Alpha ltd was incorporated in 20x1 with a paid-up capital

Question

Question 1 - Victoria is a publicly listed company that would like to acquire 100% of a private company to expand its operations. It has obtained the following draft financial statements for two companies, Grappa and Merlot. They operate in the same industry and their managements have indicated that they would be receptive to a takeover.

Statement of income for the year ended 30 September 20X3

	Grappa	Merlot
	$'000	$'000
Revenue	12,000	20,500
Cost of sales	(10,500)	(18,000)
Gross profit	1,500	2,500
Operating expenses	(240)	(500)
Finance costs - loan	(210)	(300)
Finance costs - overdraft	0	(10)
Finance costs - lease	0	(290)
Profit before tax	1,050	1,400
Income tax expense	(150)	(400)
Profit for the year	900	1,000
Note: Dividends paid during the year	250	700

Statement of financial position as at 30 September 20X3

	Grappa	Merlot
Non-current assets	$'000	$'000
Freehold factory [Note (i)]	4,400	0
Owned plant [Note (ii)]	5,000	2,200
Leased plant [Note (iii)]	0	5,300
Non-current assets	9,400	7,500
Current assets
Inventory	2,000	3,600
Trade receivable	2,400	3,700
Bank	600	0
Current assets	5,000	7,300
Total assets	14,400	14,800
Equity and liabilities
Equity shares of $1 each	2,000	2,000
Property revaluation reserve	900	0
Retained earnings	2,600	800
Equity	5500	2800

Examination - January Semester 2016

Non-current liabilities
Finance lease obligations [Note (iii)]	0	3,200
7% loan notes	3,000	0
10% loan notes	0	3,000
Deferred tax	600	100
Government grants	1,200	0
Non-current liabilities	4,800	6,300
Current liabilities
Bank overdraft	0	1,200
Trade payables	3,100	3,800
Government grants	400	0
Finance lease obligations [Note(iii)]	0	500
Taxation	600	200
Current liabilities	4,100	5,700
Total equity and liabilities	14,400	14,800

Note:

(i) Both companies operate from similar premises.

(ii) Additional details of the two companies' plant are:

	Grappa	Merlot
	$'000	$'000
Owned plant - cost	8,000	10,000
Leased plant - original fair value	0	7,500

There were no disposals of plant during the year by either company.

(iii) The interest rate implicit within Merlot's finance lease is 7.5% per annum. For purpose of calculating ROCE and gearing, all finance lease obligations are treated as long-term interest bearing borrowings.

(iv) The following ratios have been calculated for Grappa and can be taken as correct for comparison with Merlot:

Return on year end capital employed (ROCE)	14.8%
Capital employed taken as shareholders' funds plus
Long-term interest bearing, see Note (iii) above
Pre-tax return on equity (ROE)	19.1%
Net assets (total assets less current liabilities) turnover	1.2 times
Gross profit margin	12.5%
Operating profit margin	10.5%
Current ratio	1.2:1
Closing inventory holding period	70 days
Trade receivables' collection period	73 days
Trade payables' payment period (using Cost of sales)	108 days
Gearing [see Note (iii) above)]	35.3%
Interest cover	6 times
Dividend cover	3.6 times

Required:

(a) Calculate for Merlot the ratios equivalents to all those given for Grappa above in (iv).

(b) Assess the relative performance and financial position of Grappa and Merlot for the year ended 30 September 20X3 to inform the directors of Victoria in their acquisition decision.

(c) Explain the limitation of ratio analysis. Analyse and identify any further information that may be useful to the directors of Victoria when making an acquisition decision.

Question 2 - This question consists of two parts (Part I and II). You are required to answer both parts.

Part I - Alpha Ltd was incorporated in 20X1, with a paid-up capital of 5,000,000 ordinary shares. Its accounting year end is 31 December each year.

On 1 October 20X4, Alpha Ltd issued 1,000,000 convertible preference shares (CPS). The CPS carries a net dividend rate of 7 cents per share (which are payable quarterly) and are convertible into ordinary shares at a rate of 1:1 as from 1 January 20X5 onwards.

Alpha Ltd profits after tax were $1,000,000 for each of the years ended 31 December 20X4 and 20X5.

Required:

To explain the effects of the above events,

(a) Compute the basic earnings per share for the year 20X4.

(b) Compute the diluted earnings per share for the year 20X4.

(c) Compute the basic earnings per share for the year 20X5.

(d) Compute the diluted earnings per share for the year 20X5.

Part II - In some cases, exercises of options or conversion of securities to shares would lead to an increased EPS.

Explain briefly a procedure used for an anti-dilution test.

Question 3 - This question consists of two parts (Part I and II). You are required to answer both parts.

Part I - On 1 January 20X0, UVC Limited issued $100,000, 9%, 5 year bonds at a premium of $4,100. It pays interest semi-annually on 1 January and 1 July. The market interest rate was 8%.

Required:

(a) Write the journal entry to issue the bond on 1 January 20X0.

(b) Construct the amortization schedule assuming that the effective interest rate is used to amortize the premium for the years from 1 January 20X0 to 1 January 20X2.

(c) Write the journal entry for the first interest payment using the effective-interest method to amortize the premium.

Part II - Describe with an example the circumstances which affect whether bonds are issued at a premium or at a discount. Name one reason why issuance of bond at a premium is rare in practical world.

Question 4 - (a) Three factors that are potential sources of noise and bias that may affect the quality of accounting are (i) manager's accounting choices; (ii) rigidity in accounting rules; and (iii) random forecast errors. Comment on how accounting regulation can affect each of those factors and the quality of accounting.

(b) List and describe four (4) red flags that would alert an analyst conducting financial statement analysis. For each red flag, discuss what are some questions that need to be answered by a more detailed analysis of the company.