal must be in writing to the Secretary to the Tribunal within 30
days after the date on which such decision was given;
 A notice of appeal shall be filed which will set out all the grounds of law
on which the appellant‘s case is based; and
 Upon receipt of a notice of appeal, the secretary to the Tribunal shall
cause the notice to be given to the Chief Registrar of the Federal High
Court along with all the exhibits tendered at the hearing before the
Tribunal.

49
iii. The tax implication of the company’s proposed transportation business

The profit of oil producing companies that are involved in transportation

business shall not be assessable to tax under the Petroleum Profits Tax Act or
put differently, the business is covered under the Companies Income Tax Act
2004 (as amended).

We hope that this report adequately represents the mandate assigned to us. Should
you need any further clarification on this, we will be glad to address it.

Yours faithfully,

Debby Made
Principal Consultant

(b) Sunny Oil Producing Nigeria Limited

Petroleum Profit Tax
For 2018 Year of Assessment

N‘000 N‘000
Export sales (W1):
Bonny light ($63.06 x N305 x 150,000) 2,884,995
Forcados ($65 x N305 x 100,000) 1,982,500
Bonny medium ($64.50 x N305 x 90,000) 1,770,525
Domestic sales (N720 x 80,000) 57,600
Natural gas (W2) 487,679
7,183,299
Deduct: Allowable expenditure:
Operating expenses 255,000
Tangible drilling cost 80,000
Production & exploration
(N1,100,600 – N80,000 – N200,200) 820,400
Intangible drilling cost 420,800
Admin expenses 225,500
Non-productive rent 80,700
Bad debts 20,150
Repairs and renewals 92,600
Transport & traveling 73,200
Royalties or domestic sales 22,500
Royalties others 200,400
Miscellaneous expenses
(N63,800 - N12,750 - N50,000) 1,050
Salaries and wages 830,700
Pension fund contribution 74,450
Customs duty 10,400

50
 Habour dues 3,300
Interest on loan 52,350
Appraisal wells (N120,000 x 2/3) 80,000
Tertiary education tax (2/102 x N3,089,799) 60,584 3,404,084
Adjusted profit 3,779,215
Deduct: unrelieved loss b/f 750,000
(i) Assessable profit 3,029,215
Less: Capital allowances
Lower of:
Actual capital allowances for the year 130,250
Unutilised capital allowance b/f 12,500
142,750
Petroleum investment allowance (w3) 24,845
167,595
Or
85% of assessable profit (85% of N 3,029,215) 2,574,833
Less 170% of PIA (1.7 x N24,845) 42,237
2,532,596
167,595
ii. Chargeable profit 2,861,620
iii. Assessable tax @ 85% of N2,861,620 2,432,377
Less MOU -
iv. Chargeable tax 2,432,377
Tertiary education tax 60,584
Chargeable tax 2,432,377
v Total tax payable 2,492,961

Workings

(1) Export sales

Bonny Light Forcados Bonny medium
API $ API $ API $
Standard 360 63.03 360 65.00 360 64.53
Actual 370 360 350
10x 0.03 0.03 00x 0.03 (0.00) (10 )x 0.03 (0.03)
63.06 65.00 64.50

51
(2) Natural gas sales
60−66 15.5−x
Akin Gas Limited =
60−70 15.5−14.3

−6 15.5 − x
=
− 10 1.2
= 𝐱 𝟏𝟒. 𝟕𝟖%

N‘000
Gross sales 220,000
Less: G-factor allowance
(14.78% of N220,000,000) (32,516)
Net sales 187,484

Bollah Limited
70 − 71 14.3 − x
= =
70 − 80 14.3 − 13.6

−1 14.3 − x
= =
10 0.7

= 𝐱 𝟏𝟒. 𝟐𝟑%

N‘000
Gross sales 350,000
Less: G-factor allowance
(14.23% of N350,000) 49,805
Net sales 300,195

Total net sales = N187,484,000 + 300,195,000 = N487,679,000

(3) Petroleum investment allowance (PIA)

N‘000
Plant: N 120,500,000 x 10% = 12,050
Pipeline & storage tank: N 85,300,000 x 15% = 12,795
Total 24,845

52
Marking Guide

Marks Marks
a i) 1 mark for each of the points on preparations to be
made by the consultant and the company subject to
a maximum of 2 points 2

a ii) 1 mark for each of the points on the steps to be

taken by the company if the decision is not
favourable to it subject to a maximum of 2 points 2

a iii) ½ mark for each of the points on the tax implication

of the company‘s proposed transportation business
subject to a maximum of 2 points 1

bi. Heading 1
/4
Export sales :
Bonny light 1
/4
Forcados 1
/4
Bonny medium 1
/4
Domestic sales 1
/4
Natural gas 1
/4
Operating expenses 1
/4
Tangible drilling cost 1
/4
Production & exploration 1
/4
Intangible drilling cost 1
/4
Admin expenses 1
/4
Non-productive rent 1
/4
Bad debts 1
/4
Repairs and renewals 1
/4
Transport and traveling 1
/4
Royalties (domestic sales) 1
/4
Royalties (others) 1
/4
Miscellaneous expenses 1
/4
Salaries and wages 1
/4
Pension fund contribution 1
/4
Customs duty 1
/4
Habour dues 1
/4
Interest on loan 1
/4
Appraisal wells 1
/4
Tertiary Education tax 1
/4
Adjusted profit 1
/4
Unrelieved loss b/f 1
/4

53
 Workings:

Export sales (Bonny light)

(Forcados) ½
Bonny medium
Natural gas (Akin Ltd) 1
/4
(Bollah Ltd) 1
/4
i. Assessable profit 1
/4 8
Actual capital allowances for the year 1
/4
Unutilized capital allowance b/f 1
/4
Petroleum investment allowance 1
/4
Total value 1
/4
85% of assessable profit 1
/4
Less 170% of PIA 1
/4
Total value 1
/4
Capital allowance figure (N 167,595) 1
/4
Workings on PIA (Total value) ½
ii. Chargeable profit ½ 3
iii. Assessable tax @ 85% of chargeable profit 1
iv. Chargeable tax 1
v. Total tax payable:
Tertiary education tax ½
Chargeable tax ½
Total tax payable 1 2
Total 20

Examiner’s Report

The question tests the candidates‘ knowledge on assessment and appeal

procedures and petroleum profits tax computations.

Majority of the candidates attempted the question and they exhibited a clear
understanding of the requirements of the question and performance was
satisfactory.

The commonest pitfall was the inability of the candidates to correctly treat the loss
relief brought forward and donation in the determination of assessable profit.

Candidates are advised to cover the specific areas of the syllabus which relates to
the topic by using the Institute‘s Study Text, other relevant textbooks and tax laws.

54
SOLUTION 3

PQR & CO. CHARTERED ACCOUNTANTS, LAGOS

INTERNAL MEMORANDUM

Date: November 25, 2020

From: Desk Officer (International Tax Matters)

To: The Principal Partner

RE: REPORT ON LARRY LIMITED’S REQUEST ABOUT REGIONAL ECONOMIC

INTEGRATION AND TRADE BLOC

I refer to our client‘s request on regional integration and trade bloc and hereby
present a report for your review before same is presented to the client.

a) Regional integration
This is a process in which neighbouring states enter into an agreement in
order to upgrade cooperation through common institutions and rules.

The objectives of the agreement could range from economic to political and
environmental. Although, it has typically taken the form of a political
economy initiative where commercial interests are the focus for achieving
broader socio-political and security objectives, as defined by national
governments.

Regional integration has been organised either via supranational

institutional structures or through inter-governmental decision-making, or a
combination of both.

Past efforts at regional integration have often focused on removing barriers

to free trade in the region, increasing the free movement of people, labour,
goods, and capital across national borders, reducing the possibility of
regional armed conflict (for example, through confidence and security
building measures), and adopting cohesive regional stances on policy issues,
such as the environment, climate change and migration.

The examples include North American Free Trade Agreement (NAFTA), Asian
Pacific Economic Cooperation Forum (APECF).

55
 Trade blocs
A trade bloc is basically a free-trade or near-free-trade formed by one or
more tax, tariff, and trade agreement between two or more countries.

Some trading blocs have resulted in agreements that have been more
substantive than others in creating economic cooperation. Of course, there
are pros and cons for creating regional agreements.

In the past decade, there has been an increase in these trading blocs with
more than one hundred agreements in place and more in discussion.

Some of the examples include European Union (EU), ECOWAS, Africa

Continentila Free Trade Area (ACFTA).

b) Objectives of regional integration

Regional integration is the joining of individual states within a region into a
larger whole. The degree of integration depends upon the willingness and
commitment of independent sovereign states to share their sovereignty.
Regional integration initiatives should fulfill at least the following eight
important objectives:

i) The strengthening of trade integration in the region;

ii) The creation of an appropriate enabling environment for private
sector development;
iii) The development of infrastructure programmes in support of
economic growth and regional integration;
iv) The development of strong public sector institutions and good
governance;
v) The reduction of social exclusion and the development of an inclusive
civil society;
vi) Contribution to peace and security in the region;
vii) The building of environmental programmes at the regional level; and
viii) The strengthening of the region‘s interaction with other regions of the
world.

c) Benefits of regional economic integration and trade blocs

The benefits derivable from regional economic integration and trade blocs
agreement include the following:

i) Trade creation: These agreements create more opportunities for

countries to trade with one another by removing the barriers to trade and
investment. Due to a reduction or removal of tariffs, cooperation results
in cheaper prices for consumers in the bloc countries. Studies indicate
that regional economic integration significantly contributes to the
relatively high growth rates in the less-developed countries;

56
 ii) Employment opportunities: By removing restrictions on labour
movement, economic integration can help expand job opportunities;

iii) Consensus and cooperation: Member nations may find it easier to

agree with smaller numbers of countries. Regional understanding and
similarities may also facilitate closer political cooperation;
iv) Impetus for private sector planning and investment: Regional
economic integration can serve a useful economic purpose beyond the
direct gains from trade liberalisation, by reducing uncertainties and
improving credibility and thus making it easier for the private sector to
plan and invest; and

v) Other non-economic benefits: Regional economic integration may

allow a member country to reap other non-economic benefits, such as
peace and security.

d) Disadvantages of regional economic integration and trade blocs

These include:
i) Trade diversion: The flip side to trade creation is trade diversion.
Member countries may trade more with each other than with non-
member nations. This may mean increased trade with a less efficient or
more expensive producer because it is in a member country. In this sense,
inefficient companies can be protected inadvertently with the bloc
agreement acting as a trade barrier. In essence, regional agreements
have formed new trade barriers with countries outside of the trading
bloc.

ii) Employment shifts and reductions: Countries may move production to

cheaper labour markets in member countries. Similarly, workers may
move to gain access to better jobs and wages. Sudden shifts in
employments can distort the resources of member countries.

iii) Loss of national sovereignty: With each new round of discussions and
agreements within a regional bloc, nations may find that they have to
give up more of their political and economic rights.

iv) Regional integration and trade blocs are forms of trade barriers with
countries which are not members of the trading bloc.

v) Investment diversion: One of the problems facing many smaller

economies is lack of foreign investment. Investment decision is a
potential economic disadvantage of regional economic integration
programme. Foreign investors from non-member countries may see a
member country as less attractive place to invest due to higher burden of
tariffs and regulations against non-member states.

57
e) Common market and Economic Union
Regional economic integration has enabled countries to focus on issues that
are relevant to their stage of development as well as encourage trade
between neighbours. Common market and Economic Union are types of
regional economic integration.

Common market allows for the creation of economically integrated markets

among member countries.

Trade barriers and any restrictions on the movement of labour and capital
between member countries are removed.

Like customs unions, there is a common trade policy for trade with non-
member nations. The primary advantage to workers is that they no longer
need a visa or work permit to work in another member country of a common
market. An example is the Common Market for Eastern and Southern Africa
(COMESA).

Economic Union: This is created when countries enter into an economic

agreement to remove barriers to trade and adopt common economic policies.

An example is the European Union (EU).

Economic Union requires the integration of monetary and fiscal policies such
as use of common currencies and fixed exchange rates.

It is hoped that the matters discussed above will meet your expectations.

Mrs Charity Kay

Marking Guide

Marks Marks
Heading/Address 1
a) ½ mark each for correct description of regional
Integration subject to a maximum of 3 points 1½

½ mark each for correct description of trade blocs subject

to a maximum of 3 points 1½ 4

b) 1 mark for each objective of regional integration subject to

a maximum of 5 points 5

c) 1 mark for each benefit of economic integration and trade

blocs subject to a maximum of 4 points 4

58
d) 1 mark for each disadvantage of economic integration and
trade blocs subject to a maximum of 3 points 3

e) 1 mark each for correct description of common market

subject to a maximum of 2 points 2
1 mark each for correct description of economic union
subject to a maximum of 2 points 2

Total 20

Examiner’s Report

The question tests candidates‘ understanding of the principles of economic regional

integration and trade bloc.

Many candidates‘ attempted the question but sizeable number of them lacked
understanding of the question and performance was poor.

The major pitfall of the candidates was their inability to differentiate common
market from economic union.

Candidates are advised to read the relevant laws and textbooks on economic
regional integration and trade bloc.

59
SOLUTION 4

LMN & Co (Tax Consultants)

Kaduna

March 6, 2020

The Managing Director

Able Associates
Kano

Dear Sir,

RE: NIGERIAN TAX INCENTIVES

I refer to your letter with Reference Number Able/03/20 dated February 25, 2020
engaging our firm to provide professional advice on the above subject. Our
comments are as follows:

a) Objectives of tax incentives

Tax incentives in Nigeria are meant to:
(i) Encourage voluntary tax compliance;
(ii) Attract domestic and foreign investments into Nigeria;
(iii) Encourage businessmen to invest in certain preferred sectors of the
economy;
(iv) Encourage investment to develop rural areas and export processing
(EPZ);
(v) Promote export activities;
(vi) Encourage repatriation of foreign earnings to Nigeria;
(vii) Encourage research and development activities;
(viii) Encourage and accelerate the growth of small scale businesses; and
(ix) Encourage businesses to make financial contributions to activities
which the government considers socially desirable.

60
b) Forms of tax incentives

The incentives may be granted based on industry or type of tax and may
include:

(i) Exemption from payment of taxes;

(ii) Reduction in rate of tax to be paid;
(iii) Grant of allowances and deductions from profits subject to tax, etc;
and
(iv) Claiming of reliefs such as loss relief and double taxation relief.

c i) Manufacturing sector
Fiscal measures have been drawn to provide for deductions and allowances
in the determination of taxable income of manufacturing enterprises. They
include:
 Pioneer status
This is a concession to pioneer companies located in economically
disadvantaged areas by providing a tax holiday period of three to five
years. These industries must be considered by the government to be
beneficial to the country‘s economy and in the interest of the public.
Companies that are involved in local raw material development; local
value added; labour intensive processing; export–oriented activities;
in-plant training; are also qualified for additional concessions;
 Tax relief for research and development (R&D)
Up to 120% of expenses on R&D are tax deductible provided that such
R&D activities are carried out in Nigeria and are connected with
businesses to which allowances are granted. The result of such
research could be patented and protected in accordance with
internationally accepted industrial property rights;
 Small business income tax rate of 20% if the business is within its first
5 years and turnover of N1 million or below (Prior to Finance Act
2019);

 Based on the provisions of the Finance Act 2019, any business with
less than N25 million turnover is exempted from companies income
tax. While, any company with turnover from N25 million to less than
N100 million attracts income tax rate of 20% on total profit;

61
 Local raw materials utilization;
30% tax concession for five years to industries that attain minimum
local raw materials utilisation as follows: agro – 80%; agro allied –
70%; engineering – 65%; chemical – 60%; and petro-chemical – 70%;
 Labour intensive mode of production
15% tax concession for five years. The rate is graduated in such a way
that an industry employing one thousand persons or more will enjoy
15% tax concession while an industry employing one hundred will
enjoy only 6%, while those employing two hundred will enjoy 7% and
so on;
 Local value added
10% tax concession for five years. This applies essentially to
engineering industries, while some finished imported products serve
as inputs. This is aimed at encouraging local fabrication rather than
the mere assembly of completely knocked down parts;
 In-plant training
2% tax concession for five years, of the cost of the facilities for
training;
 Export oriented industries
10% tax concession for five years. This concession will apply to
industries that export not less than 6% of their products;

 Rural investment allowance

This is an allowance given to a company which incurs capital
expenditure or the provision of facilities, such as electricity, water and
tarred road. The rates are as follows:

No facilities at all (100%); no electricity (50%); no water (30%) and no

tarred road (15%).

 Investment in economically disadvantaged areas

100% tax holiday for seven years and additional 5% depreciation over
and above the initial capital depreciation; and
 Excise duty
Excise duty is the money paid to the government by manufacturing
concerns for goods purchased. It is a production tax. The tax can also
be levied on intangible items such as internet data and
telecommunication fees.

62
c ii. Agriculture

Incentives include;
General incentive-pioneer status;
 Tax relief for research and development;
 30% tax credit for 5 years for agro-allied form that attains maximum
level of local raw material utilization of 70%;
 Effective 2012 YOA, agricultural machinery and equipment attracts no
duty;
 No restriction on the amount of capital allowance claimable in any year
of assessment;
 Agricultural business is exempted from minimum tax provision;
 Interest on loans granted to agricultural business is exempted from tax
provided the moratorium period is not less than 18 months and the
interest is not more than the base lending rate at the time it was
granted;
 Agro-allied plants and equipment enjoy enhanced capital allowance of
up to 50%; and
 Application of small business income tax rate of 20% if the business is
within its first 5 years and turnover is N 1 million or below.

c iii. Telecommunications
These include:
 Provision of non-fiscal incentives to private investors in addition to a
tariff structure that ensures that investors recover their investment over a
reasonable period of time, bearing in mind the need for differential
tariffs between urban and rural areas; and
 Rebate and tax relief are provided for the local manufacture of
telecommunications equipment and provision of telecommunication
services.

d. Non-tax factors considered by foreign investors in locational determinants,

will differ from one business to another, depending on the objectives of the
investment.

The more important non-tax factors include:

 Economic and political stability;

 Adequate physical, business, accounting and legal infrastructure;
 The absence (or limited presence) of bureaucratic obstacles;
 Adequate communication channels;
 Ability to negotiate profit freely;
 Effective banking system; and
 The availability of an adequate dispute resolution mechanism.

63
Please do not hesitate to contact us if you require any further clarification on the
above subject.

Yours faithfully,

Victor Aminu
Principal Consultant

Marking Guide

Mark
a. Heading/address 1
½ mark for each objective of tax incentives subject to a
maximum of 6 points 3 4
b. 1 mark for each form of tax incentives mentioned subject to
a maximum of 2 points 2
c. i 1 mark each for tax incentives available to the
manufacturing sector subject to a maximum of 6 points 6
ii ½ mark each for tax incentives available to the
agricultural sector subject to a maximum of 4 points 2
iii 1 mark each for tax incentives available to the
telecommunications sector subject to a maximum of 2 2
points
d. 1 mark each for correct discussion on non-tax factors
subject to a maximum of 4 points 4
Total 20_

Examiner’s Report

The question tests candidates‘ understanding of tax incentives available to specific

sectors in the Nigerian business environment.

Many candidates attempted the question and they showed fair understanding of it
and performance was above average.

The commonest pitfall was the candidates‘ inability to identify the various
incentives available to agricultural and telecommunication sectors.

The candidates are encouraged to read widely before sitting for examinations in
order to perform well.

64
SOLUTION 5

a. Organisation for Economic Co-operation and Development (OECD) identifies

three key factors in deciding whether a jurisdiction is a tax haven or not.
These are:

i) Nil or only nominal taxes

Tax havens impose nil or only nominal taxes (generally or in special
circumstances) and offer themselves, or are perceived to offer
themselves, as a piece to be used by non-residents to escape high taxes
in their countries of residence;

ii) Protection of personal financial information

Tax havens typically have laws or administrative practices under which
businesses and individuals can benefit from strict rules and other
protections against scrutiny by foreign tax authorities. This prevents the
transmittance of information about taxpayers who are benefitting from
the low tax jurisdiction; and

iii) Lack of transparency

A lack of transparency in the operation of the legislative, legal or
administrative provisions is another factor used to identify tax havens.
The OECD is concerned that laws should be applied openly and
consistently, and that information needed by foreign tax authorities to
determine a taxpayer‘s situation is available.
Lack of transparency in one country can make it difficult, if not
impossible, for other tax authorities to apply their laws effectively.
Secret rulings, negotiated tax rates, or other practices that fail to apply
the law openly and consistently are examples of a lack of transparency.
Limited regulatory supervision or a government‘s lack of legal access to
financial records is a contributing factor.

b. To avoid tax competition, many high tax jurisdictions have enacted

legislation to counter the tax sheltering potential of tax havens. Generally,
such legislation tends to operate in the following ways:

i) Attributing the income and gains of the company or trust in the tax haven
to a taxpayer in the high-tax jurisdiction on an arising basis. Controlled
foreign corporation legislation is an example of this;
ii) Transfer pricing rules, standardization of which has been greatly helped
by the promulgation of OECD guidelines
iii) Restrictions on deductibility or imposition of a withholding tax when
payments are made to offshore recipients;
iv) Taxation of receipts from the entity in the tax haven, sometimes
enhanced by notional interest to reflect the element of deferred payment.
The EU withholding tax is probably the best example of this.

65
 v) Exit charges or taxing of unrealized capital gains when an individual,
trust or company emigrates;
vi) Many jurisdictions employ blunter rules. For example, in France,
securities regulations are such that it is not possible to have a public
bond issue through a company incorporated in a tax haven; and
vii) Usage of ―forced disclosure‖ of tax mitigation schemes. These involve the
revenue authorities compelling tax advisors to reveal details of the
scheme, so that the loopholes can be closed during the following tax
year, usually by one of the methods highlighted above. Although not
specifically aimed at tax havens, given that so many tax mitigation
schemes involve the use of offshore structures, the effect is much the
same.

d. Advantages of tax havens

These include:
i) Personal residency
Since the early 20th century, wealthy individuals from high- tax
jurisdictions have sought to relocate themselves to low-tax
jurisdictions. In most countries in the world, residence is the primary
basis of taxation. Almost no tax haven assesses any kind of capital
gains tax or inheritance tax. Individuals who are unable to return to a
higher-tax country in which they used to reside for more than a few
days a year are sometimes referred to as tax exiles;

ii) Corporate residency

Corporate persons, in contrast to natural persons, can own subsidiary
corporations in many countries. That allows them to take advantage
of the variety of laws, regulations and conventions in multiple
countries, without overtly engaging in any questionable activities.
Only in extreme cases will they move their formal corporate
headquarters; and

iii) Asset holding

This involves utilizing an offshore trust or offshore company or a trust
owning a company. The company or trust will be formed in one tax
haven and will usually be administered and resident in another. The
function is to hold assets, which may consist of a portfolio of
investments under management, trading companies or groups,
physical assets such as real estate or valuable chattels. The essence of
such arrangements is that by changing the ownership of the assets
into an entity which is not tax resident in the high-tax jurisdiction,
they cease to be taxable in that jurisdiction.

66
 Criticism of tax havens

These are:

i) Tax havens have been criticised because they often result in the
accumulation of idle cash which is expensive and inefficient for
companies to repatriate;

ii) The tax shelter benefits result in a tax incidence disadvantaging the
poor;

iii) Many tax havens are thought to have connections with fraud, money
laundering and terrorism;

iv) Investigations of illegal tax haven abuse have been ongoing, there have
been few convictions;

v) Lobbying pertaining to tax havens and associated transfer pricing has

also been criticized; and

vi) Activities in tax havens facilitate practice of base erosion and profit
shifting (BEPS).

Marking Guide

Marks Marks
a 2 marks for each of the OECD‘s perspectives subject to a
maximum of 3 points 6
b 1 mark for each method of coping with the issue of tax
Have subject to a maximum of 5 points 5
c 2 marks for correct discussion on advantages of tax haven, 6
maximum of 3 points
1 mark each for criticism subject to a maximum of 3 points 3 9
Total 20

Examiner’s Report

The question tests candidates‘ knowledge on issues relating to tax haven.

Many candidates did not attempt the question. The performance of the candidates
in part (a) of the question was poor, whilst that of parts (b) and (c) was average.

The major pitfall was the inability of the candidates to explain the key factors in
deciding whether or not a jurisdiction is a tax haven from the perspective of the
OECD.

67
Candidates are advised to read widely the Institute‘s Study Text, Pathfinder and
other relevant textbooks, as this will go a long way in assisting them to pass future
examinations.

SOLUTION 6

a) (i) Structure and taxing rights of different levels of government

For tax purposes and in accordance with its constitutional provision, Nigeria
is divided into three constituencies – The Federal, State and Local
Governments. The taxing right for each of the three tiers of government is
contained in the Taxes and Levies (Approved List for collection) Act Cap T2
LFN 2004 (as amended).

Federal Government
The Federal Government is responsible for the administration and collection
of taxes due from all taxable corporate bodies, personnel of the Nigerian
Armed Forces and those employed in Nigeria‘s foreign missions through the
Federal Inland Revenue Service (FIRS).

Examples of taxes collected by Federal Government are Companies income

tax, Petroleum profits tax, Value added tax, Personal income tax from
members of armed forces personnel, police force, Capital gains tax for
companies and non-residents, withholding tax from companies, etc.

NOTE: With the enactment of the FCT-IRS Act 2015, taxes payable by
residents of the FCT are now due to the FCT-IRS.

State Government

Each state government is responsible for administration, assessment and

collection of the taxes due from all taxable persons resident in the state with
the exception of the Nigerian Armed Forces and employees of the Nigeria
foreign missions through each State‘s Internal Revenue Service (SIRS).

Examples of taxes collected by State Government are Personal income tax,

withholding tax from individuals and unincorporated entities, Capital gains
tax for individuals and unincorporated entities, road taxes, pools betting and
lotteries, gaming and casino taxes, development levy, etc.

68
 Local Government

Local government is responsible for collecting levies such as shop and kiosk
rates, tenement rates, on and off liquor licenses fees, slaughter slab fees,
marriage, birth and death registration fees, motor park levies, road closure
levy, etc.

Local government taxes/levies are collected by the Local Government

Revenue Committee in each state.

(a) (ii) Functions of organs of tax administration in Nigeria are as follows:

Federal Inland Revenue Service Board (FIRSB)

The FIRSB shall be responsible to:

 Provide the general policy guidelines relating to the functions of the

Service;

 Manage and superintend the policies of the Service, on matters relating to

the administration of the revenue assessment, collection and accounting
system under this Act or any enactment or law;

 Review and approve the strategic plans of the Service;

 Employ and determine the terms and conditions of service including

disciplinary measures of the employees of the Service;

 Stipulate remuneration, allowances, benefits and pensions of staff and

employees in consultation with the National Salaries, Income and Wages
Commission; and

 Do such other things, which in its opinion, are necessary to ensure the
efficient performance of the functions of the Service under the Act.

State Board of Internal Revenue Service (SBIRS)

The SBIRS shall be responsible for:

 Ensuring the effectiveness and optimum collection of all taxes and

penalties due to the Government under the relevant laws;
 Doing all such things as may be deemed necessary and expedient, for the
assessment and collection of the tax and shall account for all sums so
collected, in a manner to be prescribed by the Commissioner;
 Making recommendations, where appropriate, to the JTB on tax policy,
tax reform, tax legislation, tax treaties and exemptions as may be
required from time to time;

69
  Generally controlling the management of the State Service on matters of
policy, subject to the provisions of the law setting up the State Internal
Revenue Service; and
 Appointing, promoting, transferring and imposing discipline on
employees of the State Internal Revenue Service.

Local Government Revenue Committee (LGRC)

The LGRC shall be:

 Responsible for the assessment and collection of all taxes, fines and rates,
under its jurisdiction and shall account for all amounts so collected, in a
manner to be prescribed by the Chairman of the Local Government;

 Autonomous of the local Government Treasury department and shall be

responsible for the day-to-day administration of the Department, which
forms its operational arm;

 Responsible for tax payer education; and

 Responsible for collection of data and information to develop and reform tax
policies legislation and administration.

(b) Multiple taxation

Multiple taxation is a tax regime under which various and similar types of
taxes are imposed on taxpayers by different tiers of government. For
instance, while the Federal Government imposed the Value added tax on
consumption and made it applicable throughout the Federation, some
notably, Lagos State, introduced the sales tax based on the same principle as
the former and made it applicable in Lagos State.

i) Causes of multiple taxation in Nigeria

The possible causes of multiple taxation in Nigeria are:

 The number of taxes which local government has constitutional right to

collect;

 Lack of funding, particularly, for most States may result to multiple

taxation where the Board attempts to source for fund through levying of
tax notwithstanding whether such tax had already been levied either by
the Federal or Local Governments;

 Some of the state governments deliberately deny their local governments

the revenue due to them, consequently the local government as a way of

70
 survival desperately and aggressively focus on anything that will
generate revenue to them;

 Lack of tax education and awareness;

 Inability of all the tiers of government adequately fund their departments

and agencies;

 Multiplicity of revenue agencies;

 Overlapping taxing rights as contained in the Constitution and the taxed
and levies (approved list for collection); and

 Manual tax administration system and unauthodox tax collection

mechanism.

ii) Possible solutions to multiple taxation in Nigeria include:

 Streamlining the number of taxes in Nigeria in view of the low yields of
many of the taxes, This will involve the review of current statutory
provisions in Nigeria;

 Reviewing all the existing taxes in Nigeria and harmonise where

necessary, as recommended by various study groups;

 Reviewing of the Constitution to address the overlap in taxing rights and

limit the number of taxes that can be imposed by different levels;

 Abolishing unauthodox method of tax collection and implement

technology for tax administration; and

 Limiting the number of revenue agencies.

Marking Guide

Marks Marks
a.i 1 mark on general comments/introduction to structure
and taxing rights 1
1 mark each for discussions on Federal Government, State
State Government and Local Government 3 4
ii 1 mark each on functions of two organs of the
administration in Nigeria subject to a maximum of 4 points 8
per organ
b. 1 mark each on causes of multiple taxation in Nigeria subject
to a maximum of 4 points 4
1 mark each on possible solutions to multiple taxation in
Nigeria subject to a maximum of 4 points 4 8
20

71
Examiner’s Report

The question tests candidates‘ knowledge on tax administration and fiscal policy in
Nigeria.

Many candidates attempted the question and they showed mixed understanding of
the question. The performance of the candidates in part (a) of the question was
above average while it was fair in part (b).

The major pitfall was the candidates‘ poor understanding of the causes and
solutions to multiple taxation in Nigeria.

Candidates are advised to pay attention to the specific areas of the syllabus relating
to the topic as this will enable them to perform very well in future examinations.

72
 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA
PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2020
STRATEGIC FINANCIAL MANAGEMENT
Time Allowed: 31/4 hours (including 15 minutes reading time)

INSTRUCTION: YOU ARE REQUIRED TO ANSWER FOUR OUT OF SIX

QUESTIONS IN THIS PAPER

SECTION A: COMPULSORY QUESTION (40 MARKS)

QUESTION 1
Assume today is November 20, 2019. In 2018, the Oyin Division of Aba plc
successfully launched a new premium wine- ‗Aladun‘, in Nigeria. The Divisional
Board of Oyin Division is now considering plans put forward by the Divisional
Marketing Manager to launch the full range of Aladun in another country ‗‘Linder‘‘.
Linder has Linderian dollar (L$) as currency and the launch is planned for January
1, 2020.

It is well known within the industry that it can be very difficult for a foreign
company to break into the Linderian market for fruit wine because there is
significant loyalty towards local Linderian brands and imported South African
brands. Initial market research based on free tasting sessions has met an
encouraging response but there is still some uncertainty over the success of the
launch. However, the greatest danger to the success of Aladun in Linder is
considered to be the risk that a Nigerian competitor might launch a similar range
of products in the same market.

Financial data for the project

To date, N5 million has been spent on initial market research for the Linderian
market. If the project is approved, an additional N20 million will be required for
detailed market research and packaging design. The cost of the launch itself
includes an expensive radio and television advertising, campaign in Linder and it is
expected to cost about N10 million. Both of these costs are tax deductible in
Nigeria. In addition, L$84 million will be spent on a distribution centre in Linder.
All of these one-off costs are payable on January 1, 2020.
Estimates of net operating cash flows for the project vary considerably according to
assumptions made regarding consumer and competitor reaction to the launch of
‗Aladun‘ in Linder. Forecast cash flow figures for sales revenue and associated costs
for the project for the year ending December 31, 2020 have been estimated based
on two possible outcomes, known as Scenario A and Scenario B. The forecasts are:
Forecast operating cash flow figures for the year ending December 31, 2020.

73
Scenario A: Sales revenue L$100 million
Costs L$10 million plus N20 million
Scenario B: Sales revenue L$55 million
Costs L$10 million plus N15 million
All operating cash flows shown above are expected to grow by 5% per annum in
subsequent years for the duration of the project.

It can be assumed that if Scenario A occurs in 2020, it will also occur in all
subsequent years. The same is true for Scenario B. It is estimated that there is a
70% probability of occurrence of Scenario A and a 30% probability of Scenario B.
Other relevant financial information:

 Oyin Division evaluates projects of this nature at a risk-adjusted after-tax

discount rate of 15% over a 4 year period.
 The proposed new distribution centre to be built in Linder is expected to
have a residual value of L$52 million after 4 years.

 Corporate income tax is charged in Nigeria at 35% on taxable profits and is

paid at the end of the year in which the taxable profit arises. No separate tax
is charged in Linder. Tax depreciation allowances are available in Nigeria on
all capital expenditure (incurred both in Nigeria and Linder) at a rate of
100%. Balancing charges will arise on any residual value. There are
sufficient profits elsewhere in the group to be able to take advantage of
these tax benefits or any taxable losses that occur.
 Operating cash flows should be assumed to arise at the end of the year to
which they relate.

 The exchange rate is expected to be N1 = L$1.2000 on January 1, 2020 and

the naira is expected to strengthen against the L$ by 2% a year in each of the
next 4 years.
 The project could be abandoned on January 1, 2021 and the distribution
centre sold for an estimated L$70 million. If the project were abandoned on
January 1, 2021, no further cash inflows or outflows would arise from then
onwards and there would be no penalties for pulling out of the market.

Required:
a. Ignoring the abandonment option:
i. Calculate the NPV for the project as at January 1, 2020 for Scenarios A
and B individually as well as the overall total expected NPV.
(17 Marks)

ii. Calculate the payback period for the project for each of Scenarios A and B.
(4 Marks)
74
 iii. Interpret your results from (a)(i) and (a)(ii) (4 Marks)

b. Evaluate whether or not the project should be abandoned on January 1,

2021 if Scenario B occurs. (7 Marks)

c. Advise how real options and other strategic financial issues might influence
the initial investment decision. (8 Marks)
(Total 40 Marks)

SECTION B: YOU ARE REQUIRED TO ANSWER ANY THREE OUT OF FIVE

QUESTIONS IN THIS SECTION (60 MARKS)

QUESTION 2

Peter John plc (PJP) is considering a takeover bid for Yekin plc (YP).
PJP's board of directors has issued the following statement:
'Our superior P/E ratio and synergistic effects of the acquisition will lead to a post-
acquisition increase in earnings per share and in the combined market value of the
companies'.

Summarised financial data for the companies:

N Million
PJP YP
Sales 480.0 353.0
Profit before tax 63.0 41.0
Tax (18.9) (12.3)
Profit after tax 44.1 28.7
Dividends 20.0 11.0
Non-current assets (net) 284.0 265.0
Current assets 226.4 173.0
Total assets 510.4 438.0
Equity and liabilities
Ordinary shares (10 kobo par value) 40.0 30.0
Reserves 211.2 192.0
Medium and long term borrowing 86.0 114.0
Current liabilities 173.2 102.0
510.4 438.0
Notes:
(i) After tax saving in cash operating costs of N7,500,000 per year indefinitely
are expected as a result of the acquisition
(ii) Initial redundancy costs will be ₦ 10 million before tax

75
(iii) PJP's cost of capital is 12%
iv) Current shares prices are: PJP N29, YP N18
(v) The proposed terms of the takeover are payment of 2 PJP shares for every 3
YP shares.
Required:
a. Calculate the current P/E ratios of PJP and YP (2 Marks)
b. Estimate the expected post acquisition earnings per share and
comment upon the importance of increasing the earnings per share.
(4 Marks)
c. Estimate the effect on the combined market value as a result of the
takeover using:
i. P/E based valuation
ii. Cash flow based valuation
State clearly any assumptions that you make (5 Marks)
d. Discuss the limitations of your estimates in (c) above (3 Marks)
e. Evaluate the strategic implications of making a hostile bid for a
company compared with an aggressive investment programme of
organic growth. (6 Marks)
(Total 20 Marks)

QUESTION 3
a. What are the main responsibilities faced by companies when developing an
ethical framework, and in what ways can these responsibilities be
addressed? (10 Marks)
b. Discuss how ethical considerations impact on each of the main functional
areas of a firm. (10 Marks)
(Total 20 Marks)

QUESTION 4

a. What risks might an industrial company face as a result of interest

movements? (8 Marks)

b. A plc wants to borrow N200 million for five years with interest payable at
six-monthly intervals. It can borrow from a bank at a floating rate of NIBOR
plus 1% but wants to obtain a fixed rate for the full five-year period. A swap
bank has indicated that it will be willing to receive a fixed rate of 8.5% in
exchange for payments of six-month NIBOR.

76
 Required:

Calculate the fixed interest six-monthly payment with the swap in place.
(4 Marks)
c. Calculate:

i. The interest payments if NIBOR is 10% (4 Marks)

ii. The interest payments if NIBOR is 7.5% (4 Marks)

(Total 20 Marks)

QUESTION 5
Yinko plc operates in the hospitality and leisure industry. The board of directors
met recently to discuss a number of financial proposals.
Proposal 1
To increase the company‘s level of debt by borrowing a further N100 million and
use the funds raised to buy back its shares.

Proposal 2
To increase the company‘s level of debt by borrowing a further N100 million and
use these funds to invest in additional non-current assets in the form of expansion
in available rooms in one of their hotels.

Proposal 3
To sell excess non-current assets in another hotel. The net book value of the assets
is ₦100 million and they will be sold for N135 million. This will enable the
company to focus on the other high-performing hotel units. These other hotel units
will require no additional investment in non-current assets. All the funds raised
from the sale of the non-current assets will be used to reduce the company‘s debt.

Yinko plc Financial Information

Extracts from the Forecast Financial Position for the coming Year
Nmillion
Non-current assets 1,410
Current assets 330
Total assets 1,740
Equity and liability:
Share capital (40 kobo per share par value) 240
Retained earnings 615
Total equity 855
Non-current liabilities 700
Current liabilities 185
Total liabilities 885
Total liabilities and capital 1,740

77
Yinko‘s forecast after tax profit for the coming year (in the absence of the above
proposals) is expected to be N130 million. The current share price is N3.20 per
share.
The non-current liabilities consist solely of a 6% medium term loan redeemable
within seven years. The term of the loan contract stipulates that an increase in
borrowing will result in an increase in the coupon payable of 25 basis points on the
total amount borrowed, while a reduction in borrowing will lower the coupon
payable by 15 basis points on the total amount borrowed.

Yinko‘s effective tax rate is 20%. The company‘s estimated after tax rate of return on
investment is expected to be 15% on any new investment. It is expected that any
reduction in investment would suffer the same rate of return.

Required:
a. Estimate the impact of each of the three proposals on the forecast statement
of financial position, the earnings per share, and the financial gearing (Total
Debt/Total Assets) of Yinko Plc.

Show your workings. (16 Marks)

b. Discuss your results. (4 Marks)
(Total 20 Marks)

QUESTION 6
Binko Industrial Services plc is an all equity financed and a Stock Exchange listed
company. Over recent years the company's management has adopted a fairly
cautious and conservative policy of not seeking expansion, but has been contented
to earn a steady level of profits, most of which have been distributed as dividends.

Recently there have been some personnel changes at board level with the result
that the company has more actively been seeking new investment opportunities. In
the financial year which has just ended the company reported profits of ₦50
million, a similar figure to that of recent years.

It has been estimated that the company's cost of equity is 15% per annum.
Four investment projects have been identified, all of which could commence
immediately. The estimated cash flows and timings of these projects are as follows.

78
Project A B C D
₦m ₦m ₦m ₦m
Year 0 (20) (20) (30) (10.0)
1 7.5 6.5 8.0 5.0
2 7.5 6.5 8.0 5.0
3 7.5 6.5 8.0 5.0
4 6.5 8.0
5 6.5 8.0

Each of these projects is in the same risk class as the company's existing projects.

You have been asked by the board to give your advice on dividend policy at next
week's board meeting.

Required:
a. Calculate how much Binko Industrial Services plc should pay to shareholders
as dividend in respect of the company's financial year which has just ended,
assuming that Modigliani and Miller were correct in their original 1961
proposition on dividend policy.

You should ignore taxation in this calculation. (5 Marks)

b. Prepare notes on which you will base your contribution to the board
meeting. These should include a brief explanation of the Modigliani and
Miller proposition on dividend policy and reasons why the company's board
may decide not to pay the level of dividend which you indicated in (a). You
should bear in mind the fact that most members of the board have little or
no accounting or financial knowledge. Your comments must relate to the
particular circumstances of Binko Industrial Services plc

Ignore inflation.
Work to the nearest ₦1,000 (15 Marks)
(Total 20 Marks)

79
 Formulae
Modigliani and Miller Proposition 2 (with tax)
𝑉𝐷
𝐾𝐸𝐺 = 𝐾𝐸𝑈 + 𝐾𝐸𝑈 − 𝐾𝐷 (1 − 𝑡)
𝑉𝐸𝐺
Asset Beta
𝑉𝐸 𝑉𝐷 (1 − 𝑇)
𝛽𝐴 = 𝛽 + 𝛽
(𝑉𝐸 + 𝑉𝐷 (1 − 𝑇)) 𝐸 (𝑉𝐸 + 𝑉𝐷 (1 − 𝑇)) 𝐷

Equity Beta
𝑉𝐷
𝛽𝐸 = 𝛽𝐴 + (𝛽𝐴 − 𝛽𝐷 ) (1 − 𝑡)
𝑉𝐸
Growing Annuity
𝑛
𝐴1 1+𝑔
𝑃𝑉 = 1−
𝑟−𝑔 1+𝑟

Modified Internal Rate of Return

1
𝑃𝑉𝑅 𝑛
𝑀𝐼𝑅𝑅 = 1 + 𝑟𝑒 − 1
𝑃𝑉𝐼
The Black-Scholes Option Pricing Model
C0 = S0N(d1) – Ee-rt N(d2)
𝑆
𝐼𝑛 0 + (𝑟 + 0.5𝜎 2 )𝑇
𝑑1 = 𝐸
𝜎 𝑇
d2= d1 - 𝜎 𝑇
The Put Call Parity
C + Ee-rt = S + P

Binomial Option Pricing

𝑢 = 𝑒 𝜎× 𝑇/𝑛
d = 1/u
𝑎 = 𝑒 𝑟𝑇 /𝑛
𝑎−𝑑
𝜋=
𝑢−𝑑
The discount factor per step is given by = 𝑒 −𝑟𝑇 /𝑛

80
 Annuity Table
Present value of an annuity of 1 i.e. 1 - (1 + r) -n

r
Where r = discount rate

n = number of periods

Discount rate (r)

Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0·990 0·980 0·971 0·962 0·952 0·943 0·935 0·926 0·917 0·909 1

2 1·970 1·942 1·913 1·886 1·859 1·833 1·808 1·783 1·759 1·736 2

3 2·941 2·884 2·829 2·775 2·723 2·673 2·624 2·577 2·531 2.487 3

4 3·902 3·808 3.717 3·630 3.546 3.465 3·387 3·312 3·240 3·170 4

5 4·853 4·713 4·580 4·452 4·329 4·212 4·100 3·993 3.890 3·791 5

6 5·795 5·601 5·417 5·242 5·076 4·917 4·767 4·623 4.486 4·355 6

7 6·728 6.472 6·230 6·002 5·786 5·582 5·389 5·206 5·033 4·868 7

8 7·652 7·325 7·020 6·733 6·463 6·210 5·971 5·747 5·535 5·335 8

9 8·566 8·162 7·786 7.435 7·108 6·802 6·515 6·247 5·995 5·759 9

10 9·471 8·983 8·530 8·111 7·722 7·360 7·024 6·710 6.418 6·145 10

11 10·368 9·787 9·253 8·760 8·306 7·887 7.499 7·139 6·805 6.495 11

12 11·255 10·575 9·954 9·385 8·863 8·384 7·943 7·536 7'161 6·814 12

13 12·134 11·348 10·635 9·986 9·394 8·853 8·358 7·904 7·487 7·103 13

14 13·004 12·106 11·296 10·563 9·899 9·295 8·745 8·244 7·786 7·367 14

15 13·865 12·849 11·938 11·118 10·380 9·712 9·108 8·559 8·061 7·606 15

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0·901 0·893 0·885 0·877 0·870 0·862 0·855 0·847 0·840 0·833 1

2 1·713 1·690 1·668 1·647 1·626 1·605 1·585 1·566 1·547 1·528 2

3 2.444 2.402 2·361 2·322 2·283 2·246 2·210 2·174 2·140 2·106 3

4 3·102 3·037 2·974 2·914 2·855 2·798 2·743 2.690 2·639 2.589 4

5 3·696 3·605 3·517 3·433 3·352 3·274 3·199 3·127 3·058 2·991 5

6 4·231 4·111 3·998 3·889 3·784 3·685 3·589 3.498 3.410 3·326 6

7 4·712 4·564 4.423 4·288 4·160 4·039 3·922 3·812 3·706 3·605 7

8 5·146 4·968 4.799 4·639 4.487 4·344 4·207 4·078 3·954 3·837 8

9 5·537 5·328 5·132 4·946 4·772 4·607 4.451 4·303 4·163 4·031 9

10 5·889 5·650 5.426 5·216 5·019 4·833 4·659 4.494 4·339 4·192 10

11 6·207 5·938 5·687 5.453 5·234 5·029 4·836 4·656 4.486 4·327 11

12 6·492 6·194 5·918 5·660 5·421 5·197 4·988 4·793 4·611 4.439 12

13 6·750 6.424 6·122 5·842 5·583 5·342 5·118 4·910 4·715 4·533 13

14 6·982 6·628 6·302 6·002 5·724 5.468 5·229 5·008 4·802 4·611 14

15 7·191 6·811 6.462 6·142 5·847 5·575 5·324 5·092 4·876 4·675 15

81
82
 SOLUTION 1

a.(i). Scenario A
Year 0 1 2 3 4
Distribution centre (L$
million) (84) 52
Net L$ cash flows growing at
5% (L$ million) 0 90 94.50 99.23 104.19
Exchange rate 1.200 1.2240 1.2485 1.2734 1.2989
Naira equivalent cash flows
(₦million) (70) 73.53 75.69 77.93 120.25
Market research/launch (30)
Naira cash outflows, growing
at 5% (₦million) _ 0__ _(20) (21)_ (22.05) (23.15)
Net (100) 53.53 54.69 55.88 97.10
Tax relief on distribution
centre (₦m) (w1) 0 24.02 (14.01)
Tax relief on market
research/launch(₦m) 0 10.50
Tax payable on NCF
excluding residual (₦m) 0___ (18.74) (19.14) (19.56) (19.97)
NCF (100) 69.31 35.55 36.32 63.12
PVF at 15% 1.000 0.870 0.756 0.658 0.572
PV (₦m) (100) 60.30 26.88 23.90 36.10
Total NPV=₦47.18 million.

Scenario B
Year 0 1 2 3 4
Distribution centre (L$
million) (84) 52
Net L$ CF growing at 5% (L$
million) 45 47.25 49.61 52.09
Exchange rate 1.2000 1.2240 1.2485 1.2734 1.2989
Naira equivalent CF
(₦million) (70) 36.76 37.85 38.96 80.14
Market research/launch (₦
million) (30)
Naira cash outflows
growing at 5% (₦million) ____ (15) (15.75) (16.54) (17.36)
NCF (₦m) (100) 21.76 22.10 22.42 62.78

Tax impact of capital

allowances (w1) (₦million) 0 24.02 (14.01)
Tax relief on market
research/launch(₦million) 0 10.50
Tax payable on NCF
excluding residual (₦million) 0_ (7.62) (7.74) (7.85) (7.96)

Naira NCF (100) 48.66 14.36 14.57 40.81

PVF at 15% 1 0.870 0.756 0.658 0.572
PV (₦million) (100) 42.33 10.86 9.59 23.34
Total NPV = - ₦13.88million.

83
Expected Values
Scenario NPV Prob ENP
V
₦m
A 47.18 0.7 33.03
0
B -13.88 0.30 -4.16
ENPV 28.87

Working Notes
Tax relief on distribution centre
- On cost = 84m/1.2240 × 35% = ₦24.02m
(Tax savings due in year 1)
- On scrap value:
52m/1.2989 × 35% = ₦14.01m
(Tax liability due in year 4)

ii) Payback

Scenario A

Year NCF Cumulative

(₦m) NCF (₦m)
0 (100) (100.00)
1 69.31 (30.69)
2 35.55 4.86
Payback = 1 + 30.69/35.55 = 1.86 years

Scenario B
Year NCF Cumulative NCF
(₦m) (₦m)

0 (100) (100.00)
1 48.66 (51.34)
2 14.36 (36.98)
3 14.57 (22.41)
4 40.81 18.40
Payback = 3 + 22.41/40.81 = 3.55years

84
iii) Interpretation of results
The results of the NPV and payback investment appraisal exercise can be
summarized in the following table:

Scenario A Scenario B Expected result

NPV (₦m) 47.18 Loss of 13.88 28.8
Payback 1.86 years 3.55 years -

The expected NPV of the project is ₦28.8 million and therefore we might
conclude that the project should go ahead on basis of a positive NPV.

However, it is dangerous to make decisions on the basis of expected values in

the case of one-off projects. Such action implies a risk-neutral attitude to the
possibilities. An assessment of the risk appetite and risk capacity of the
company is important when looking at the implications of a loss under Scenario
B.
Expected value is a more useful tool where there are a large number of
repeated projects with independent results. There is some indication that the
company may be undertaking a number of product launches at the same time,
but details are not available for analysis here.

The payback results also reinforce the conclusion that the project is risky under
Scenario B. Payback is not achieved until mid-way through year 4 (toward the
end of the project) under Scenario B, indicating that the project struggles to pay
back the funds invested at all, let alone show a profit.
In this case, it is important to consider the results for each of the two Scenarios
separately. Under Scenario A, there are strong positive results for both NPV and
Payback. However, the results are poor under Scenario B, with a negative NPV
for the project. This is telling us therefore that there is a chance that the
Linderian launch will not be successful (and we have estimated this chance at
30%). Whether the project will be accepted or not will therefore depend on the
risk attitude of the Board and whether it is willing to accept the possibility of
such losses.

b. Evaluation of the abandonment option

We know that it would be possible to abandon the project at the end of the first
year without penalty and retain the ability to realise a residual value of L$70
million on the investment in the distribution centre. This would however be
subject to a balancing charge in respect of tax depreciation allowances already
claimed. Given that ‗if the project were abandoned‘, the L$70 million would be
received on the first day of the financial year, this balancing charge would not
crystalise into a cash flow until the end of the financial year – ie: 31 December
2021.

85
 All costs incurred prior to 1 January 2021 such as the marketing, and launch
costs and the investment in the distribution centre should be ignored as they
would have become sunk costs. The net operating cash flows for the year ending
31 December 2020 should also be ignored, although the net operating cash
flows for the years ending 31 December 2021, 2022 and 2023 are still relevant.

Net present value calculations:

Scenario B – Abandon 1.1.21 31.12.21
₦ ₦
Distribution centre – sale
(₦57.19 =L$ 70.00/1.2240) 57.190
Balancing charge ₦57.19 million × 35% (20)
Discount factor 1.000 0.870
PV 57.190 (17.400)
Total NPV: ₦39.79 million,
i.e. appropriately ₦40 million

31Dec: 2021 2022 2023

Scenario B – Do not abandon ₦ ₦ ₦
Net naira equivalent cash flows 14.360 14.570 40.810
Discount factor 0.870 0.756 0.658
PV 12.490 11.010 26.850

Total NPV: ₦50.35 million i.e. approximately ₦50 million

Examiner‘s Note: Valid alternative approaches will be given full credit. For
example, recalculating Scenario B assuming that the project is abandoned early.

Evaluation:

 The PV of the remaining cash flows is greater if the project is not abandoned at
this point (NPV of ₦50 million versus ₦40 million if the project were to be
abandoned)
 The ultimate decision will also depend on the sensitivity of the cash flows – is it
possible that cash flows could be low in early years but increase in later years
once the product has gained acceptance in the market?
 It will also depend on other factors such as the possible loss of reputation as a
consequence of early withdrawal from the market or loss of market share to a
competitor.
 The development of this new market may be a key element required to meet the
company‘s strategic aim of increased market share in both domestic and
overseas markets.

86
Conclusion:
There are strong arguments for continuing with the project rather than abandoning
it on 1 January 2021, even if Scenario B holds true for the remaining term of the
project. Based on a financial evaluation of future present values and possibility of
other benefits of developing a market presence in the Linderian market at this time.

c) Advise how real options and other strategic financial issues might
influence the initial investment decision.
Even under the ‗worst case‘ scenario, Scenario B, it is unlikely that the
project would be abandoned and therefore the abandonment option has
little influence on the investment decision and little value on 1 January
2020. The abandonment option is ‗out-of-the-money‘, on that date. However,
it does not follow that the option has no value on 1 January 2020 because
there is always a possibility that out-turn results are even worse than
predicted by Scenario B and the option would then be exercised. The
‗insurance‘ provided by the abandonment option has some value, linked to
the extent of loss that would be avoided and the probability that the option
would move to being ‘in-the-money‘ by the end of the year. Depending on
the risk appetite of the company, this insurance against an even larger loss
may be sufficient to influence the investment decision in favour of
proceeding with the investment.
Other real options include ‗wait‘ and ‗follow on‘.
A ‗follow on‘ would seem to be the most likely to apply in this instance. If,
for example, ‗Aladun‘ were to be successful in Linder, it might open up the
possibility of the launch of further product lines in Linder. This option could
therefore have significant value and should be evaluated and built into the
investment appraisal of this project.
A ‗wait‘ option could be dangerous in this case as it could give competitors
time to break into the market ahead of us and establish a market lead.
Other strategic financial issues that might be raised in discussion include:
 Availability of finance. What is the company‘s credit worthiness and
credit rating? Is there a refinancing risk? Are sufficient funds available to
fund this expansion?
 Do some areas of the business need to be sold in order to release capital
for expansion?
 Impact on shareholder returns such as earnings per share. Under
Scenario A the project returns more than 15% on the investment on an
NPV basis, but under Scenario B the project would damage earnings per
share due to its loss making position.
 Impact on gearing. The impact of the project on gearing is likely to be
immaterial due to the relatively small size of the project in relation to the
group as a whole. However, group gearing is quite high and this could

87
 limit the scope for pursuing aggressive growth in both product range and
geographical spread in the near future.
 Risk appetite. What would be the likely response of shareholders of a
failure of this project? To what extent could a loss be absorbed by other
parts of the group?

Marking Guide
Mark Mark
a (i) Scenario A
- Recognition of the amount spent on distribution centre
and the residual value in years 0 and 4 0.5
- Calculation of the growing cash flows-years 1 to 4 1.0
Calculation of the exchange rate-years 1 to 4 1.0
Conversion of the foreign currency to Naira 0.5
Recognition of the cost of market research/launch in year 0 0.5
Calculation of the Naira cash out/flows for years 1 to 4 1.0
Computation of the tax relief on distribution centre 0.5
Computation of the tax relief on market research/launch 0.5
Computation of tax payable on net cash flow 1.0
Determination of the present value factor for years 0 to 4 0.5
Calculation of the present value for years 0 to 4 0.5
Computation of the net present value 0.5

Scenario B
- Recognition of the amount spent on distribution centre and the
residual values in years 0 and 4 0.5
- Calculation of the growing cash flows for years 1 to 4 1.0
- Calculation of the exchange rate for years 1 to 4 1.0
- Conversion of the foreign currency to Naira=years 1 to 4 0.5
- Recognition of the cost of market research /launch in year O 0.5
- Calculations of the Naira cash outflows for years 1 to 4 1.0
- Computation of the tax relief on: Distribution centre 0.5
: Market Research/launch 0.5
- Computation of tax payable on net cash flow 1.0
- Determination of the present value factor for years 0 to 4 0.5
- Calculations of the present value for years 0 to 4 0.5
- Computation of the net present value 0.5
- Computations of the expected values for scenarios A & B 1.0 17
ii) Computation of payback period-Scenario A 2
Computation of payback period-Scenario B 2 4
iii) Summary of the result of calculations of the NPV and payback
investment appraisal exercise 0.5
Comment on the result of the calculated NPV 1.5
Conclusion on the pay back results of Scenarios A and B 0.5
Comment on the result of the payback years 1.5 4

88
b) Recognition of sunk costs 1.0
Computation of the PV in case of Abandonment - Scenerio B 1.5
Computation of the PV in case of non-abandonment – Scenerio B 1.5
Evaluation of the result of the PV 2.0
Conclusion 1.0 7

c) Advice on how real options and other strategic financial issues

might influence the initial investment decision 8
40

Examiner’s Report
The question tests candidates‘ knowledge of foreign capital project. They were
expected to calculate expected net present value and payback period. They were
also expected to evaluate an option to abandon the project after the first year.
Being a compulsory question, almost all the candidates attempted the question but
the level of performance was very poor.
Common mistakes include:
 Computing capital allowances on advertising costs, cost of market research, etc;
 Adding together figures given in foreign currency and in naira;
 Inability to calculate the appropriate exchange rates;
 Applying the Black-Schole option pricing model to part (b) despite the fact that
the key variables needed for model are not available in the question; and
 Producing generic comments in parts (a)(iii) and (c).
We recommend that candidates should supplement their reading with examination-
type of questions from time to time.

SOLUTION 2

a) PJP currently has 400 million ordinary shares, and Fader 300 million.
Earnings per share:

PJP YP
N44.10 N28.70
= 11.025 kobo = 9.57 kobo
400m 300m

P/E ratios

PJP YP
2,900 1,800
= 263.04 = 188.09
N11.025 N9.57

89
 b) A 2-for-3 share exchange will result in the issue of 300 million x 2/3 new shares,
or 200 million shares, giving a total of 600 million shares.
₦ million
Current combined earnings after tax 72.80
Additional earnings from operating savings 7.50
80.30
Ignoring the one-off redundancy payments the expected earnings per share is:
N80.30m
= 13.383kobo
600m

Increasing earnings per share alone is not enough. The effect on the market
value is the crucial factor. When a relatively high P/E company acquires a
company with a lower P/E, the expected earnings per share will increase, but
not necessarily the total market value of the companies.

c) i) The current combined value of the two companies is:

(400m shares x ₦29) + (300m shares x ₦18) = ₦17 billion.

If the market is efficient, ignoring any synergistic or other effects of the

takeover, the post-acquisition P/E will be the weighted average (by earnings) of
the current P/E ratios.

263.04 × N44.10m + (188.09 × ₦28.70m)

= 233.50
N72.80m

The new EPS takes into account the operating savings.

Multiplying the P/E by the new EPS 233.5 x 13.383 = 3,124.93

3124.93 x 600 million shares gives a market value of ₦18.750billion.

However, this ignores the impact of the redundancy costs, ₦7,000,000 after
tax.
When this is included the combined value of the companies is still expected to
substantially increase.

ii) Changes in expected cash flows as a result of the takeover are as follows:

₦7,500,000
PV of operating savings (to infinity) = = ₦62,500,000
0.12

Redundancy costs, after tax relief (₦7,000,000)

Net effect on NPV ₦55,500,000

90
 If the market is efficient the market value of the combined company should
increase by ₦55,500,000 as a result of the expected increase in NPV, much
less than the estimate using P/E based valuation.

d) Both estimates are likely to be inaccurate. Many other factors are likely to affect
the post-acquisition share price. For example:

 The effect of the acquisition on corporate growth rates.

 There may be problems integrating the operations and workforce of the two
companies.
 PJP's managers may not be able to apply enhanced management skills to
YP's operations.
 The effect of the change in risk and capital structure is not known.
 With respect to the P/E estimate:
 P/E ratios use accounting data rather than cash flow data.
 Accurate estimates of future earnings are very difficult, and earnings can
rapidly change.

With respect to cash flows:

 The value of all expected cash flows pre and post-acquisition should be
compared, not just the changes in a few cash flows. However, post-
acquisition cash flows are very difficult to determine.
 Cash flows savings of ₦7,500,000 per year forever are unrealistic.
 The cost of capital of PJP is likely to change as a result of the acquisition of
YP.

The implications of making a hostile bid

The board should be clear about the strategic implications of making a hostile bid
for a company rather than carrying out an aggressive investment programme of
organic growth.

A hostile bid involves:

• A reduction in competition. The company may be buying a competitor who will
no longer be competing against it and its competitive position should be
improved.
• A much faster speed of growth. It is much quicker to buy an existing company
with existing staff and existing contracts.
• Buying an under-performer. The challenge would be to tighten up the company
and release its full potential.
• More expense than the organic alternative. A bidding company has to pay a
premium to acquire a target company. However, there may be synergistic
benefits from the merger that would make paying the premium worthwhile.
• Possible culture clash between ourselves and the target company managers and
employees

91
 • The use of cash resources to finance any cash alternative to the paper offer. If
cash is tight, then the company should offer an unattractive cash alternative to
try and persuade the target shareholders to accept paper rather than cash.
Organic growth involves:
• Less risk. Steady organic growth is a much safer option, where individual
problems can be addressed as they arise, rather than having to deal with all the
problems in an entire company from day one of ownership.
• Less damage to the stock price in the market. It is traditionally the case that the
market will mark down the price of a bidding company's stock/shares on
announcement of the bid, recognising the risk inherent in the deal and the fact
that managers may concentrate on the deal rather than on running the existing
business.
• More choice on precisely where to expand. Organic growth allows a company to
choose more carefully the geographical areas and business areas that you wish
to operate in.

Marking Guide
a) Calculations of earning per share (EPS) for PJP & YP 1.0
Calculations of price earnings ratios P/E ratios – PJP & YP 1.0 2
b) Calculation of number of shares after merger 1.0
Calculation of total earnings after merger 1.0
Computation of the earnings per share after merger 1.0
Comment on the importance of increasing EPS 1.0 4
i) Computation of the current combined value of PJP&YP 1.0
Computation of the post- acquisition P/E ratio 0.5
Calculation of the post acquisition market value 1.0
ii) Calculation of PV of operating savings (to infinity) 1.5
Adjustment of redundancy cost, after tax relief, to determine
net effect on PV 0.5
Comment on the net effect on NPV 0.5 5
c) ½ mark per valid listed limitation factor, max 6 points 3
d) 1 mark per valid point on hostile bid, max 4 points 4
1 mark per valid point on organic growth, max 2 points 2 6
20

Examiner’s Report
The question tests candidates‘ knowledge of take over and some related basic
calculations like EPS, pre-and-post-takeover P/E ratios, capitalization of synergies,
etc.
Most candidates attempted the question and once again, the level of performance
was very poor.

92
In computing the post-takeover P/E ratio, candidates did not realize the need to
make use of the pre-takeover total earnings of each of the two companies to
estimate post-takeover weighted average P/E ratio. Furthermore, almost all the
candidates could not isolate and capitalize the relevant cashflows required in
section (c) (ii).

We recommend that candidates should cover the entire syllabus when preparing for
the Institute‘s examinations and solve past examination questions.

SOLUTION 3

a) The main responsibilities faced by companies when developing an ethical

framework are:
i) Economic
ii) Legal
iii) Ethical
iv) Philanthropic

The ways in which these responsibilities can be addressed are:

Economic
i) Management should always be acting in the best interests of the company's
shareholders, and should therefore always be actively making decisions that
will increase shareholders' wealth.
ii) Projects that have positive NPVs should be pursued as far as funds will
allow, as such projects will increase the value of the company and thus
shareholders' wealth.
iii) While management may have a different attitude towards risk than do the
shareholders, they should always manage risk according to shareholders'
requirements.
iv) Financing - the optimal financing mix between debt and equity should be
chosen as far as possible.
v) Dividends - there is no legal obligation to pay dividends to ordinary
shareholders, but the reasons for withholding dividends must be in the
interests of the company as a whole (for example, maintaining funds within
the company in order to finance future investment projects).

Legal
i) Companies must ensure that they are abiding by the rules and regulations
that govern how they operate. Company law, health and safety, accounting
standards and environmental standards are examples of these boundaries.

93
ii) Failure to abide by the rules can cost companies dearly. One only has to look
at the fate of WorldCom and Enron bosses, as well as Nick Lesson of Barings
Bank, for examples of how failure to operate within the legal framework can
cause companies to collapse, taking with them the jobs (and often pension
funds) of thousands of employees.

Ethical
i) Ethical responsibilities arise from a moral requirement for companies to act
in an ethical manner.
ii) Pursuit of ethical behaviour can be governed by such elements as:

 Mission statements
 Ethics managers
 Reporting channels to allow employees to expose unethical behaviour
 Ethics training and education (including ethics manuals)

Philanthropic
i) Anything that improves the welfare of employees, the local community or the
wider environment.
ii) Examples: provision of an employees' gym; sponsorship of sporting events;
charitable donations.

Alternative relevant points should be rewarded accordingly

b) Main functional areas of a firm include:

i) Human resources
ii) Marketing
iii) Market behaviour
iv) Product development

Human resources
i) Provision of minimum wage. In recent years, much has been made of 'cheap
labour' and 'sweat shops'. The introduction of the minimum wage is designed
to show that companies have an ethical approach to how they treat their
employees and are prepared to pay them an acceptable amount for the work
they do.
ii) Discrimination - whether by age, gender, race or religion. It is no longer
acceptable for employers to discriminate against employees for any reason -
all employees are deemed to be equal and should not be prevented from
progressing within the company for any discriminatory reason.

Marketing
i) Marketing campaigns should be truthful and should not claim that products
or services to something that they in fact cannot.
ii) Campaigns should avoid creating artificial wants. This is particularly true
with children's toys, as children are very receptive to aggressive advertising.

94
iii) Do not target vulnerable groups (linked with above) or create a feeling of
inferiority. Again, this is particularly true with children and teenagers, who
are very easily led by what their peer groups have. The elderly are also
vulnerable, particularly when it comes to such things as electricity and gas
charges - making false promises regarding cheaper heating for example may
cause the elderly to change companies when such action is not necessary
and may in fact be detrimental.

Market behaviour
i) Companies should not exploit their dominant market position by charging
vastly inflated prices.
ii) Large companies should also avoid exploiting suppliers if these suppliers
rely on large company business for survival. Unethical behaviour could
include refusing to pay a fair price for the goods and forcing suppliers to
provide goods and services at uneconomical prices.

Product development
i) Companies should strive to use ethical means to develop new products - for
example, more and more cosmetics companies are not testing on animals, an
idea pioneered by such companies as The Body Shop.
ii) Companies should be sympathetic to the potential beliefs of shareholders -
for example, there may be large blocks of shareholders who are strongly
opposed to animal testing. Managers could of course argue that if potential
investors were aware that the company tested their products on animals
then they should not have purchased shares.
iii) When developing products, be sympathetic to the public mood on certain
issues - the use of real fur is now frowned upon in many countries; dolphin-
friendly tuna is now commonplace.
iv) Use of Fairtrade products and services - for example, Green and Blacks
Fairtrade chocolate; Marks &.Spencer using Fairtrade cotton in clothing and
selling Fairtrade coffee.

Marking Guide Mark Mark

a) ½ mark for each listed point, max 4 points 2
2 marks for explaining the listed point 8 10
b) ½ mark for each main functional areas listed, max 4 points 2
2 marks for explaining the main functional areas listed 8 10
20

95
Examiner’s Report

This question tests the candidates‘ knowledge of ethical issues in finance. Most of
the candidates attempted the question but performance was below average.

Candidates were expected to discuss and provide examples of ethical issues in

various functional areas of a firm. More than 90% of the candidates who attempted
the question could not produce meaningful solution.

It is required that they should make efforts to read widely and apply their work
experiences in examination situations.

SOLUTION 4

a) There are a number of different risks facing commercial organisations. All

businesses have to contend with the ups and downs of business life, booms
and slumps, risky decisions about what to produce, what prices to charge,
how and where to market their goods and so on. Firms which have borrowed
money, or are about to borrow money in the near future, face the additional
risk of exposure to interest rate changes. If a company has a considerable
amount of variable rate debt (for example a large overdraft or variable rate
bank loan) then it faces the risk that interest rates may rise and its
repayments increase.

The effect of this on the business could be dramatic, reducing cashflow and
profit and perhaps, if the rise in rates is a large one and the company is
highly geared (with a high proportion of debt), bringing the risk of
liquidation. Alternatively, a business with a large amount of fixed rate
borrowing (for example a fixed rate loan or fixed interest preference shares
or bonds) is exposed to a fall in interest rates. If the company has borrowed
large sums at 10% fixed, and a short time later rates fall to 8%, it will be
paying more for its debt than it needs to. Cashflow and profits could be
better if only the debt were not a fixed rate.

Companies thinking about borrowing in the near future also face risk. Should
they borrow at a fixed rate now because they are worried about a rise in
interest rates or should they wait in the hope that rates may fall shortly? A
wrong decision could be costly.

Finally, there are companies with debt capital maturing that will need to be
replaced. A company may have issued N5million of bonds due to mature
between 2024 and 2026. The company itself will have the choice as to
exactly when they will repay the holders of the debt. If they think that

96
 interest rates are likely to be lower in 2024 than in 2026 they can repay the
bond holder early in 2024 and replace the debt with a new issue of bonds
then. If they think rates will be lower in 2026 they can wait and replace the
debt when it is cheaper to do so. Decisions like this are risky: making the
wrong choice could cost millions of naira.

b) A Plc borrows N200million with interest rate at 6-month NIBOR plus 1%. This
transaction is in the cash market. In the swap market, it receives 6-month
NIBOR and pays fixed interest at 8.5%. The net effect is to acquire a fixed
rate obligation at 9.5% for the full term of the swap.
(In the following analysis, N stands for NIBOR)
%
Cash market: borrow at N + 1% (N+1)
Swap market: receive (floating) N
pay (fixed) (8.5)
Net payment (fixed) (9.5%)

A Plc will therefore fix its payments at N9.50m – (N200m × 9.5% × 6/12) every
six months for the five year.

At each six-monthly fixing (re-setting) date for the swap, the payment due
from A to the swaps bank or from the bank to A will depend on the market
rate for six-month NIBOR at that date.

c) i) NIBOR 10%

Suppose that on the first re-set date for the swap, at the end of month 6
in the first year, 6-month NIBOR is 10%. The payment due to each party to
the swap will be as follows:
Nm
Due from A-8.5% (N200m × 8.5% × /12)6
= (8.5)
Due to A-10%(N200m × 10% × 6/12) = 10
Net amount due to A Plc 1.5

A Plc will receive this amount six months later at the end of 12 months of
the first year- rates are fixed in advance and payments made in arrears. A
plc will pay interest on its cash market loan at NIBOR + 1% which for this
six-month period is 11% (10% + 1%). Taken with the amount received
under the swap agreement, the net cost to A Plc is equivalent to interest
payable at 9.5%.
Nm
Interest on loan = (N200m × 11% × /12) =
6
(11)
Net receipt from swap 1.5_
Net interest payment (for 6 months) (9.50)
Effective annual rate = /200 × /6
9.5 12
= 9.5%

97
 ii) NIBOR 7.5%

With the principles set up above, we can speed up the calculations as

detailed below:
₦m
Swap payments:
- Due from A-at 8.5% (8.5)
- Due to A -7.5% (N200m × 7.5% × /12)
6
7.5
- Net amount (Net Payment from Swap (1.0)
Cash market:
Interest on loan – at 8.5% (7.5% + 1%)
= (N200m × 8.5% × 6/12) (8.5)
Net payment from Swap (1.0)
Net interest payment (9.5%)
Effective annual cost (as above) 9.5%

Marking Guide Mark Mark

a) 2 marks per valid risk discussed, max 4 risks 8
b) Calculation of the fixed interest six monthly payment 3
Comment on the result of the calculation 1 4
c) Calculation of the interest payment when: NIBOR is 10% 4
NIBOR is 7.5% 4 8
20

Examiner’s Report
This question tests candidates‘ knowledge of interest rate risk generally and
hedging using interest rate swap in particular. Less than 20% of the candidates
attempted the question but performance was very poor.

Candidates were expected to discuss how changes in interest rates affect both
lenders and borrowers. They were also expected to illustrate the effect of pre-
designed swap arrangement. Most of the candidates that attempted the question
demonstrated lack of knowledge of this area of the syllabus.

Candidates are advised to cover every section of the Institute‘s syllabus when
preparing for the examinations

98
SOLUTION 5

a) Forecast Financial Position – Yinko Plc

Current Proposal Proposal 2 Proposal

1 ₦m 3
₦m ₦m ₦m
Non-current assets 1,410.00 1,410.00 1,510.00 1,310.00
Current assets 330.00 323.60 338.60 322.16
Total assets 1,740.00 1,733.60 1,848.60 1,632.16
Current liabilities 185.00 185.00 185.00 185.00
Non-current liabilities 700.00 800.00 800.00 565.00
Total liabilities 885.00 985.00 985.00 750.00
Share capital (40kobo/share) 240.00 227.50 240.00 240.00
Retained earnings 615.00 521.10 623.60 642.16
Total equity 855.00 748.60 863.60 882.16
Total liabilities and capital 1,740.00 1,733.60 1,848.60 1,632.16
Number of shares 600m 568.75m 600m 600m
Profit after tax (adjusted) ₦130m ₦123.60m ₦138.60m ₦157.158m
EPS (kobo) 21.67 21.73 23.10 26.19
Financial leverage 50.9% 56.8% 53.3% 46.8%

Working Notes
Proposal 1
Debt is increased by ₦100million and shareholders fund reduced by the same
amount as follows:
₦000
Share capital-par value*:
40𝑘𝑜𝑏𝑜
₦100m × 12,500
320𝑘𝑜𝑏𝑜
Retained earnings:
320−40
₦100m × 87,500
320
100,000

(* Only the par value can be removed from share capital. This is very important
please)

Additional interest net of tax

₦‘000
 On additional borrowing:
100m × 6.25% × (1 – 0.20) 5,000
 Extra coupon on existing debt
= 700m × 0.25% × (1 – 0.20) 1,400
6,400

99
 This is taken from retained earnings.
Balance of retained earnings
= ₦615m – (87.50m + 6.40m) = ₦521.10m
Furthermore, the additional interest of ₦6.40m is taken off current assets
because presumably it is paid out of cash.
Balance of current assets = 330m – 6.40m = ₦323.60m
The alternative is to assume that the additional interest has not been paid
and therefore taken to interest payable in current liabilities. That leaves
current assets constant at ₦330m and increases current liabilities to
₦191.40m.
Adjusted PAT = ₦130m – 6.40m = ₦123.60m

Proposal 2

 Borrowing of ₦100m increases non-current assets and non-current liabilities

by the same amount.

 Retained earnings and current assets are impacted as follows

Retained Current
earnings assets
₦000 ₦000
Additional interest as above (6,400) (6,400)
Return on additional non-current assets
= ₦100m × 15% 15,000 15,000*
Net change 8,600 8,600

(* If cash sales, it will be part of cash or bank and if credit sales, it will be in
receivables)
Adjusted PAT = ₦130m + ₦8.60m = ₦138.60m

Proposal 3
Non-current assets are reduced by ₦100m (the net book value of the assets
sold). The profit on disposal of ₦100m increases retained earnings (through
profit and loss account). The net change in retained earnings and current assets
are as follows:
Retained Current
earnings assets
₦000 ₦000
Profit on disposal 35,000
Interest savings on loan paid:
₦135,000,000 × 0.06 × (1 – 0.2) 6,480 6,480
Reduction of interest on remaining loan
= ₦565,000,000 × 0.0015 × (1 – 0.2) 678 678
Return lost due to reduction in investment

100
 = ₦100,000,000 × 0.15 (15,000) (15,000)
Net change 27,158 (7,842)
Note: If the profit from the sale of the asset is assumed to be ₦28million (₦35m
less tax of 20%), then the statement of financial position, EPS and gearing
figures will all change to reflect this.

Adjusted PAT = ₦130m + 27.158m = ₦157.158

b) Discussion
Proposals 1 appears to produce opposite results to others. Proposal 1 would lead
to a small increase in the earnings per share (EPS) due to reduction in the
number of shares. However, the level of gearing would reduce substantially (by
about 12%)
With proposal 3, although the overall profits would increase. because of the
profit from sale of assets with interest savings is larger than the lost earnings
due to downsizing. It has the lowest gearing.
Proposal 2 would give a significant boost in the EPS from 21.67kobo to
23.10kobo. This is mainly due to increase in earnings through extra investment.
However, the amount of gearing would increase by more than 4.7%.
Overall proposal 1 appears to be the least attractive option. The choice between
proposals 2 and 3 would be between sustainability of earning and less gearing
Proposal 3, may not be sustainable because profit from sales of asset is a one-
off transaction.

Other factors to consider are the capital structure of the competitors, the
reaction of the equity market to the proposal, the implications of the change in
the risk profile of the company and the resultant impact on the cost of capital.

(Note: Credit will be given for alternative relevant comments and suggestions)

Marking Guide Mark Mark

a)
Proposal 1
Calculation of change in current asset 0.5
Adjustment in non-current liabilities 1.0
Adjustment of share capital 0.5
Adjustment of retained earnings 0.5
Calculation of new number of shares 1.0
Adjustment in profit after tax 0.5
Calculation of new EPS 1.0
Computation of new financial leverage 1.0 6

101
Proposal 2
Adjustment of non-current asset 1.0
Adjustment of current asset 0.5
Adjustment of non-current liabilities 0.5
Adjustment of Retained earnings 0.5
Calculation of new profit after tax 0.5
Calculation of EPS 0.5
Calculation of financial leverage 0.5 4

Proposal 3
Computation of the new balance on non-current assets 1.0
Adjustment of current assets 0.5
Calculation of new balance on non-current liabilities 1.0
Adjustment of retained earnings 0.5
Adjustment of profit after tax 1.0
Calculation of the new EPS 1.0
Calculation of the new financial leverage 1.0 6
b)
1 mark per acceptable discussion, max 4 points 4 20

Examiner' Report
The question tests candidates‘ knowledge of financial projection, using given
scenarios. Only about 50% of the candidates attempted the question and again the
level of performance was poor.

There were numerous calculation errors in candidates‘ solutions. The various

impacts of the given proposals on income, equity, leverage, etc were not well
thought out.

It is recommended that candidates should practice with past examination

questions.

102
SOLUTION 6
a) Net present value of projects
A = -20m + (7.5m × 2.283) = ₦2.88m
B = -20m + (6.5m × 3.352) = ₦1.79m
C = -30m + (8m × 3.352) = ₦3.18m
D = -10m + (5m × 2.283) = ₦1.42m

As there is sufficient capital to undertake all positive NPV projects, the company
should invest in Band D and use ₦30m.

The dividend under the Modigliani and Miller policy is the residue,
i.e. ₦50m – ₦30m = ₦20m. It could also be argued that under M&M's
assumptions any dividend would do, as shortfalls of cash could be replaced by
new equity issues.

b) Notes for board meeting

i) Modigliani and Miller proposition

M&M suggested that, under the assumption of a perfect capital market, the
dividend valuation model would give the share price exactly. It followed that
if the share price was the present value of future dividends, the actual
pattern of those dividends did not matter to the share price as long as the
present value of these remained unchanged. For example, shareholders
would be indifferent in valuing a share between a constant stream of
dividends and a large lump sum dividend paid at some point in the future, if
the value in present value terms were the same.
M&M therefore concluded that the only way to enhance the share price was
to invest in positive NPV projects, as these would result in a higher present
value of dividends reflecting the beneficial project cash flows being paid out
as dividends.

The current dividend should be whatever was not needed for investing in
Positive NPV projects (residual dividend policy).

M&M suggested that any shareholders who require income (i.e. dividends)
and who are unhappy with the level of dividend paid can sell some of their
shares. These shares will have increased in value as a result of the company
accepting positive NPV projects.

This is in effect the manufacture of 'home-made' dividends.

No loss of wealth would result as in a perfect market there are no
transactions costs.

103
ii) Reasons the company may not pay ₦20m dividend

• Imperfections in the capital market

The above analysis assumes a perfect capital market and that any
imperfections will impair the conclusion. The major imperfections that
may cause Binko Industrial Services Plc. to reconsider its dividend are
discussed below.

• Information content of dividends

In a perfect market investors know everything about a company and its
intentions, and in particular know that a dividend is reduced only in
order to fund attractive projects.

In reality, information is restricted and many investors may not be aware

of the reasons – (information asymmetry).

The dividend itself is taken as an important indicator of company health,

and cutting the dividend from its previous fairly constant level may
convince the investors of problems in the company.
If enough shareholders decide to sell their holding the share price will
drop.

• Tax preferences of shareholders

A perfect capital market assumes indifference between income in the
form of dividends and capital gains made as the share price rises.
In reality, however, the different tax positions of investors will mean that
some prefer dividend income, while some prefer an increase in share
prices.

• Transaction costs
The buying and selling of shares is not costless in the real world.
Therefore, the 'manufacture' of home-made dividends would cause a loss
in the wealth of shareholders, leading to a preference for payouts
(dividends) rather than retentions.

• Clientele theory
It follows that Binko Industrial Services Plc. should discover whether its
shareholders prefer dividends or capital gains.
However, as the company has been following a policy of paying out most
of its profits as dividends for a number of years, it is likely to have
attracted those investors (or the clientele) who prefer this policy.
A change to one of retaining profits in order to give a capital gain may
well be unpopular with these current investors, and may prompt a wide
trading of the shares as they are replaced by investors who prefer a
policy of retention.

104
 • Preference for cash now
Some investors will prefer to take the dividend now, rather than rely on
an increase in future years.
In a perfect market this will be fully reflected in the discount rate (cost of
equity) used and so be compensated in the share price; in real life this
may not be so.

• Other sources of finance

While there are arguments for continuing to payout nearly all the profits
as dividend, it must be recognised that viable projects need funding, and
that using retained earnings is far cheaper than any other source of
equity finance.
However, the company currently has no debt, and finance could be
raised with a reasonably cheap redeemable or irredeemable debenture.
Management, however, normally consider retained earnings to be more
convenient than external equity or debt, and it is likely that the company
will want to retain some of the ₦50m profit for projects and for
unexpected needs.

• Project estimates
The calculation of the dividend depended upon the net present value of
the projects, which in turn depended upon estimates of the cash flows
and the company's cost of capital.
Reassessment of any of these estimates may lead to a different dividend,
and the company may want to undertake some sensitivity analysis on
these net present values.

• Future fund raising

If the firm is about to embark upon a major expansion programme, it is
likely to need external equity in the near future. It could therefore be
unwise to cut dividends too sharply, as this could undermine shareholder
confidence in the new management and make later issues of new equity
difficult.

Marking Guide
a)
Calculation of NPV of project A 1.0
Calculation of NPV of project B 1.0
Calculation of NPV of project C 1.0
Calculation of NPV of project D 1.0
Comment on the result of the calculations of net interest values
of A, B, C, & D 1.0 5

105
b)
i) Explanations of Modigliani & Miller proposition)
1 mark per valid point, max 3 points 3.0
ii) 2 marks for each reason given in support of the company
not being able to pay a N20m dividend, max 6 reasons 12.0 15
20

Examiner’s Report
The question tests candidates‘ knowledge of dividend policy, especially the residual
theory of dividend.

Candidates were expected to calculate the net present values of a given set of
capital projects. This is needed to determine how much is required to finance
profitable projects and how much fund is left for the payment of dividend. They
were also required to explain other factors that influence payment of dividend.
Almost 90% of the candidates attempted the question but only the (a) part was
properly answered.

Candidates could not provide acceptable solutions to section (b).

Once again, we recommend complete coverage of the Institute‘s syllabus when

preparing for this examination.

106
 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA

PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2020

ADVANCED AUDIT AND ASSURANCE

Time Allowed: 31/4 hours (including 15 minutes reading time)

INSTRUCTION: YOU ARE REQUIRED TO ANSWER FOUR OUT OF SIX QUESTIONS IN

THIS PAPER

SECTION A: COMPULSORY QUESTION (40 MARKS)

QUESTION 1

You are a manager in Obuns & Co, a firm of Chartered Accountants, responsible for
the audit of Akudre Plc, a listed entity, for the year ended 31 May 2020. The
company operates in the textile industry. It manufactures a range of goods
including clothing, linen and soft furnishings. The company employs a team of
approximately 750 sales staff around the country who sell the company‘s products
to both households and small to medium-sized businesses. Your firm was appointed
as auditor in January 2020. Around 75% of Akudre Plc‘s sales transactions are cash-
based and each of the company‘s sales staff prepares a cash sales report on a
monthly basis.

According to Akudre Plc‘s Chief Executive Officer, Adu Oke, and in order to foster
‗an entrepreneurial spirit‘ amongst his staff, each staff member (including the
senior management team) is encouraged to make cash sales on a commission basis
to friends and family. Mr. Oke leads the way with this scheme and recently sold
products with a value of N4,000,000 to his business associates. He transferred these
funds directly into an off-shore bank account in the company‘s name to which he is
the sole signatory.

Review of audit working papers

Your review of the audit working papers and an initial meeting with Mr. Oke
identified the following potential issues.

The audit engagement letter and the working papers of the taxation section of the
audit file, you established that Obuns & Co. performed the taxation computation for
Akudre Plc and completed the tax returns for both the company and Mr. Oke. All of
the taxation services have been invoiced to Akudre Plc as part of the total fee for
the audit and professional services. Mr. Oke‘s personal tax return includes a

107
significant number of transactions involving the purchase and sale of properties in
various international locations.

The taxation working papers include a detailed review of a number of off-shore

bank accounts in Mr. Oke‘s name which identified the transactions on the
properties.

Financing
In addition, the audit committee requests that the audit engagement partner
attends a meeting with the company‘s bank officials, which is planned to be held
the week after the auditor‘s report is issued. The purpose of the meeting is for the
company to renegotiate its existing lending facility and to extend its loan. The
meeting will be attended by the Chief Finance Officer, a representative of the audit
committee, as well as the bank manager. The company is hoping that the audit
partner will be able to confirm the company‘s strong financial position at the
meeting, and also confirm that the audit included procedures on going concern,
specifically the audit of the company‘s cash flow forecast for the next two years,
which the bank has requested as part of their lending decision.

Required:
a. Discuss the policies and procedures which Obuns & Co. should have in place
in relation to an anti-money laundering programme. (5 Marks)
b. Evaluate whether there are any indicators of money laundering activities by
either Akudre Plc or its staff. (4 Marks)
c. Describe the requirements of ISA 250: Consideration of Laws and Regulations
in an Audit of Financial Statements. (5 Marks)
d. Discuss the actions required when an auditor identifies or suspects material
instances of non-compliance by a client with the requirements of ISA 250.
(5 Marks)
e. Using the information provided in the financing section, identify and
evaluate any ethical threats and other professional issues which arise from
the requests made by the audit committee. (3 Marks)
f. If it is the view of the auditors that the loan finance is essential to the
continued survival of the company and that at the time of reporting the
absence of a finalised agreement represents a material uncertainty
regarding going concern.
Evaluate the additional audit procedures that the auditor would carry out to
ascertain if a material uncertainty exists. (10 Marks)

108
g. Evaluate the impact of the following scenarios on the audit report:
i Use of going concern assumption appropriate but a material
uncertainty exists
ii. Use of going concern assumption appropriate, a material uncertainty exists
and adequate disclosures have been made in the financial statements
iii. Use of going concern assumption appropriate, a material uncertainty exists
but disclosures made in the financial statements are inadequate
iv. Use of going concern assumption inappropriate
(8 Marks)
(Total 40 Marks)

SECTION B: YOU ARE REQUIRED TO ANSWER ANY THREE OUT OF FIVE

QUESTIONS IN THIS SECTION (60 MARKS)

QUESTION 2

You are the engagement partner on the audit of Uchenna & Associates. The audit
senior sent you the schedule of uncorrected misstatements as shown below,
including notes to explain each matter included in the schedule.
Profit or loss Statement of financial
position
Debit Credit Debit Credit
A Litigation provision 20,000,000 20,000,000
b Restructuring provision 13,000,000 13,000,000
c Correction of deprecation 5,000,000 5,000,000

The audited financial statements recognised revenue of N250 million and total
assets of N1.24 billion. The materiality threshold was determined as N12.5million.
You are holding a meeting with the management tomorrow, at which the
uncorrected misstatements will be discussed.

Notes:
(i) The entity was involved in a litigation in respect of a dispute with a customer
over the quality of goods shipped. The customer had obtained a court
judgement against Uchenna & Associates and was awarded N20million in
damages. Uchenna & Associates has appealed the judgement and its
solicitors are confident that it would win the appeal. Management has not
recognised any amount in the financial statements in relation to the
litigation, arguing that they are likely to win the appeal. The audit
conclusion is that a provision should be included in the financial statements.

(ii) Management had recognised a provision in respect of a restructuring

involving the closure of one of its factories. Management approved the
closure at a board meeting in April 2019, but no announcement has been
made to the employees.
The audit conclusion is that the provision should not be recognised.

109
 (iii) The audit team had recomputed depreciation expense and noted an
understatement of N5,000,000.

Required:
a. Explain the requirements of ISA 450: Evaluation of Misstatements
Identified during the Audit, with regards to uncorrected audit
misstatements. (15 Marks)
b. The matters which should be discussed with management in relation to
each of the uncorrected misstatements. (5 Marks)
(Total 20 Marks)

QUESTION 3

You are the Audit Manager at HWO, an audit firm. HWO has secured the audit of SIGMA
For Africa, a not-for-profit organisation. You have been assigned the audit of SIGMA
For Africa. The extract of the unaudited financial statements is as follows:

SIGMA For Africa

Statement of financial position
Notes As at 31 December
2019 2018
N‘000 N‘000
Non-current assets 3 76,465 90,492

Other assets 4 28,659 1,327

Current Assets:
Receivables 5 29,636 39,486
Cash and cash equivalents 6 196,546 476,087
Total assets (A) 331,306 607,392

Long term liabilities 7 63,908 66,853

Current Liabilities:
Suppliers and service providers 8 34,509 69,776
Creditors and credit balances 9 92,164 158,985
Total liabilities (B) 190,581 295,614

Total assets less liabilities: (A)-(B) 140,725 311,778

Accumulated fund (Unrestricted net assets):

Used for current activities 50,495 219,959
Used for non-current assets and other assets 90,230 91,819
140,725 311,778

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SIGMA for Africa
Statement of activities
Notes For the year ended
31 Dec 2019 31 Dec 18
N‘000 N‘000
Income from activities 10 2,456,890 2,863,219
Cost of activities 11 (1,245,679) (1,734,568)
Net income from activities 1,211,211 1,128,651
General and administrative expenses 12 (1,382,264) (1,416,036)
Net deficit for the year (171,053) (287,385)

Furthermore, you were assigned an audit senior. Based on preliminary discussions

with your audit senior, you noted that the senior had no prior experience with audits
of not-for-profit entities.

Required:
To help your audit senior understand how to audit a not-for-profit organisation,
prepare a presentation note summarising the key considerations in the audit for the
following areas:
a. Planning (4 Marks)
b. Risk analysis (4 Marks)
c. Internal control (4 Marks)
d. Audit evidence (4 Marks)
e. Reporting (4 Marks)
(Total 20 Marks)

QUESTION 4

Holloway Interiors Limited operates a large shop at Garki, Abuja. The company‘s year
end is April 30. The company sells expensive furniture and does interior decoration.
Normally, a sale transaction is initiated when a walk-in customer signs off on an
invoice duly filled by the sales clerk. The customer pays for the goods using cash,
bank transfers or POS. The sales clerk records the sale on the system and prints out a
receipt in duplicate. The customer gets a copy and the sales clerk files the second
copy. Thereafter, the customer carries the purchased item away or the company
delivers the item. However, due to the COVID 19 pandemic, the Federal Government
announced a lock down of Abuja, thereby imposing a restriction on movement of
goods and persons. In response, the company closed its showrooms and all of its
products were showcased online and all sales were made online. Furthermore, the

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company delivers all purchases by customers and customers are given the choice to
pay before or after delivery. Due to the logistics of delivery, sometimes the delivery of
items can take a week after the sale was initiated online.

You are the Audit Manager on the audit of Holloway Interiors Limited.

Required:

a. Discuss the general IT controls that you expect to find in Holloway Interiors.
(10 Marks)
b. Discuss the FIVE steps model of recognising revenue under the requirements of
IFRS 15 Revenue from Contracts with Customers. (10 Marks)
(Total 20 Marks)

QUESTION 5

Maideline Nigeria Limited manufactures tyres for use by cars, trucks and trailers.
The company is owner-managed, that is, the shareholders are also the directors of
the company. On June 1, 2020, the directors made a decision to wind up the
company. The high cost of operating in the country, the depreciation of the Naira
against the US dollar and the economic impact of COVID 19 has led to harsh
operating conditions that had severely impacted the entity‘s ability to carry on
business in the country.

Management notified the employees, suppliers and customers that Maideline would
cease all manufacturing activities on September 30. All the factory workers and
most of the employees in the accounts and administration departments were
terminated, effective September 30. Most of the employees who remained in
employment with the company after September 30 will be made redundant on
November 30. However, the company retained a small head office operations,
consisting of the Company Secretary and a small accounting and administrative
support team. This head office unit will continue to operate for a few more years
until the company‘s operations are wound down completely.

Maideline had 20 branches and a head office. 12 of these branches operate from
buildings owned by the company. The remaining 8 branches operate from leased
buildings. The expiration of the lease terms ranges from three to five years. Under
the terms of the lease agreements, none of these premises can be sub-let and the
leases cannot be sold.

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On the adoption of IFRS 16, the entity had assumed that the lease will be renewed
at the end of the lease tenure and had recorded a lease liability and a right-of-use
asset. A small head office building will continue to be occupied and used until the
lease expires in three years‘ time. Maideline accounts for all its tangible non-
current assets at cost less depreciation. The entity had recognised deferred tax
assets in prior years due to unrelieved tax losses and unutilised capital allowances.

All the products sold by Maideline carry a one-year warranty. Until May 31, 2020,
the company sold extended two-year and three-year warranties, but extended
warranties were not offered on any products sold from March 1, 2020. Maideline
sold its products through national and international distributors, under three-year
agreements. Maideline also had annual contracts with its major suppliers for the
purchase of components. So far, none of the distributors or suppliers has initiated
legal proceedings against Maideline for breach of contract. However, some
distributors are withholding payments from Maideline on their account balances,
awaiting settlement of the penalty payments they claimed are now due to them
from Maideline.

Required:
Using the information provided, identify and explain the financial statement risks
to be taken into account in planning the final audit of Maideline in respect of the
year ended December 31, 2020. (20 Marks)

QUESTION 6

Nash Investigations Limited specialises in conducting investigations for corporate

clients. It employs ex-police officers, security consultants, IT and fraud specialists.
Nash Investigations recently dropped its firm of auditors and has approached your
firm to participate in a tender process for selecting the new auditor. You are a
manager in the audit firm and you will be working with a senior auditor on this
assignment. The senior auditor has never been involved in a tender process or
appointment of new auditor. You have been provided with the following
information:
(i) Nash Investigations is a major service provider to your firm, particularly in
the provision of IT and fraud consultancy;
(ii) Nash Investigations has acrimoniously dropped their previous auditors and
are withholding fees, pending the resolution of a number of issues especially
to their accusations on the competence of the auditors;

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(iii) Nash Investigations is currently facing a hostile take-over bid from Technical
Investigations Group, a company you also audit;
(iv) Media reports of a fraud allegation leveled against one of the directors of the
Company; and
(v) One of the partners in the audit firm is also a director in Nash Investigations.

Required:

Prepare briefing notes to explain the following matters to the audit senior:

a. The audit tendering process in terms of the stages that the audit firm will go
through should it decide to participate in the tender. (5 Marks)
b. The requirements of the ICAN Code of conduct on advertising and publicity
(5 Marks)
c. The requirements of the ICAN code of conduct on fees (5 Marks)
d. The impact of each additional piece of information provided above and how
the information would influence your decision to participate in the audit
tender for Nash Investigations. (5 Marks)
(Total 20 Marks)

SOLUTION 1

1a. The policies and procedures which Obuns & Co. should have in place in
relation to an anti-money laundering programme include the following:

i. Putting in place systems, controls and procedures to ensure that the

firm is not used for money laundering purposes;

ii. Appointing a Money Laundering Reporting Officer (MLRO), whose

responsibility is to receive reports on suspected money laundering
activities from firm‘s employees and report them to the appropriate
authorities;
iii. Establishing and enhancing record-keeping systems for all
transactions (which must be kept for at least five years, with controls
to ensure that they are not inadvertently destroyed);

iv. Establishing and enhancing record-keeping systems for verifying the

identity of clients (by obtaining official documents, such as – for an
individual – passport or driving license, supported by recent utilities
bills, and for a company – certificate of incorporation and Tax
Identification Number (TIN));

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 v. Establishing procedures within the firm for reporting any suspicion of
money laundering by the client; and
vi. Training and educating staff on procedures for detecting and reporting
suspicions of money laundering activities.

b. Indicators of possible money laundering activities by both Mr. Oke and the
company include the following:

i. The number of staff involved in cash sales and the difficulty in

ensuring that all cash takings enter the proper channel;
ii. Mr. Oke‘s personal tax returns includes a significant number of
transactions involving the purchase and sale of properties in various
international locations;
iii. The taxation working papers include a detailed review of a number of
off-shore bank accounts in Mr. Oke‘s name which identified the
property transactions;
iv. Each staff (including the senior management team) is encouraged to
make cash sales and is paid on a commission basis to sell the
company‘s products to friends and family; and
v. When Mr. Oke recently sold products with a value of N4,000,000 to his
business associate, he transferred the funds directly into an off-shore
bank account in the company‘s name to which he is the sole signatory

c. ISA 250: Consideration of Laws and Regulations in an Audit of Financial

Statements requires the auditor to:

i. Obtain a general understanding of the applicable legal and

regulatory framework and how the entity is complying with that
framework. This is part of obtaining an understanding of the entity
and its environment – here, the legal environment – as required by
ISA 315 (Identifying and Assessing the Risks of Material Misstatement
through Understanding the Entity and its Environment);
ii. Obtain sufficient appropriate audit evidence in respect of compliance
with those laws and regulations which might be expected to have a
direct effect on material amounts and disclosures in the financial
statements;
iii. Make enquiries of management as to whether or not the entity is
complying with the relevant laws and regulations;
iv. Inspect any correspondence with the relevant authorities;
v. During the audit, remain alert to the possibility that other audit
procedures might bring instances of non-compliance to the auditor‘s
attention;

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 vi. Obtain written representations from management that all known
instances of non-compliance or suspected non-compliance have been
disclosed to the auditor; and
vii. Document all identified or suspected instances of non-compliance and
the results of discussions with management and/or other parties.

d. When an auditor identifies or suspects material instances of non-compliance

with the requirement of ISA 250, the following actions are required:

i. Obtain an understanding of the nature of the act and the

circumstances under which it has occurred;
ii. Evaluate the possible effect of the non-compliance on the financial
statements;
iii. For suspected non-compliance, discuss the matter with management.
If compliance is not demonstrated, take legal advice;
iv. If there is insufficient evidence of a suspected non-compliance,
consider the impact on the audit report;
v. Consider whether or not the non-compliance impacts on other areas of
the audit (for example, on the overall risk assessment); and
vi. Consider how to report the non-compliance – to those charged with
governance and/or to shareholders and/or to the authorities.

e. Ethical threats and professional issues arising from the request made by the
audit committee include the following:

i. The audit committee has asked the audit engagement partner to

attend a meeting with the bank, the objective of the meeting being
the renegotiation of the company‘s loan. This is an advocacy threat to
objectivity, as the audit partner will be supporting the client in its
renegotiation and may be perceived as supporting or confirming the
company‘s financial position;

ii. If the partner were to attend the meeting and confirm the strength of
the company‘s financial position, or confirm any work performed on
the cash flow forecast, there could be legal implications;

iii. Partner attending the meeting and confirming the company‘s strong
position would potentially expose the audit firm to liability; it could
be perceived that the audit firm is in some ways guaranteeing the
loan or guaranteeing that the company is in a position to service the
debt;

116
 iv. The partner‘s attendance at the meeting could be seen as supporting
the company in its attempt to raise further finance; and

v. These ethical issues should be discussed with the audit committee,

with an explanation provided as to why the audit firm should not
attend the meeting with the bank.

f. The following are additional audit procedures which the auditor would carry
out to ascertain whether a material uncertainty exists:

i. Discussions with management: Inquire of management as to the

validity of its going concern assumptions and implications of these
assumptions and also future plans for the business.

Where management has not yet performed an assessment of the

entity‘s ability to continue as a going concern, a request should be
made that an assessment be carried out by management;

ii. Evaluation of management‘s future plans and actions: The auditor

should carry out an evaluation of management‘s future plans and
actions with regards to its going concern assessment. The auditor
should also assess whether the outcome of these plans would improve
the situation and the feasibility of these plans;

iii. Obtain a cashflow forecast: Where the entity has prepared a cashflow
forecast, the auditor should discuss with management, evaluate the
reliability of the underlying data generated to prepare the forecast
and determine whether there is adequate support for the assumptions
underlying the forecast.

The auditor should consider whether any additional facts or

information have become available since the date on which
management made its assessment;

iv. Information from the client‘s bank: If the client is expecting to rely on
continuing financial support from its bank (for example, a
continuation of its bank overdraft facility) the bank should be asked
to confirm that the finance will be available;

v. Requesting management representation: The auditor should obtain

written representations from management and where appropriate,
those charged with governance, regarding their plan for future action
and the feasibility of these plans; and

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 vi. Management‘s assumptions: Where management assumptions include
continued financial support by third parties, and such support is
important to the ability of the entity to continue as a going concern,
the auditor may need to request written confirmations, including
terms and conditions from those third parties and to obtain evidence
about their ability to provide support.

g. i. Use of going concern assumption appropriate but a material

uncertainty exists.

If the auditor concludes that the use of the going concern assumption
is appropriate in the circumstances but a material uncertainty exists,
the auditor shall determine whether the financial statements:

 Adequately describe the principal events or conditions that may

cast significant doubt on the entity‘s ability to continue as a going
concern and management‘s plans to deal with these events or
conditions; and
 Disclose clearly that there is a material uncertainty related to
events or conditions that may cast significant doubt on the entity‘s
ability to continue as a going concern and, therefore, that it may
be unable to realize its assets and discharge its liabilities in the
normal course of business.

ii. Use of going concern assumption appropriate, a material uncertainty

exists and adequate disclosures have been made in the financial
statements.

If adequate disclosure is made in the financial statements, the auditor

shall express an unmodified opinion and include an emphasis of
matter paragraph in the auditor‘s report to:

 Highlight the existence of a material uncertainty relating to the

event or condition that may cast significant doubt on the entity‘s
ability to continue as a going concern; and
 Draw attention to the note in the financial statements that
discloses the relevant matters.

iii. Use of going concern assumption appropriate, a material uncertainty

exists but disclosures made in the financial statements are inadequate

 If adequate disclosure is not made in the financial statements,

the auditor shall express a qualified opinion or adverse
opinion, as appropriate, in accordance with ISA 705

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 (Modifications to the Opinion in the Independent Auditor‘s
Reports).
 The auditor shall state in the auditor‘s report that there is a
material uncertainty that may cast significant doubt about the
entity‘s ability to continue as a going concern.

iii. Use of going concern assumption inappropriate

 If the financial statements have been prepared on a going

concern basis, but in the auditor‘s judgment, management‘s
use of the going concern assumption in the financial
statements is inappropriate, the auditor shall express an
adverse opinion.
 The auditor may give an unmodified opinion if the financial
statements have been prepared on an alternative acceptable
basis (for example, a break-up basis) and there is adequate
disclosure of this basis. An emphasis of matter paragraph may
be required in the auditor‘s report to highlight the alternative
acceptable basis.

Marking Guide

Marks
a) 1 mark each for any 5 points 5
b) 1 mark each for any 4 points 4
c) 1 mark each for any 5 points 5
d) 1 mark each for any 5 points 5
e) 1 mark each for any 3 points 3
f) 2. marks each for any point subject to a maximum of
five (5) points 10
g) 1 mark each for any 2 points in the four (4) solutions 8
40

Examiner’s Report

The question tests candidates‘ knowledge of the regulations that need to be

complied with by companies and the extent of such compliance. It also tests ethical
threats and going concern assumptions on auditors‘ reports.
This being a compulsory question, about 90% of the candidates attempted it but the
performance was below average.
The commonest pitfalls of the candidates were the lack of essential knowledge of
the regulatory frameworks and the difficulty in the identifying the indicators of
money laundering activities.

119
Candidates are advised to familiarize themselves with the various regulatory
frameworks and study the Institute‘s Study Text and Pathfinders.

SOLUTION 2

a. ISA 450: Evaluation of Misstatements Identified during the Audit requires the
following from the auditor with regards to uncorrected misstatements:

i. Communication with management: The auditor should communicate

on a timely basis all audit misstatements with the appropriate level of
management unless prohibited by law or regulations from doing so.

If management refuses to correct all or some of the misstatements

communicated by the auditor, he shall obtain an understanding of
management‘s reasons for not making the corrections and shall take
that understanding into account when evaluating whether the
financial statements as a whole are free from material misstatements;

ii. Evaluate the effect of uncorrected misstatements: Prior to evaluating

the effect of uncorrected misstatements, the auditor shall reassess
materiality determined in accordance with ISA 320 to confirm
whether it remains appropriate in the context of the entity‘s actual
financial results.

The auditor shall determine whether uncorrected misstatements are

material, individually or in aggregate. In making this determination,
the auditor shall consider:

- The size and nature of the misstatements, both in relation to

particular classes of transactions, account balances or
disclosures and the financial statements as a whole, and the
particular circumstances of their occurrence; and

- The effect of uncorrected misstatements related to prior periods

on the relevant classes of transactions, account balances or
disclosures, and the financial statements as a whole;

iii. Communication with those charged with governance:

- The auditor shall communicate with those charged with
governance uncorrected misstatements and the effect that they,
individually or in aggregate, may have on the opinion in the
auditor‘s report, unless prohibited by law or regulation.

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 - The auditor‘s communication shall identify material
uncorrected misstatements individually. The auditor shall
request that uncorrected misstatements be corrected.

- The auditor shall also communicate with those charged with

governance the effect of uncorrected misstatements related to
prior periods on the relevant classes of transactions, account
balances or disclosures, and the financial statements as a
whole;

iv. Audit documentation: The auditor shall include in the audit

documentation the following matters:
- The amount below which misstatements would be regarded as
clearly trivial;
- All misstatements accumulated during the audit and whether
they have been corrected; and
- The auditor‘s conclusion as to whether uncorrected
misstatements are material, individually or in aggregate, and
the basis for that conclusion;

v. Accumulate all misstatements found during the audit unless they are
clearly trivial;

vi. Prior to evaluating the effect of uncorrected misstatements,

reassessing materiality;

vii. If the total of misstatements identified during the audit approach (or
could approach) materiality, decide if the overall audit strategy and
audit plan need to be revised;

viii. Communicate all misstatements found during the audit to an

appropriate level of management and request that the misstatements
be corrected; and

ix. Written representations: The auditor shall request a written

representation from management or those charged with governance
whether they believe the effects of uncorrected misstatements are
immaterial, individually and in aggregate, to the financial statements
as a whole. A summary of such items shall be included in or attached
to the written representation.

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b. The following matters should be discussed with management in relation to
each of the uncorrected misstatements:
i. Litigation provision
 The amount of N20m exceeds the materiality threshold of
N12.5m. The item is clearly material.

 The precarious nature of litigation is such that the outcome

cannot be determined while litigation is still in progress. The
opinion of the company‘s lawyers cannot be relied upon as a
basis to exclude the provision in the financial statements.

 The fact that the customer won the case against Uchenna &
Associates tilts the case in favour of the customer, although the
result of the Appeal is yet to be ascertained.

ii. Restructuring provision

 The adjustment in relation to the provision is material to profit.
The provision appears to have been recognised too early.
 IAS 37: Provisions, Contingent Liabilities and Contingent Assets,
requires that for a restructuring provision to be recognised,
there must be a present obligation as a result of a past event,
and that is only when a detailed formal plan is in place and the
entity has started to implement the plan, or announced its
main features to those affected.

 A board decision is insufficient to create a present obligation as

a result of a past event. The provision should be recognised
when the announcement is made to the employees .

 Management should be asked to explain why they have

included the provision in the financial statements, for example,
there may have been an earlier announcement of which the
auditor is unaware.

 In the absence of any such further information, management

should be informed that the accounting treatment of the
provision is a material misstatement, which if it remains
unadjusted will have implications for the auditor‘s opinion.

iii. Depreciation
 The understatement to depreciation expense is not material on
an individual basis to either the statement of profit or loss or
the statement of financial position.

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  Despite the amount being immaterial, it should not be
disregarded, as the auditor should consider the aggregate
effect of misstatements on the financial statements.
 ISA 450 does state that the auditor need not accumulate
balances which are ‗clearly trivial‘, by which it means that the
accumulation of such amounts clearly would not have a
material effect on the financial statements.
 If this amount remains unadjusted by management, it will not
on an individual basis result in material misstatement to the
financial statements.

Marking Guide

Marks Marks
a.(i) 1 mark for each of the 2 points 2
(ii) 1 mark for each of the 3 points 3
(iii) 1 mark for each of the 2 points 2
(iv) 2 marks for specific points 2
(v) 1 mark each for any two points 3
(vi – viii) 1 mark for each of the points 3 15
b. (i) 1 mark for any of the correct points 1
(ii) 1 mark each for any 2 points 2
(iii) 1 mark each for any 2 points 2 5
Total 20

Examiner’s Report

The question tests the candidates‘ knowledge on the evaluation and treatment of
misstatements identified during audit according to the requirements of ISA 450. It
also tests the candidates understanding of guidance to management in that regard.

Less than 50% of the candidates attempted the question and the performance was
average.

The commonest pitfall of the candidates was the lack of adequate knowledge of the
process of treatment of misstatements in the audit process.

Candidates are advised to take seriously the practical work experience embedded
in the Institute‘s students training programme.

123
SOLUTION 3

The audit senior should recognise the specific features of the not-for-profit
organisation (NFPO). However, it is important to realise that the auditor is still
performing an audit, and the overall structure of the audit of an NFPO will be
similar to the audit of a commercial organisation. However, the detail of the audit
will probably differ. The main points to bear in mind with the audit of an NFPO are
summarised below. These are general principles. They should be modified as
appropriate to reflect the circumstances of each particular NFPO.

a. Planning

Consider:

i) The objectives and scope of the audit work;

ii) Any local regulations that apply;
iii) The environment in which the organisation operates;
iv) The form and content of the final financial statements and the audit
opinion; and
v) Key audit areas, including risk.

b. Risk analysis

Carry out an audit risk analysis under the usual headings of inherent risk, control
risk and detection risk in respect of the following:

i. Inherent risk (reflecting the nature of the entity‘s activities and the
environment);
ii. Control risk (internal controls, and the risk that these may be
inadequate: controls over cash collection and cash payments may be a
key area for an NFPO such as a charity, because large amounts of
cash may be collected from the public by volunteers)
iii. Detection risk (the risk that the auditor will fail to identify any
material error or misstatement in performing the audit).

c. Internal control

Key areas of internal control in an NFPO include:

i. Segregation of duties (although this may be difficult in a small NFPO

with only a few employees);
ii. Cash controls;
iii. Controls over income (donations, cash collections, membership fees,
grants); and

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 iv. The use of funds only for authorised purposes.

d. Audit evidence

A substantive testing approach (rather than a systems-based approach) is

likely to be necessary in a small NFPO, because of weaknesses in its internal
control system.

Key areas may include:

i. The completeness of recording transactions, assets and liabilities;
ii. The possibility of misuse of funds;
iii. Analytical procedures may be used to ‗make sense‘ of the reported
figures; and
iv. There should be a review of the final financial statements, including a
review of the appropriateness of the accounting policies.

e. Reporting

The key areas in reporting include:

i. If a report on an NFPO is required by law, the standard external audit

report should be used; and
ii. If the audit is performed on a voluntary basis, the report needs to
reflect the agreed objective of the audit.

However, it is good practice for the report to follow the general structure laid
down by ISA 700: Forming an Opinion and Reporting on Financial
Statements

i. Title;
ii. Addressee;
iii. Responsibilities of auditors versus the responsibilities of directors;
iv. Responsibility for financial statements;
v. Other reporting responsibilities;
vi. Basis for opinion;
vii. Going concern and key audit matters (if applicable);
viii. The audit opinion; and
ix. Date, name and address of auditor.

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Marking Guide

Mark Mark
a. 1 mark each for any 4 points 4
b. 2 marks each for any 2 points 4
c. 1 mark each for any 4 points 4
d. 1 mark each for any 4 points 4
e. 1 mark each for any 2 points 2
f. ½ mark each for any 4 titles of sections of the report 2 4
Total 20

Examiner’s Report
The question tests candidates‘ knowledge on the procedures and some of the stages
involved in carrying out the audit of an entity.

About 60 % of the candidates attempted the question and the performance was
above average.

The commonest pitfall of the candidates was the lack of understanding processes of
executing an audit engagement.

Candidates are advised to endeavour to read widely for improved performance in

subsequent examinations.

SOLUTION 4

a. The general IT controls that are expected to be found in Holloway Interiors

Limited are discussed below:

Control area Controls required

Development of  Appropriate standards should be established and enforced for

computer-based designing, developing, programming and documenting each
information systems new system.
and applications  Suitable testing procedures should be carried out on each new
system.
 The design of a new system should be approved formally by the
management of the system user.
 There should be a segregation of duties between system
designers and system testers (to reduce the risk of error or fraud)
 There should be suitable staff training in the design and testing
of systems.

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Documentation and  Formal testing procedures should be applied for any change to a
testing of current programme.
programme changes  There should be formal authorisation procedures for programme
changes.
 There should be suitable staff training in making and testing
programme changes.
Prevention or  There should be a segregation of duties between programmers and
detection of computer system operators.
unauthorised  All programme changes must be fully documented
 Access to programme files must be restricted
programme changes
 Programme logs should be used to record access to program files and
programmes
 There should be anti-virus software and back-up copies of programme
files should be kept, to prevent or detect or deal with ‗malicious‘
changes to programmes.
Prevention of the use  Standard operating procedures should be established, and
of incorrect operations should be performed by suitably-trained staff
programmes or data  The scheduling of ‗jobs‘ for a computer centre should specify the
files programme files and data files to be used.
 There should be effective supervision of computer centre
operations.
 Reviews of operations should be carried out regularly by
management.
Prevention of  There must be restricted access to data files, limited to authorised
unauthorised personnel because transaction are processed immediately by the
amendments to data online system and access controls need to be strong.
files  Transaction logs should be kept of all uses of data files,to
provide an audit trail and these should be reviewed by
management.
 Fire walls (hardware and software) should be used to prevent
unauthorised access through internet.
Ensuring continuity of  Secure back-up copies should be kept of programme files and
operations data files.
 Measures should be implemented for the protection of
equipment against fire, power failure and other hazards.
 Disaster recovery programmes should be in place, in the event of
a major disaster that puts the main computer system out of
action.
 There should be suitable maintenance and service agreements
for all major externally-acquired software.

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b. The five step model is as outlined as follows:

Step 1: Identify the contract

i. IFRS 15 defines a contract as an agreement between two or more
parties that creates enforceable rights and obligations and specifies
that enforceability is a matter of law.
ii. Contracts can be written, oral or implied by an entity‘s customary
business practices.
iii. A contract with a customer exists if collection of consideration is
probable, rights to goods or services and payment terms can be
identified, it has commercial substance and it is approved and the
parties are committed to their obligations.

Step 2: Identify the performance obligations

i. Entities are to identify each promise to deliver a good or provide a
service to a customer.

ii. A promise constitutes a performance obligation if the promised good

or service is distinct.
iii. A promised good or service is distinct if it meets both of the following
criteria.
 the customer can benefit from the good or service either on its
own or together with other resources that are readily available
to the customer; and

 the entity‘s promise to transfer the good or service to the

customer separately identifiable from other promises in the
contract.

Step 3: Determine the transaction price

i. The transaction price is the amount of the consideration to which an
entity expects to be entitled in exchange for transferring goods or
services to a customer.

ii. To determine this amount, an entity considers factors like the risk of
revenue reversal when determining how much variable consideration
to include in the transaction price, the consideration payable to the
customer, non cash consideration and the significant financing
component.

Step 4: Allocate the transaction price

i. Entities will generally allocate the transaction price to each
performance obligation in proportion to its stand-alone selling price.

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 ii. The best evidence of the stand-alone price is an observable price from
a stand alone sales of that good or service to a customer. However, if
the stand-alone price is not directly observable, then an entity can
estimate it by either evaluating the market in which it sells its goods
or services and estimating the price that customers are willing to pay,
forecasting expected costs plus an appropriate margin or in limited
circumstances, subtracting the sum of observable stand-alone selling
prices of other goods or services in the contract from the total
transaction price.

Step 5: Recognise revenue when (or as) the entity satisfies a performance
obligation
i. An entity recognises revenue when (or as) it satisfies a performance
obligation by transferring control of the goods or service to a
customer. Control may be transferred either at a point in time or over
time.
ii. The indicators that control has passed include a customer having a
present obligation to pay, physical possession, legal title, risks and
rewards of ownership or having accepted the asset.

Marking Guide
Marks
a. ½ mark each for each point subject to a maximum 20 points 10
b. 1 mark each for mentioning each of 5 steps 5
1 mark each for the explanation of 5 steps 5
10

Examiner’s Report

The part (a) of the question tests candidates‘ knowledge on general information
technology (IT) controls, whilst part (b) tests candidates‘ knowledge on the
recognition of revenue from contracts in accordance with IFRS 15: Revenue from
Contracts with Customers.

Almost 80% of the candidates attempted the question because of the popular nature
of the IT and the performance was good.

The commonest pitfall of the candidates‘ was the lack of detailed knowledge of the
requirement of the respective segments of the IT programme, while in part (b),
candidates displayed poor knowledge in itemizing the steps in the model.

Candidates are advised to devote time to their studies and to go through ICAN
Study Texts and Pathfinders.

129
SOLUTION 5

The financial statement risks to take into account in planning the final audit are as
follows:

a. Basis of preparation of the financial statements: The financial statements

should not be prepared on a going concern basis. The directors need to
include a note in the financial statements explaining the basis of the
conclusion and the accounting policies applied in drawing up financial
statements on a non-going concern basis;

b. Termination expenses: Management needs to determine the amount of

termination expenses required. If termination expenses has not been paid at
year end, provisions for termination payments will be needed in the
financial statements;

c. Internal control: The use of a small accounting team may increase errors in
processing accounting transactions towards the end of the year. Segregation
of duties (as an internal control) might have been adversely affected;
d. Accounting policy of own buildings: The accounting policy of the 12
buildings owned by the entity will be changed from depreciated cost to fair
value because there is an expectation that they might be sold;

e. Impairment of right-of-use assets: It is expected that the right-of-use assets

will have a component on amounts prepaid with regards to the leased
buildings and the assumed renewal of the lease. There will be a need to
assess the right-of-use asset for impairment in the light of the decision to
wind down the company‘s operations;

f. Provision for warranties: Warranty provisions will be recognised for goods

sold to customers which are still under warranty;

g. Agreements with suppliers and distributors: Management needs to review

the contracts with distributors and suppliers to identify any breaches as a
result of the decision to wind down the company, the financial impact of
these breaches needs to be determined and potentially recognized in the
financial statements;

h. Lease liability: The lease liability for the assumed lease renewal should be
derecognised since the company is no longer likely to renew its lease
agreements when they end;

i. Companies income tax liability: The tax liability will be determined based on
the requirement of the relevant tax laws;

130
j. Inventory valuation: The company operates in auto industries and tyres
have expiring dates or period and inventories might be subject to
obsolescence. Therefore, inventories in the financial statements might be
overstated; and

k. Deferred tax asset: Considering that the entity is on the verge of ceasing
operations, it is unlikely that there would be future taxable profit for the
recoverability of the deferred tax asset and so this has to be derecognised.

Marking Guide

Marks
1 mark each for identifying the risk 10
1 mark each for the explanation of risk identifying 10
Total 20

Examiner’s Report
The question test candidates‘ knowledge on financial risks inherent in planning for
a final audit.

About 60% of the candidates attempted the question and overall performance was
average.

The commonest pitfall of the candidates was their inability to identify the financial
statement risks to be considered in planning a final audit.

Candidates are advised to link the theoretical issues in the study text to practical
situation when given in a scenario.

SOLUTION 6

a. Tendering is a commercial process widely-used by companies (especially

larger companies) when they wish to change auditors. The invitation may or
may not include the existing auditor. Tendering involves two or more audit
firms being invited by a company to submit a proposal for its audit work,
which include:

i. Tendering should commence only when a firm has been approached

by a prospective client. In any case, a firm should not submit a tender
for the work unless it can give satisfactory answers to the following
questions:

131
 - Does the firm have the expertise to carry out this audit?
- Does the firm have (or could it have) sufficient staff available
at the appropriate time?
- Are there any ethical reasons why the firm could not act (for
example, a problem with independence, or a conflict of
interest)?
- Are there any problems, of which the firm is aware, with the
current audit or auditors?

ii. Collect background information about the possible new client. (This is
necessary when evaluating any new client, whether the fee is to be
set by tender or by any other method);

iii. Establish the precise scope of the work to be performed and the
specific requirements of the prospective client;

iv. Carry out a preliminary audit risk assessment and prepare a

preliminary plan for the audit. The plan must cover the staffing
requirements and the time requirements for the work;

v. Estimate a fee;

vi. Prepare a submission document for the potential client. The contents
of this document will typically include:

- An outline of the key characteristics of the firm;

- Clarification of the nature of the audit work or other non-audit
work to be performed;
- A statement of the requirements of the client and how the firm
will comply with them;
- An outline of how the work will be performed;
- The proposed fee and the basis of its calculation;
- The range of other services which the firm could offer to the
client; and
vii. If required, prepare and give a presentation to the potential client.

b. When a professional accountant in public practice solicits new work through

advertising or other forms of marketing, there may be a threat to compliance
with the fundamental ethical principles.

The main requirements for marketing professional services are that the
advertising and publicity material used by any firm:

132
 i) Must not bring into disrepute the professional body, the firm or the
profession as a whole;
ii) Should not make exaggerated claims for services offered,
qualifications possessed or experience gained – it should be honest
and truthful and not mislead;
iii) Must not discredit the services provided by other firms or make
disparaging references or unsubstantiated comparisons to the work of
another Chartered Accountant;
iv) Must not break any locally-recognised codes of advertising practice;
v) In addition, it is recommended that advertising and publicity material
should avoid any reference to fees. If fees are mentioned, there should
be a statement of the basis on which the fees are to be charged;
vi) Comments about fees:
- Must not be misleading;

- Must not offer discounts; and

- Must not make comparison with the fees of other service

providers; and

vii) ICAN‘s professional code of conduct and guide for members states that
if a Chartered Accountant in public practice is in doubt whether a
proposed form of advertising or marketing is appropriate, he/she
should consult through the Registrar/Chief Executive of ICAN.

c. ICAN‘s code of conduct provides specific guidance regarding fees as follows:

i) ICAN advises minimum charge-out rates in respect of fees for
professional services which are intended to set a benchmark below
which members are not ordinarily expected to charge;

ii) A member should inform a client in writing prior to commencement of

any engagement the basis upon which any fee he proposes to charge
for his services will be calculated and, on request and where
practicable, the level of fees likely to be charged for any assignment;

iii) The member should discuss and explain the basis on which fees will
be calculated, including the estimated initial fee, at the earliest
opportunity. This discussion should be confirmed in writing, normally
in an engagement letter;

iv) Firms should not quote a level of fees for new audit work which is
lower than that charged by an existing auditor. Firms should also not
quote by tender a level of fees which they have reason to believe is
significantly lower than those quoted by other tendering firms. In
both instances the firm‘s objectivity could be threatened;

133
 v) When performing audit work, firms should ensure that their work
complies with auditing standards and guidelines and, in particular,
quality control procedures. In the event of a complaint being made to
the Institute (which might have arisen as a result of a Professional
Practice Monitoring Committee‘s inspection), where fees were a
feature in obtaining or retaining the work, firms should be prepared
to demonstrate that:
 The work done was in accordance with auditing standards; and
 The client was not misled as to the basis on which fees for the
current and subsequent years were to be determined;

vi) A member whose fees have not been paid may be entitled to retain
certain books and papers of a client upon which he has been working
by exercising a lien and may refuse to pass on information to the
client or his successor Chartered Accountant, until those fees are paid.
However, a member who so acts should be prepared to take
reasonable steps to resolve any dispute relating to the amount of that
fee. The incoming auditor has a duty to assist in the recovery of such
fees within a reasonable time; and

vii) Fees should generally not be based on a percentage or on contingency

calculations for audit work, reporting assignments and similar non-
audit roles.

d. The impact of the five additional information are as follows:

i) Since Nash Investigation is a major service provider to our firm, the

issue of a possible threat to our independence arises and we may not
be able to submit a tender for the audit;
ii) Also there should be professional clearance when a firm of auditor is
taking up a job which has been previously handled by a professional
colleague, and we were told that Nash Investigation is withholding
fess of her previous auditor, hence, our firm will not participate in the
tendering process;
iii) As a firm of auditors, there is professional requirement which
stipulates that one should not act for two opposing parties in any
negotiation or claim unless one is appointed as an arbitrator due to
process of law and tendering process is not arbitration process, hence,
our firm will not be able to participate in the audit tender. It is of
note that Nash Investigations is currently facing a hostile takeover bid
from Technical Investigations Group. Hence our Firm will not be able
to participate in the audit tender;

134
iv) If we confirm that the reason for parting ways with the old audit firm
is incompetence and there is no independence issue; then we can take
up the audit and press for the payment of the withheld fees on behalf
of the previous auditors. It is of note that Nash investigation is
currently facing a hostile takeover bid from Technical Investigations
Group. Hence our firm will not be able to participate in the audit
tender; and

v) Having one of our partners as a director in an audit client is a threat

to our independence which will amount to conflict of interest and if
we are to submit a tender for the audit, the partner needs to either
resign as partner or as a member of the board of directors.

Marking Guide
Marks
a. 1 mark for any point (max 5) 5
b. 1 mark for any point (max 5) 5
c. 1 mark for any point (max 5) 5
d. 1 mark each for the 5 points 5
20

Examiner’s Report
The question tests candidates‘ knowledge on various issues on professional
code of conduct and professional ethics.

About 60% of the percentage of candidates that attempted the question and
the performance was poor.

The commonest pitfall of the candidates was their inability to explain the
requirements of the professional code of conduct of members as regards
advertising and publicity, and fees

Candidates are advised to go through ICAN Study Text and other relevant
reading materials.

135
 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA

PROFESSIONAL LEVEL EXAMINATION – NOVEMBER 2020

CASE STUDY
Time Allowed: 4 hours (including reading time)

INSTRUCTION: YOU ARE TO USE THE CASE STUDY ANSWER BOOKLET FOR
THIS
PAPER
Pre-seen

This material is issued prior to the examination date to enable candidates

familiarise themselves with the case scenario so as to undertake any research and
analyses they think fit. This pre-seen part of the Case Study examination is also
published on the Institute‘s website: www.ican.org/students.

You MUST NOT bring this material with you to the Examination Hall. On receipt of
the material, you are to spend the few days to the examination date to familiarise
yourself with the information provided, carry out additional research and analyses
about the industry and analyse the financials provided in preparation for the
examination. Candidates should note that the use of pre-seen part of the Case Study
will not significantly help them in their preparation for this examination. It is
essential that they carry out sufficient analyses on their own in order to have a
good understanding of the pre-seen part of the case scenario.

At the start of the examination, candidates will receive the complete case scenario
which will include both the pre-seen and the unseen which includes the
requirements. You must use the answer paper provided by the Institute in the
Examination Hall. Any solution presented with other papers WILL NOT be marked.

Assessment of the Case Study

The marks in the Case Study examination are awarded for professional skills and
are approximately allocated as follows:

 Assimilating and using information

20%
 Structuring problems and solutions
20%
 Applying judgement
20%
 Drawing conclusions and making recommendations
20%

136
 Demonstrating integrative and multidisciplinary skills
10%
 Presenting appropriate appendices
10%

Of the total marks available, 20% is awarded for the executive summary and
approximately 10% for the relevant discussion of ethical issues within your answers
to the requirements. Although ethical issues do not form a specific requirement, as
this is deemed to have been tested in other subjects of the ICAN professional
examination, but will be tested within a requirement which may include the
following areas:

 Lack of professional independence or objectivity;

 Conflicts of interest among stakeholders;
 Doubtful accounting and or creative accounting practice;
 Unethical business/commercial practice; and
 Inappropriate pressure to achieve a reported result.

Candidates should note that marks are not awarded for just simply restating facts
from the case scenario but are awarded for demonstrating professional skills and
technical depth. Therefore, to succeed, candidates are required to:

 Show sufficient evidence of knowledge of the case scenario;

 Be able to carry out appropriate analyses of the issues involved and suggest
feasible solutions to the problems identified;
 Demonstrate ability to make informed judgement on the basis of analyses
carried out; and
 Generate reasoned conclusions upon which relevant recommendations are
made.

Any candidate that omits any one of these will have a slim chance of success in the
examination.

137
November 2020 Case Study: Dotmak Nigeria Limited

List of exhibits

1 About you (Ibrahim Danladi) and your employer, Dotmak Nigeria Limited

2 Repositioning Tito shoes in Nigeria

3 Dotmak Nigeria Limited: history, operations, competitors board and

management

4 The challenges and opportunities of the shoe industry in Nigeria

5 Dotmak Nigeria Limited management accounts – 2016 to 2018

6 Dotmak Nigeria Limited: Cost/pricing structure

7 Press article

138
 Exhibit 1

About you (Ibrahim Danladi) and your employer (Dotmak Nigeria Limited)

You are Ibrahim Danladi, writing the Professional level of ICAN examination. You
are working as a management accountant at the corporate office of Dotmak Nigeria
Limited which manufactures and distributes high quality shoes and personal
accessories. You report to the finance controller, Joseph Apororo and your
responsibilities include:

 Preparing detailed financial analyses and reports on the performance of the

company;
 Assessing operational and strategic business proposals to see how each aligns
with the corporate objectives and its impact on the company‘s business and
financial risks;
 Assessing the funding gaps and recommending appropriate sources of fund,
taking into consideration the company‘s optimal financial structure;
 Evaluating investment proposals and reporting to the board on their
acceptance or rejection based on the company‘s current financial strategic
objectives, ethical and other commercial considerations.

Your responsibilities demand that you keep yourself current with both the
company‘s internal and external operating environments so as to be able to
contribute objectively to the company‘s strategic thrust.

139
 Exhibit 2

Repositioning Tito shoes in Nigeria

To reposition Tito shoes in Nigeria, we have decided to partner with Tito

international to build a shoe plant in Abuja. This shoe plant would provide jobs for
more than 128 Nigerians. The plant which would be situated at the Idu Industrial
Layout in Nigeria‘s capital, would be fully manned by Nigerians, and would be
making the full range of Tito shoes. At the moment, we are sensitising the market
for Tito shoes in Nigeria by establishing a retail shop in Abuja that sells the full
range of Tito shoes and accessories. The response of the customers has given us
more motivation to go into the production of Tito shoes in Nigeria. Everybody
working in the retail store is a Nigerian.

At the moment, we have six people undergoing training as supervisors at the Tito
factory. The Tito retail outlet is situated at the Silver Entertainment Centre, Central
Business District, Abuja. We believe that the return of Tito would improve the
country‘s economy. To have the confidence to partner with us and come back is a
good sign also for the country. Government is also trying to attract foreign
investment; whether direct or indirect. Nigerians can expect what they have
always known about Tito. First of all, its quality and affordability. At present,
there are plans to expand to other states in the country by opening a retail shop in
each state capital. We are also not losing our tradition. We are bringing the old
with the new and we are infusing both to satisfy our customers.

140
 Exhibit 3

Dotmak Nigeria Limited: history, operations, competitors, board and

management

History
Dotmak Nigeria Limited (DNL) was established by Mr. Jude Duru. Mr. Duru trained
as a mechanical engineer and has worked for several years in Tito factory based in
Canada. Mr. Duru returned to Nigeria in January 2014 to establish a shoe factory.
In June 2014, Mr Duru established Dotmak Nigeria Limited to manufacture men‘s,
women‘s and children‘s shoes. Since inception, DNL has grown rapidly and made
an incursion into the production of military and para-military forces‘ shoes and
accessories. Dotmak shoe is renowned for its comfort, quality and durability, which
have made it a household name in Nigeria.

Since its incorporation in 2014, Dotmak Nigeria Limited, with its slogan, ‗Keep
Africa Walking‘, aims at ensuring that it produces made-in-Nigeria shoes that can
compete in the global market at affordable prices. Producing quality foot wears for
oil companies, factories, military and para-military organisations, is the company‘s
own way of contributing its quota to the development of the economy and boosting
the efficiency and overall productivity of these entities.

The factory, built to the best international standard, has produced boots for the
Nigerian Army, Nigeria Police, ‗Back to School‘ shoes for numerous nursery,
primary, and secondary schools. The company also produces industrial safety shoes
for construction and oil and gas companies; and combat/jungle boots & service
shoes for the military and para-military institutions.

Operations
DNL has its factory in Lagos and it is equipped with modern machines and
equipment, for shoe production. Dotmak also has well-trained specialists in
making handcraft shoes and shoe designers. The factory has capacity to produce
1,000 shoes in a day and working for 260 days in a year.

Staff of Dotmak are not allowed to join the labour union and have been made to
sign an agreement that they will not form any union. Conditions of service are not
very attractive, but because of the unemployment situation in the country, workers
are made to work twelve hours per day without adequate overtime payment.
Provision for annual leave is a week for all categories of staff.

All the raw materials of the company are sourced locally and this has made the
company‘s shoes truly Nigerian. Apart from occasional shortages, all the materials
are available all the year round.

141
The company sells mostly to its distributors but also maintains demonstration
showrooms in Lagos, Abuja and Port Harcourt, where its shoes are displayed and
sold to customers. However, all contract customers, such as schools, the armed
forces and para-military agencies, are allowed to deal directly with the company.

One of the problems faced by the company in its factory is power shortage and the
company has to depend on alternative electricity at a very high cost. Therefore, the
company has made an unwritten agreement with the officials of the power
distribution company in the area to provide uninterrupted 8-hour supply of power
to the company on a daily basis for a monthly payment to these officials. The
company does not ask for receipt for this payment.

Board and management

DNL is run by a board of four directors, with Mr. Jude Duru as the chairman/chief
executive, Mrs. Josephine Duru and two independent non-executive directors. Only
Mr. Duru works as an executive of DNL and he is assisted by a General manager
who is a seasoned cobbler. The management team comprises:

Mr. Jude Duru Chairman/chief executive

Mr. Taiwo Opeolu General manager
Mr. Joseph Apororo Finance Controller
Mallam Sani Tijani Factory manager
Mrs Mary Arochukwu Administration/purchasing manager

142
 Exhibit 4

The challenges and opportunities of the shoe industry in Nigeria

The leather industry was a major contributor to the Nigerian economy in the past,
however, due to neglect and unfavourable economic climate and little or no
encouragement from the government in the area of policy formulation, the industry
suffered a decline.

Challenges of the leather industry

Most of the challenges faced by the industry are:

Importation of cheap shoes into the country: With mass-produced shoes

flooding the Nigerian market from all over the world in recent time, there is a need
for government to arrest the trend through a deliberate action that would help
reposition the leather industry. Whereas, if the industry is repositioned, capital
flight associated with the importation of foot wears from countries like Taiwan,
South Korea, China, Vietnam, India and Indonesia would become a thing of the
past.

Changing Consumer Preferences: The 21st-century consumers are more educated

and knowledgeable and as a consequence, they become more demanding and
inquisitive in their search of information of the product. This presents a serious
challenge to shoemakers, as they have to follow and quickly adapt to consumer
preferences, which are fundamental in purchasing decisions.

It is not only about adapting to new fashion trends but considering the whole new
set of desires and beliefs. For instance, many consumers search for transparency
and security. They want to ensure that the footwear they buy is safe and that it was
made according to existing regulations. For these consumers, it is important that
products are made from good quality materials, feel comfortable and won‘t bring
any hazard to their health. Some consumers also show concern for where and how
their products are made. Therefore, footwear companies must then re-think and
adapt their products to best-fit consumers‘ desires.

Poor power supply: Poor power supply reduces productivity considerably and is
mentally draining. Using alternatives throws production costs off the charts.

Inconsistent local raw materials: Then, there is the problem of inavailability of

raw materials. The quality of materials from local suppliers is inconsistent.
Materials and tools can be good one month, and be absolutely terrible the next.
This makes planning production schedule extremely frustrating. Accessories which
are the main materials in shoe design range could disappear from the market for
months, resurfacing later, after hope has been lost and design discarded.

143
Going further down the long list of problems shared by the community of designers,
lack of equipment is repeated a lot. Very creative concepts get trashed because it is
impossible to use the available equipment to execute them properly. Some
designers of high-heeled or non-regular shoes resort to outsourcing their
production to companies in Turkey, Lisbon, Italy or China. This waters down the
‗Proudly Nigerian‘ mantra that got them started in the first place. One would
attempt to purchase these machines, but again, there are no skilled operators and
that is the next huge problem.

Funding: The cost of importing machinery and equipment, and running the factory
is enormous and bank loans are difficult and expensive to source.

Opportunities
Rapid Pace of Urbanisation: Urbanisation is a global phenomenon and one of the
main drivers of increasing demand for consumer goods, especially footwears.
According to Professor Alberto Castro, from the Catholic University of Portugal in
the study –―Footwear Consumer 2030‖, it is expected that global urbanisation will
rise from 51.1% to 60% by 2030. And this is a phenomenon occurring on a much
larger scale in developing countries, when compared to developed ones. Therefore,
demand for shoes and other related products will continue to increase in the
majority of international markets and most especially in developing countries.

E-Commerce: E-Commerce has become a premier platform for sale of shoes. Its
strength over traditional brick and mortar modes is that it can offer selection,
convenience and value. These three elements are prime factors for the footwear
industry. Where the restraints of a physical store limit the amount of styles and
sizes available at any given time, e-commerce can virtually make any and every
shoe available, often at a better price, without the hassle of shopping in person. In
2012, online shoe sales globally increased to over $7.8 billion, according to Daily
Deal Media. As more companies embrace this mode, the opportunity for more
revenue is there.

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 Exhibit 5

Dotmak Nigeria Limited management accounts – 2016 to 2018

Dotmak Nigeria Ltd

Management accounts
Notes
Income statement for the
year ended 30 September Notes 2018 2017 2016
₦000 ₦000 ₦000
Revenue 1 731,860 622,380 507,800
Factory costs 2 (288,840) (245,580) (196,320)
Gross profit 443,020 376,800 311,480
Distribution costs 3 (52,780) (43,060) (33,940)
Selling expenses 4 (263,400) (223,700) (183,600)
Administrative expenses 5 (103,280) (85,080) (68,180)
Operating profit 23,560 24,960 25,760
Net finance (expense)/income (340) (780) 1,380
Profit before taxation 23,220 24,180 27,140
Taxation (5,800) (6,040) (6,780)
Profit for the year after taxation 17,420 18,140 20,360

Statement of financial position

as at 30 September 2018 2017 2016
₦000 ₦000 ₦000

Non-current assets
Tangible assets 6 139,820 104,820 67,220

Current assets
Inventories 7 40,780 36,260 29,420
Accounts receivable 8 21,840 20,300 16,240
Cash and cash equivalents 240 - 14,600
62,860 56,560 60,260
Total assets 202,680 161,380 127,480

Shareholders' equity
Ordinary share capital 2,000 2,000 2,000
Retained earnings 91,000 73,580 55,440
Total shareholders' equity 93,000 75,580 57,440
Current liabilities
Accounts payable 9 109,680 85,520 70,040
Bank overdraft - 280 -
Total current liabilities 109,680 85,800 70,040
Total equity and liabilities 202,680 161,380 127,480

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Statement of cash flows for the
year ended 30 September 2018 2017 2016
₦000 ₦000 ₦000
Profit before tax 23,220 24,180 27,140
Adjustments for:
Depreciation & loss on disposals 34,560 33,520 19,880
Net finance expense 340 780 (1,380)
58,120 58,480 45,640
Changes in inventories (4,520) (6,840) (2,680)
Changes in accounts receivable (1,540) (4,060) (4,040)
Changes in accounts payable 24,400 16,220 7,680
Cash generated from operations 76,460 63,800 46,600
Taxation paid (6,040) (6,780) (6,340)
Net finance expense paid (340) (780) 1,380
Net cash from operating activities 70,080 56,240 41,640
Investing activities
Purchase of non-current assets (70,680) (72,820) (30,260)
Proceeds from disposal of non-current
assets 1,120 1,700 1,040
Net cash used in investing activities (69,560) (71,120) (29,220)
Net change in cash and cash
equivalents 520 (14,880) 12,420
Cash and cash equivalents at start of
year (280) 14,600 2,180
Cash and cash equivalents at end of
year 240 (280) 14,600

Notes to the management accounts

Note 1 Revenue
2018 2017 2016
₦000 ₦000 ₦000
Men‘s shoes 230,840 195,060 172,960
Women‘s and children‘s shoes 501,020 427,320 334,840
731,860 622,380 507,800
Note 2 Factory costs
Factory wages 102,420 85,720 67,820
Materials 163,560 135,720 108,440
Manufacturing overheads 22,860 24,140 20,060
288,840 245,580 196,320
Note 3 Distribution costs
Delivery vehicle running costs (fuel, etc.) 7,220 6,060 5,560
Distribution overheads and salaries 10,300 8,580 5,960
Courier and related delivery services 35,260 28,420 22,420
52,780 43,060 33,940

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 Note 4 Selling expenses
Retail outlets
Retail outlet costs 115,480 98,500 83,160
Refurbish, depreciation & loss on disposals 13,420 12,040 10,100
Retail outlet wages 85,720 74,840 65,880
214,620 185,380 159,140

Web and IT
Web costs 29,780 24,060 14,880
Computer & IT running costs 9,520 7,220 6,920
IT depreciation & loss on disposals 9,480 7,040 2,660
48,780 38,320 24,460
Total selling expenses 263,400 223,700 183,600
Note 5 Administration expenses
Design office and prototype costs 17,380 12,440 9,960
Marketing, advertising and catalogue 29,040 25,120 17,860
Administration staff salaries 25,560 22,960 19,780
Office costs including training 20,160 16,680 14,420
Legal and professional costs 5,160 3,520 2,720
Other costs 5,980 4,360 3,440
103,280 85,080 68,180

Note 6 Non-current assets

Tangible assets
Plant & IT Outlet Vehicles Total
Machinery Equipment Refurb.
& fittings
₦000 ₦000 ₦000 ₦000 ₦000
Cost
At 1 October 2015 79,040 21,480 46,160 4,440 151,120
Additions 5,840 3,700 17,120 3,600 30,260
Disposals (2,960) (700) (7,240) (2,240) (13,140)
At 30 September 2016 81,920 24,480 56,040 5,800 168,240
Depreciation
At 1 October 2015 55,720 11,940 23,340 2,240 93,240
On disposals (2,140) (460) (7,240) (1,240) (11,080)
Charge for the year 5,380 2,500 10,100 880 18,860
At 30 September 2016 58,960 13,980 26,200 1,880 101,020
Carrying amount
at 30 September 2016 22,960 10,500 29,840 3,920 67,220
Cost
At 1 October 2016 81,920 24,480 56,040 5,800 168,240
Additions 30,960 16,820 21,920 3,120 72,820
Disposals (29,720) (10,700) (13,440) (1,640) (55,500)
At 30 September 2017 83,160 30,600 64,520 7,280 185,560
Depreciation

147
At 1 October 2016 58,960 13,980 26,200 1,880 101,020
On disposals (24,140) (8,160) (13,440) (920) (46,660)
Charge for the year 8,340 4,760 12,040 1,240 26,380
At 30 September 2017 43,160 10,580 24,800 2,200 80,740
Carrying amount
at 30 September 2017 40,000 20,020 39,720 5,080 104,820
Cost
At 1 October 2017 83,160 30,600 64,520 7,280 185,560
Additions 16,920 26,440 26,640 680 70,680
Disposals (4,720) (9,340) (16,720) (880) (31,660)
At 30 September 2018 95,360 47,700 74,440 7,080 224,580
Depreciation
At 1 October 2017 43,160 10,580 24,800 2,200 80,740
On disposals (3,360) (6,760) (16,720) (480) (27,320)
Charge for the year 9,440 7,440 13,420 1,040 31,340
At 30 September 2018 49,240 11,260 21,500 2,760 84,760
Carrying amount
At 30 September 2018 46,120 36,440 52,940 4,320 139,820
Notes to the management accounts

Note 7 Inventories
2018 2017 2016
₦000 ₦000 ₦000
Raw materials 6,300 4,440 2,140
Work in progress 660 560 320
Finished goods 33,820 31,260 26,960
40,780 36,260 29,420
Note 8 Accounts receivable
Trade receivables 14,080 13,040 10,060
Prepayments 5,340 4,980 4,160
Sundry receivables 2,420 2,280 2,020
21,840 20,300 16,240
Note 9 Accounts payable
Trade payables 88,300 65,900 51,120
Taxes and social charges 16,040 14,640 14,260
Accruals 5,340 4,980 4,660
109,680 85,520 70,040

148
 Exhibit 6

Dotmak Nigeria Limited: Cost/pricing structure

Factory costs per pair of shoes

Note: figures shown are for the year ended 30 September 2019 (approximately
240,000 pairs)

Approximate labour costs per pair of shoes produced and sold in 2019
Adult Children
₦ ₦
Basic wage-employee cost 486.00 69.43
Average wage-employee cost 1,687.50 241.07
Skilled wage-employee cost 1,399.50 199.93
Management add-on-costs 1,332.00 190.28
4,905.00 700.71
Approximate materials costs per pair of shoes Adult Children
produced ₦ ₦
Leather for uppers 4,680.00 668.57
Soles 2,025.00 289.28
Insoles/"socks" 585.00 83.57
Laces, fastenings, etc 405.00 57.86
Packaging 135.00 19.29
7,830.00 1,118.57

Approximate factory overheads per pair of shoes produced

Adult Children
₦ ₦
Rent and rates 220.50 31.50
Power and services charges 153.00 21.86
Depreciation, repairs and maintenance charges 720.00 102.86
1,093.50 156.22
Average total factory costs per pair of shoes in the 1,975.50
year 13,828.50

For most calculation purposes, DNL uses ₦13,850.00 for adults and ₦2,000 for
children as the rounded figure. The cost for a pair of leather slippers is 75% of the
cost for a pair of shoes.

It is the practice of Dotmark Nigeria Limited to add 30% mark up for all shoes
made.

149
 Exhibit 7

Press article

Tito Nigeria To Invest N360m On Leather Plant In FCT

April 3, 2019

Tito Nigeria Limited said that it would invest about one million dollars, (N360
million) in the building of its new leather factory in the Federal Capital Territory
(FCT). Speaking during the formal opening of retail outlet in Abuja at the weekend,
the spokesperson of the company, Tobe Eze, explained that the new factory, which
would be located in Idu Industrial Area, would be ready in June. Eze added that
when completed, the factory would offer employment opportunity to many
unemployed youths in the FCT.

He maintained that the factory, when completed would be manned by Nigerians,

while efforts would also be made to extend the company‘s operations to other parts
of the country. The spokesperson stated that Tito Nigeria Limited is now in the
country to continue to offer Nigerians affordable and durable leather and shoe
products, which the company is noted for. He continued: ―We are also putting in
place measures to ensure that the business is sustained. Nigerians should expect a
new trend of shoes, which is what Tito is known for. This is because today‘s youths
want to wear new trendy shoes.‖

150
UNSEEN

151
 November 2020 Case Study: Dotmak Nigeria Limited (DNL)

List of exhibits

The following exhibits are newly provided and did not form part of the materials
provided as Pre-seen:
8. Email from Joseph Apororo to Ibrahim Danladi
9. Dotmak Nigeria Limited: management accounts for the year ended 30
September 2019.
10. Proposed shoe manufacturing plant projections.
11. 3-year supply contract from Faith Group of Schools.

Dotmak Nigeria Limited (DNL): Case Study requirement

You are Ibrahim Danladi, writing the final level of ICAN Professional Examination,
working as management accountant with Dotmak Nigeria Limited, a company that
produces and distributes men‘s and women‘s shoes. You report to Joseph Apororo,
the company‘s financial controller.

Requirement
You are required to prepare a draft report for the DNL board, as set out in the email
dated 6 October 2019 from Joseph Apororo to you (Exhibit 8). Your report should
comprise the following:
 An executive summary
 Responses to the two detailed requirements set out in exhibit 8, including
appropriate appendices.

State clearly any assumptions you have made. All workings should be attached to
your answer.

The following time allocation is suggested:

 Reading and planning 1 hour
 Performing calculations and financial analyses 1 hour
 Drafting report 2 hours

Ensure that you address the two requirements in your report or failure to address
any requirement including not submitting an executive summary will affect your
chances of success. In addition, as indicated in the Pre-seen, all four skills areas
will be assessed under each of the four elements of your report. Accordingly, not
demonstrating your judgement or failing to include appropriate conclusions and/or
recommendations in each of your reports will adversely affect your chances of
success.

152
 Exhibit 8

Email from Joseph Apororo to Ibrahim Danladi

EMAIL

From: Joseph Apororo

To: Ibrahim Danladi
Subject: Board meeting
Date: 6 October 2019

As you are aware, the next board meeting, at which our operational and strategic
plans for the coming year will be considered, is in two weeks. At this meeting, the
board would like to review our performance, to assist the board in taking decision
on our business proposals.

Therefore, I will like you to carry out:

i. A detailed review of our management accounts for the last four years under
the following headings: profitability; position; and prospect. You are also to
comment briefly on the performance and prospect of each of the two revenue
streams;

ii. An evaluation of the contract from Faith Group of Schools, to show what
impact it will have on our profitability; and

iii. An evaluation of the proposed Tito factory to show whether or not the
company would be able to recover its investment on the project.
I attach herewith exhibits 8 to 10 in respect of details of our strategic plan, Faith
Group of Schools‘ business proposal, and management accounts for the year ended
30 September 2019. You can find in your file, the management accounts for the
previous three years.
Please draft for my review, a report to be submitted to the board. Your report
should comprise:

(1) An evaluation of the company‘s performance as reflected in its management

accounts for the year ended 30 September 2019 as presented in exhibit 8.
Your evaluation should comprise an analysis of the key changes in
profitability, position and prospect of the company in comparison with the
previous three years to 30 September 2018; and

(2) A critical evaluation and assessment of the two business proposals as

contained in exhibits 9 and 10. You are to calculate the projected addition to

153
contribution from the Faith Group of Schools‘ contract and show if DNL
would be able to recover its investment in the proposed Tito Shoe factory.
Also, discuss any broader commercial and ethical considerations as well as
the risks that may be associated with these business proposals.

I look forward to receiving your draft report.

Joseph

154
 Exhibit 9

Dotmak Nigeria Limited: management accounts for the year ended 30

September 2019
Dotmak Nigeria Limited Management accounts
Note
Income statement
Year ended 30 September 2019
₦000
Revenue 1 777,740
Factory costs 2 (317,460)
Gross profit 460,280
Distribution costs 3 (62,140)
Selling expenses 4 (282,120)
Administration expenses 5 (113,640)
Operating profit 2,380
Net finance expense (620)
Profit before taxation 1,760
Taxation (440)
Profit for the year after taxation 1,320

Statement of financial position

As at 30 September 2019
₦000
Non-current assets
Tangible assets 6 115,540
Current assets
Inventories 7 46,860
Accounts receivable 8 22,940
Cash and cash equivalents 15,360
85,160
Total assets 200,700
Shareholders' equity
Ordinary share capital 2,000
Retained earnings 92,320
Total shareholders' equity 94,320
Current liabilities
Accounts payable 9 106,380
Total current liabilities 106,380
Total equity and liabilities 200,700

Dotmak Nigeria Limited

Year ended 30 September 2019
₦000
statement of cash flows
Profit before tax 1,760
Adjustments for:
Depreciation & loss on disposals 36,120

155
Net finance expense 620
38,500
Change in inventories (6,080)
Change in accounts receivable (1,100)
Change in accounts payable 2,060
Cash generated from operations 33,380
Taxation paid (5,800)
Net finance expense (620)
Net cash from operating activities 26,960
Investing activities
Purchase of non-current assets (12,320)
Proceeds from disposal of non-current assets 480
Net cash used in investing activities (11,840)
Net change in cash and cash equivalents 15,120
Cash and cash equivalents at start of year 240
Cash and cash equivalents at end of year 15,360

Notes to the management accounts

Note 1 Revenue
2019
₦000
Men's shoes 237,960
Women‘s and children‘s shoes 539,780
Total 777,740
Note 2 Factory costs
Factory wages 112,940
Materials 179,540
Manufacturing overheads 24,980
317,460
Note 3 Distribution costs
Delivery vehicle running costs 7,540
Distribution & appropriated overheads 11,580
Courier and related delivery services 43,020
62,140
Note 4 Selling expenses
Retail outlets
Retail outlet costs 124,560
Refurbishment depreciation & losses 17,300
Retail outlet wages 90,320
232,180
Web and IT
Web costs 31,960
Computer & IT running costs 9,700
Depreciation & loss on disposals 8,280
49,940
Total selling expenses 282,120

156
 Note 5 Administration expenses
Design office and prototype costs 19,020
Marketing, advertising and catalogue 29,780
Administration staff salaries 27,520
Office costs including training 22,780
Legal and professional 7,860
Other 6,680
113,640

Note 6 Non-current assets

Tangible assets
Plant & Equipment Outlet Vehicles Total
Machinery & Fittings Refurb
₦000 ₦000 ₦000 ₦000 ₦000

Cost
At 1 October 2018 95,360 47,700 74,440 7,080 224,580
Additions 520 4,280 7,080 440 12,320
Disposals (740) (1,160) (7,240) (1,120) (10,260)
At 30 September 2019 95,140 50,820 74,280 6,400 226,640
Depreciation
At 1 October 2018 49,240 11,260 21,500 2,760 84,760
On disposals (420) (760) (4,100) (680) (5,960)
Charge for the year 9,260 8,040 14,160 840 32,300
At 30 September 2019 58,080 18,540 31,560 2,920 111,100
Carrying amount
At 30 September 2019 37,060 32,280 42,720 3,480 115,540

Note 7 Inventories
2019
₦000
Raw materials 7,240
Work in progress 840
Finished goods 38,780
Total 46,860
Note 8 Accounts receivable
Trade receivables 14,840
Prepayments 5,520
Sundry 2,580
22,940
Note 9 Accounts payable
Trade payables 82,380
Taxes and social charges 18,220
Accruals 5,780
106,380

157
 Exhibit 10

Proposed shoe manufacturing plant projections

The following are the projections for the planned Tito factory:

Project cost: 1. The total cost of the project, i. e. factory building, plant and
equipment, is ₦360million.

2. There will be ₦40million investment in working capital.

Revenue projection: The plant is projected to be able to produce and sell shoes
as follows:

First year – 20,000 pairs

Second to fifth years – 30,000 pairs each.

Contribution per pair of shoes is projected as follows:

₦6,000, with a probability of 20%;
₦5,000, with a probability of 30%; and
₦4,000, with a probability of 50%.

Cost of capital: The cost of capital is projected at 18% per annum.

Note: It is the practice of Dotmak Nigeria Limited to recover its investment on a

project like this in five years.

158
 Exhibit 11

3-year supply contract from Faith Group of Schools

Email

From: Janet Oluwaseye – Faith Group of Schools

To: Jude Duru – Dotmak Nigeria Limited
Subject: Special order
Date: 20 September 2019

I am pleased to inform you that our school board is very satisfied with the shoes
you supplied to one of our schools during the last school session. The board has
therefore, chosen your company‘s back-to-school shoes for all our schools. This
means that your company will be required to produce between 20,000 and 25,000
shoes at the beginning of every school session for distribution to our various
schools, nationwide.

Our school board is prepared to enter into a three year contract to start with and
this may be renewed based on our continued satisfaction with the level of quality
and comfort of shoes supplied.

Details of the contract are:

a. We are asking for a little change in the design of the shoes to reflect Faith
Group of Schools‘ signature on the buckle of each shoe.

b. The colour of the shoes will be as follows:

 Black to be used during classes, for every pupil, approximately 20,000

pairs per session; and
 Brown slippers, after-school-wear by pupils; staying in the hostel;
approximately 5,000 pairs per session;

c. The school board is requesting for a quantity discount of 20% off your normal
selling prices.

I will be grateful to receive your response to this request, which I believe makes
business sense, being an additional revenue to your normal business.

Janet

159
ICAN CASE STUDY NOVEMBER 2020

DATE CANDIDATE NO.

TIME MARKER NUMBER

Exc Summary Req 1 Req 2 Overall TOTAL

SA
CA
BC
NC
V
Total 5 8 8 4 25

160
 Executive Summary: Dotmak Nigeria Limited

General 4. Requirement 2: Conclusions

 States the purpose of the report  Faith Group of School's order will result in additional contribution

 States the assumptions  The proposed Tito factory is viable as the company will be able to recover its

investment in five years.

 
 States reservations, e. g. scepticism  The staff condition of service is poor.

 Not allowing the staff to join labour union is a bad industrial

relations practice.

V NC BC CA SA V NC BC CA SA

2. Requirement 1: Conclusions 5. Requirement 2: Recommendations

 Operating expenses is eating into the company's profitability.  Accept Faith Group of Schools' order if not working currently at full capacity.

 Liquidity has become a problem.  The company should invest in the proposed shoe factory.

 There has been financial mismatch  The company should improve the conditions of service.

 The prospect for future profit is bleak.  Staff should be given freehand to join the labour union, if they wish.


-
V NC BC CA SA V NC BC CA SA

3. Requirement 1: Recommendations

 Institute cost control over operating expenses.

 Stop using short term funds for acquisition of long term assets.
 Reduce inventory holding to reduce working capital requirements.
 Look for cheaper sources of raw materials.

V NC BC CA SA V

161
 REQUIREMENT 1 - Dotmak Nigeria Limited's financial statement analysis.


1 USES DATA AND INFORMATION APPROPRIATELY 4 IDENTIFIES ISSUES AND OPTIONS

 
 Uses information on exhibits 5 and 9 - income statement to show  Identifies that although revenue is increasing, operating
trend of DNL operating performance. profit is decreasing.
 
 Uses information on exhibits 5 and 9- statement of financial
  Identifies that gross profit margin is gradually decreasing.

position to calculate relevant ratios.
 
 Uses information on exhibits 5 and 9 - notes to 
 management  Identifies that operating expenses have been increasing. .
accounts to show trend in performance of each revenue stream.
 
 
 Uses information on exhibits 5 and 9 to show trend in DNL's

trend in working capital
  Identifies that the company’s liquidity is very poor, although

 it is gradually improving.
 
 V NC BC CA SA  V NC BC CA SA
 
 
2 USES PROFESSIONAL TOOLS AND KNOWLEDGE 5 APPLIES PROFESSIONAL SCEPTICISM AND ETHICS

  Recognises that unless DNL's management do

 Calculates gross margin ratios  something,
the company may not continue in business for a long time.
 
  Calculates operating profit ratios
 
 Recognises that the company's liquidity is poor.

  Calculates net profit ratios.


162
  Recognises that with the trend in increase in trade payable,

  Prepares trend analysis to determine growth in performance the suppliers may stop supplying to DNL on credit.

 of DNL
 
 Recognises that debts of the company is more than the

 Calculates other relevant ratios. equity capital.

 
 Shows calculations to explain the performance and prospects
of the two revenue streams. 
 
 V NC BC CA SA  V NC BC CA SA
 

 3 USES ANALYTICAL SKILLS (material points) written report 
6 EVALUATIVE SKILLS AND JUDGEMENT


  
Determines trend in DNL's revenue.  Recognises that revenue has been growing steadily from
 year to year.
 

  Determines trend in DNL's gross margin
   Recognises that the company' s return on capital employed

 has reduced from 20.21% in 2016 to 1.19% in 2019
  

  
Determines trend in DNL's operating expenses.  Recognises that return on equity has dropped from
 35.45% in 2016 to 1.40% in 2019.
  
 Determines trend in working capital ratio.
   Recognises that the company's net after tax profit margin

 has dropped from 4.01% in 2016 to 0.017% in 2019, a
 Determines trend in return of capital employed.
   precarious situation.

 
Determines trend in operating profit margin.
 V NC BC CA SA  V NC BC CA SA


163
7 CONCLUSIONS
(Draws distinct conclusions under a heading)

 Concludes that continous increase in operating expenses is

a problem.

 Concludes that the liquidity position of the company is a threat
to its future prospect.

 Concludes that the suppliers may stop supplying materials to

DNL on credit.

 Concludes that if the trend continues, the company will make

losses in the coming years.

 Concludes that women's and children's shoes contribute to

the company's revenue better than men's shoes.
 V NC BC CA SA


8 RECOMMENDATIONS (commercial / relevant)

 Recommends that DNL should halt using current capital to


finance non current assets.
 Recommends that the company should strive to reduce

operating expenses through cost control.

 Recommends that the company should explore possibility
of sourcing raw materials from cheaper sources.
 Recommends that the company should explore the possibility
 of reducing its inventory holdings.

 V NC BC CA SA


164
 REQUIREMENT 2 -Appraisal of Faith Group of School's contract proposal and proposed Tito shoe factory

USES DATA AND INFORMATION

1 APPROPRIATELY 4 IDENTIFIES ISSUES AND OPTIONS

 Uses information in exhibit 6 to determine cost per

  Identifies that ability to produce and sell the estimated number of pairs of

pair of shoes and slippers. shoes yearly is critical to the viability of the proposed Tito factory.
 
 Uses additional information in exhibit 11 to determine selling
  Identifies that the achievement of the expected contribution is critical to the

price per pair of shoes and slippers. viability of the proposed Tito factory.
 
 Uses information in exhibit 11 to determine total cost of
  Identifies that DNL should inform Faith Group of Schools that if cost of

Faith Group of Schools order production increases, they will increase their selling price per pair of shoes
  to Faith Group of Schools.
 Uses information in exhibit 11 to determine total sales value
  Identifies that the contribution from the order from Faith Group of Schools is

of Faith Group of Schools order lower than the normal contribution, therefore, if the company currently has no
  spare capacity, the order should not be accepted.
 Uses information in exhibit 11 to determine the total
 
contribution from Faith Group of Schools order. 
 
 Uses information in exhibit 10 to evaluate the proposed Tito
 
factory. 
 
 
V NC BC CA SA V
NC BC CA SA
2 USES PROFESSIONAL TOOLS AND KNOWLEDGE 
5 APPLYING PROFESSIONAL SCEPTICISM AND ETHICS
(written into report)
  Discusses the veracity of not allowing the staff to join the labour
Determines the cost per pair of shoes and slippers.  union.


Determines the selling price per shoes and slippers for 
Discusses the issue of the staff conditions of service in Dotmak
 Faith Group of Schools' order. Nigeria Limited.
 
165
Determines the total cost of sales of Faith Group of Schools' order. Discusses the issue of leave for the staff of Dotmak Nigeria Limited.


Determines the total sales value of Faith Group of Schools' order. 
Discusses the working hours per day at Dotmak Nigeria Limited
Discusses that unofficial payment to Nigerian Power Holding's staff
Determines the net contribution from Faith Group of Schools' order  is an ethical breach.
Determines the yearly contribution from the proposed Tito.
factory. 

Determines the net present value of the yearly contribution of the 
proposed Tito factory. 

Determines the net present value of the proposed Tito factory 

V NC BC CA SA V
NC BC CA SA
  
3 USES ANALYTICAL SKILLS (material points) 6 EVALUATIVE SKILLS AND JUDGEMENT
 (uses analytical headings)

Calculates the selling price to Faith Group of Schools. 
Evaluates the expected contribution per pair of shoes from the
 order. proposed Tito factory.

Calculates the factory cost per pair of shoes and slippers. 
Calculates the total contribution from Faith Group of Schools' 
Evaluates the net present value of the proposed shoe factory..


Calculates the yearly contribution of the proposed Tito 
Evaluates the net contribution from Faith Group of Schools' order
 factory.

Calculated the present values of the yearly contribution from 
Evaluates the net contribution form Faith Group of Schools if factory
 the proposed Tito factory. overhead is treated as a fixed cost.

Calculates the net present value of the proposed Tito factory. 
Evaluates the loss in contribution as a result of accepting the order from F
 Group of schools, if the company is currently working at full capacity.

Calculates loss in contribution, if the company is currently 
working at full capacity, and still accepts the order of Faith 
 Group of Schools. 
 
V NC BC CA SA V
NC BC CA SA

 

166
7 CONCLUSIONS
(Draws distinct conclusions under a heading)

 Concludes that the order from Faith Group of Schools
will result in additional contribution

 Concludes that the company will be able to recover its

investment in the proposed Tito factory in 5 years.

 Concludes that the company will need to look into the staff
conditions of service.

 The management of DNL should allow the staff to join

the labour union if they so wish.

 Concludes that the order from Faith Group of Schools is

not worthwhile, if the company is currently working at full
 capacity.

 V NC BC CA SA

8 RECOMMENDATIONS (commercial / relevant)

 Recommends that the contract from faith Group of Schools


will results in an additional contribution of between ₦2.5m to ₦6.2m

 Recommends that the management of DNL should undertake
the proposed Tito factory project as it has a positive NPV of
 ₦18.6m
 Recommends that the management of DNL should improve on

the company's condition of staff.
 Recommends that the staff of DNL should be given freedom to

join the labour union if they so wish.
 Recommends that DNL should not accept the order from

Faith Group of Schools if the company is currently working
 at full capacity.
 V NC BC CA SA


167
 Appendices Main Report
 

1 Appendices R1: Content and style  3 Report: Structure

  
 Shows trend of DNL's operating performance-income 
statement 
 Sufficient appropriate headings
 Shows appropriate profitability ratios  Appropriate use of paragraphs / sentences
 Shows appropriate ratios on the company's liquidity and leverage position  Legible/clear hand writing
 Shows appropriate ratios to evaluate the company's future prospects  Correctly numbered pages
 Shows calculations to explain the performance and prospects of the two revenue streams. 
 V NC BC CA SA 4 V  NC BC CA SA
2 Appendices R2: Content and style  Report: Style and language
 Shows expected contribution per pair of shoe  Relevant disclaimer (external report)
 in the proposed Tito plant 
 Shows the total expected contribution per 
 Suitable language for the board
 annum in the proposed Tito plant 

 Tactful / ethical comments
 Shows the NPV of the proposed Tito plant
 

 Shows the additional contribution from the  Acceptable spelling and punctuation
 Faith Group of Schools' contract. 
 Shows loss in contribution if the Faith Group of Schools   
 order is accepted when the company is working at full capacity  
 V NC BC CA SA  V NC BC CA SA

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Appendix 1
Financial statement analysis
Dotmak Nigeria Limited
CHANGE CHANGE
2016 2017 CHANGE CHANGE % 2018 CHANGE % 2019 CHANGE %
₦000 ₦000 ₦000 ₦000 ₦000 ₦000 ₦000
Revenue 507,800 622,380 114,580 22.6 731,860 109,480 17.6 777,740 45,880 6.27
Factory costs -196,320 -245,580 -49,260 25.1 -288,840 -43,260 17.6 -317,460 -28,620 9.91
Gross profit 311,480 376,800 65,320 21.0 443,020 66,220 17.6 460,280 17,260 3.90
Distribution expenses -33,940 -43,060 -9,120 26.9 -52,780 -9,720 22.6 -62,140 -9,360 17.73
Selling espenses -183,600 -223,700 -40,100 21.8 -263,400 -39,700 17.7 -282,120 -18,720 7.11
Administrative expenses -68,180 -85,080 -16,900 24.8 -103,280 -18,200 21.4 -113,640 -10,360 10.03
-
Operating profit 25,760 24,960 -800 -3.1 23,560 -1,400 -5.6 2380 21,180 -89.90
-
Finance expenses 1,380 -780 -2,160 -156.5 -340 440 -56.4 -620 280 82.35
-
Net profit before tax expenses 27,140 24,180 -2,960 -10.9 23,220 -960 -4.0 1,760 21,460 -92.42

Ratios analysis 2016 2017 2018 2019

Profitability:
Gross margin 311,480/507800% 376,800/622,380% 443,020/731,860% 460,280/777,740%
61.34% 60.54% 60.53% 59.18%
Operating margin 25,760/507800% 24,960/622,380% 23,560/731,860% 2,380/777,740%
5.07% 4.01% 3.22% 0.31%
Net profit after tax margin 20,360/507,800% 18,140/622,380% 17,420/731,860% 1,320/777,740%
4.01% 2.91% 2.38% 0.17%
Return on capital employed
(ROCE) 25,760/127,480% 24,960/161,380% 23,560/202,680% 2,380/200,700%
20.21% 15.47% 11.62% 1.19%
Return on equity 20,360/57,440% 18,140/75,580% 17,420/93,000% 1,320/94,320%
35.45% 24.00% 18.73% 1.40%

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Current ratio 60,260:70,040 56,560:85,800 62,860: 109,680 85,160: 106,380
0.86 : 1.00 0.66 : 1.00 0.57 : 1.00 0.80 : 1.00
Acid test ratio 30,840:70,040 20,300:85,800 22,080: 109,680 38,300: 106,380
0.44 : 1.00 0.24 : 1.00 0.20 : 1.00 0.36:1
Absolute liquid ratio 14,600: 70,040 0.00:85,800 240: 109,680 15,360: 106,380
0.21 : 1.00 0.00 : 1.00 00.0 : 1.00 0.14 : 1.00
Debts to total assets 70,040/127,480% 85,800/161,380% 109,680/202,680 106,380/200,700%
54.94% 53.17% 54.11% 53.00%
Revenue to total assets 507,800/127,480 622,380/161,380 731,860/202,680 777,740/200,700
3.98times 3.86times 3.61times 3.88times
10,060/507,800
Nos of days in receivables *365 13,040/622,380*365 14,080/731,860*365 14,840/777,740*365
7.2days 7.6days 7.0days 7.0days
Nos of days in payables 51,120/108,440*365 65,900/135,720*365 88,300/163,560*365 82,380/179,540*365
172.1days 177.2days 197.1days 167.5days
No of days in stock 29,420/196,320*365 36,260/245,580*365 40,780/288,840*365 46,860/317,460*354
54.6days 53.9days 51.5days 53.9days
Return on Assets 25,760/127,480% 24,960/161,380% 23,560/202,680% 2,380/200,700%
20.21% 15.47% 11.62% 1.19%
Return on Net Asset 27,140/57,440% 24,180/75,580% 23,220/93,000% 1,760/94,320%
47.25% 31.99% 24.97% 1.87%

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Appendix 2
Dotmak Nigeria Limited
Evaluation of Faith Group of Schools' special order
Calcultion of yearly profit from contract
Black Shoes Brown slippers Total
₦ ₦ ₦
Price per pair

Cost 2,000.00 1,500.00

Mark up - 30% 600.00 450.00
Normal selling price per pair 2,600.00 1,950.00
Quantity discount - 20% 520.00 390.00
Selling price to Faith Group of Schools 2,080.00 1,560.00

Order Quantities 20,000.00 5,000.00

Sales value 41,600,000.00 7,800,000.00 49,400,000

Actual cost per pair 1,975.50 1,481.63
Order quantities 20,000.00 5,000.00

Total cost 39,510,000.00 7,408,150.00 46,918,150

Net contribution 2,090,000.00 391,850.00 2,481,850

Note: factory overhead has been treated as part of production costs since we have no information
about its variability.
An alternative treatment is to treat factory overheads as fixed cost. If this is done, the net
contribution will be:

171
 Black Shoes Brown slippers Total
₦ ₦ ₦

Sales value, as above 41,600,000.00 7,800,000.00 49,400,000

Actual cost per pair 1,819.28 1,364.46

Order quantities 20,000.00 5,000.00

Total costs 36,385,600.00 6,822,300.00 43,207,900

Net contribution 5,214,400.00 977,700.00 6,192,100

Dotmak Nigeria Limited

Calculation of loss in contribution if FGS order is accepted and the company is currently working at full
capacity.
Shoes slippers Total
₦ ₦ ₦
Normal selling price per pair 2,600 1,950

20% discount 520.00 390.00

Order quantities 20,000.00 5,000.00

Contribution lost 10,400,000.00 1,950,000.00 12,350,000

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Dotmak Nigeria Limited
Evaluation of the proposed Tito factory
Calculation of contribution per pair
Contribution Probability Expected
contribution
₦ ₦

6,000 0.20 1,200

5,000 0.30 1,500

4,000 0.50 2,000

4,700
Year 1 Year 2 - Year 5
No of pairs per annum 20,000 30,000
Contribution per pair 4,700 4,700

Total contribution per annum 94,000,000 141,000,000

Calculation of net present value
Present
Year Cash flow Disc factor value
₦million ₦million
-
Project cost 0 -360 1 360.00
-
Working capital 0 -40 1 40.00

Contribution - year 1 1 94 0.8475 79.67

Year 2 - Year
Contribution - year 2 - 5 5 141 2.2797 321.44

Working capital 5 40 0.4371 17.48

NPV

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Performance and Prospect of Revenue Streams
ACTUALS

2018- 2017- 2016-

2019 2018 2017 2016 2019 2018 2017
Profitability: N'000 N'000 N'000 N'000 Change% Change% Change%
Men's shoes 237,960 230,840 195,060 172,960 3.08 18.34 12.78
Women's and children's shoes 539,780 501,020 427,320 334,840 7.74 17.25 27.62

Examiner‘s Report
The Case Study is about a shoe-making company that decided to bring an
international shoe company that once operated successfully in the country and
became a household name, but eventually packed-up, back into the country. As a
result, Dotmak Nigeria Limited, the company, proposed to install an ultra-modern
shoe factory in Abuja for that purpose.

The company currently has a factory in Lagos that has also been operating
successfully and has been producing shoes for the armed forces in Nigeria, men
and women shoes and school children shoes.

The case scenario includes four years management accounts with appropriate
notes, both in the pre-seen and the unseen. An appendix containing the cost
structure of the company is also in the appendices in the pre-seen. In the unseen,
we have details of the costs and revenue structure of the proposed factory, and
details of contract from Faith Group of Schools that has placed a special order.
As usual, the Case Study has two requirements, as follows:

 A detail financial analysis of the four-year management accounts to reveal the

trend in the company‘s performance, position and prospect together with a
review of the performance of the company‘s two revenue streams – men and
women shoes; and
 An evaluation of the contract from Faith Group of Schools showing the
contribution from the contract and whether the contract should be accepted or
not. And an evaluation of the proposed shoe factory using net present value and
advise the board appropriately.
For candidates to perform well in the Case Study, the following appendices must be
prepared:

i. Financial analysis which must include the following: trends analysis of the
income statement; profitability ratios; efficiency ratios; liquidity ratios; and
leverage ratios;
ii. Calculation of the performance and prospect of the two revenue streams
(trend analysis);
iii. Calculation of net contribution from Faith Group of Schools contract – two
alternatives may be used, first if factory overhead is treated as a fixed cost

174
 and if factory cost is considered as part of the cost in the calculation. Both
approaches are to be marked correct;
iv. Calculation of loss in contribution if the company is working at a full
capacity and still goes ahead to accept Faith Group of School‘s contract; and
v. An investment appraisal of the proposed shoe factory.

Candidates‘ performance was very poor as only very few candidates scored up to
50%.

The commonest pitfalls of the candidates are:

 They did not calculate all the ratios required to explain the future prospect of
the company under requirement 1;
 Some of the candidates discussed SWOT analysis under requirement 1. This
was not part of the Case requirements;
 Most of the candidates did not calculate net present value to evaluate the
proposed shoe project and the few that calculated the net present value
forgot that the working capital introduced at the beginning of the project
will be recoupled at the end of the project;
 Lack of understanding of how to write a formal report with appropriate
headings and subheadings to address issues required in the Case Study
requirements; and
 Inability to write a good executive summary.
Candidates are advised to practice and perfect the art of report writing and learn to
address the specific requirements of each Case Study in future examination.

175