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ATAX – May 2022 – L3 – Q6 – Taxation of Non-Resident Companies and Individuals

Discuss the tax implications of an overseas branch and compute the associated tax liabilities.

Question

Maigona Agro Limited is a Nigerian company operating in the agricultural sector. It has a large expanse of land in the Northern part of the country, which is used strictly for the cultivation of cotton seeds. As a result of the collapse of the textile/garment industry, specifically due to the unfavourable business climate in Nigeria, the company in 2015 established a branch, BAM Textile Mills, in the United Kingdom. Part of the cotton produced locally is sold to BAM Textile Mills at a competitive price, for the production of finished product (branded textile clothing).

A tax dispute recently arose between the Management of Maigona Agro Limited and officials of the Federal Inland Revenue Service (FIRS) on the correct assessment of profits made by BAM Textile Mills. The Managing Director is of the opinion that the tax paid by BAM Textile Mills in the United Kingdom should be the final tax since the company is only an overseas branch. He further averred that the provisions of the Companies and Allied Matters Act 2020 (as amended) are only applicable to companies incorporated in Nigeria. The Managing Director was furious when the company received a reminder of notice of assessment from the FIRS and has therefore threatened to approach the Tax Appeal Tribunal for redress.

You have been engaged by the company as its Tax Consultant to provide professional advice on the tax implication of the profit made by BAM Textile Mills, UK and possibly representation at the Tax Appeal Tribunal sittings. The statement of profit or loss for the year ended October 31, 2021 (BAM Textile Mills’ result has been converted to Nigerian Naira at the prevailing exchange rate) and other relevant documents were handed over to you by the Managing Director.

The extracts from the statements of profit or loss of the two corporate entities revealed the following:

	Maigona Agro Ltd (N’000)	BAM Textile Mills (N’000)	Total (N’000)
Gross Turnover	975,100	1,820,500	2,795,600
Less:
Cost of materials/inputs	350,200	672,000	1,022,200
Salaries and Wages	122,530	400,400	522,930
Administrative Expenses	45,700	110,900	156,600
Depreciation	75,600	147,300	222,900
Donation	8,500	0	8,500
Share of Head Office Expenses	33,300	50,000	83,300
Income Tax Paid in the UK	0	72,200	72,200
Total Expenses	635,830	1,452,800	2,088,630
Net Profit	339,270	367,700	706,970

Additional Information:

The capital allowances of Maigona Agro Limited in respect of plant and equipment, farming tools, and other qualifying capital expenditure as agreed with the tax authorities was N45,000,000. The amount of capital allowances of N57,000,000 claimable by BAM Textile Mills on qualifying assets was also certified by the tax authorities.
Included in the donation was N5,000,000 given to victims of the COVID-19 (Omicron variant) pandemic in Nigeria.
The UK tax rate is assumed to be 35%.

Required:

a. Advise the management of Maigona Agro Limited on the tax implications of the overseas branch. (4 Marks)
b. Compute the tax liabilities of the company in line with your submission in (a) above. (11 Marks)

Answer

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Tags: Double Taxation, Overseas Branches, Tax Appeal Tribunal, Tax Compliance, Tax disputes, Tax implications
Level: Level 3

Topic: Taxation of Non-Resident Companies and Individuals

ATAX – May 2022 – L3 – Q5 – Ethical Issues in Tax Practice

Identify ethical issues in a tax engagement and discuss punitive measures for ensuring adherence to ethical and legal standards.

Question

Mr. Barau Olubami completed his first degree in a reputable university in Nigeria seven years ago. After the compulsory youth service, he wrote and passed the professional examination and was subsequently admitted as an associate member of the Institute of Chartered Accountants of Nigeria. He had four-year training in a professional audit firm before he decided to establish his accounting firm. The firm consists of him as the principal partner, two accounting graduates (as Assistant Auditors/Consultants), a secretary, and an office assistant.

Within six months of his professional practice, he was able to get three clients to which he provides services, that include preparation of tax records, computation of end-of-year tax liabilities, filing of tax returns, advisory to clients on tax matters, compliance with tax legislations, and management of tax audit and investigation.

In one of the social events he attended with his father, he was introduced to Mr. Chidi Odamo, his father’s schoolmate in his polytechnic days. Mr. Odamo is the Chief Executive of Odamo Nigeria Limited, a company that manufactures paints. In a private chat they both had, Mr. Odamo complained bitterly that his current tax consultant has not been helping him to pay less amount of tax liability to the relevant tax authorities, unlike what his friends in the same industry are enjoying through the assistance of their tax consultants. Mr. Olubami informed Mr. Odamo that he knew his current tax consultant very well as he was his senior in the university. He also submitted that his (Olubami’s) firm is the tax consultant to another company in the same industry with Odamo Nigeria Limited. He then promised Mr. Odamo that if he is given the tax consultancy/audit work, he knows how to resolve the issue with the tax officials and the company will be the better for it.

The engagement with the current tax consultant was terminated two weeks after Mr. Odamo and Mr. Olubami had a “fruitful” discussion and the latter’s firm was appointed as the company’s new tax consultant after both parties agreed to a clause in the engagement contract that aside from the professional fees, the firm is entitled to 20% of tax saved.

During the review of previous tax returns filed with and tax paid to the tax authority, he observed a significant material error of the sum of N3 million made by the tax authority in favour of his client (Odamo Nigeria Limited). Since this could not be regarded as tax saved by his firm, he decided not to inform the company as this is considered as “by-gone.”

During the course of the year’s tax audit, documents and information received from the company’s accountant were not independently validated. These documents were sent to the two Assistant Auditors to work with. Specifically, sales were grossly understated; the cost of new vehicle and furniture and fittings were understated while some expenses incurred were overstated.

At the completion of the work done by the two Assistant Auditors/Consultants, Mr. Olubami held a meeting with the company’s Managing Director and presented a draft report, which showed that the company’s total tax liability for the year was N12 million. He promised him that with the assistance of his “contact” at the Revenue Service, the tax liability would be reduced to N7 million. The company’s Managing Director advised him to go ahead and file appropriate returns as the matter was fully settled. Self-assessment returns were filed and perhaps with the connivance of unscrupulous tax officials, the company paid N7 million tax liability. However, if a thorough job was done, the company’s tax payable for the year would have been N18.25 million.

Required:

a. Examine TEN ethical issues that arose from the tax engagement. (10 Marks)
b. What are the punitive measures put in place to ensure that accountants in practice adhere to legal and ethical issues when preparing tax returns? (5 Marks)

Answer

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Level: Level 3

Topic: Ethical Issues in Tax Practice

ATAX – May 2022 – L3 – Q4 – Taxation of Specialized Businesses

Compute tax liabilities and discuss incentives for Dutse Mines in mining solid minerals

Question

———————————————————————
Question:

As investors and policymakers adapt to the global energy transition in a bid to offer an effective hedge against swings in oil prices, the Federal Government has recognised that it is beneficial for the country to diversify its economy. The attention of the country is now towards the development of the solid minerals sector. The Nigeria Minerals and Mining Act 2007 (as amended) was enacted to regulate the industry. Incentives for operators in the sector are as provided for in Section 5 of the Act.

One of the earliest investors in the mining sector, Dutse Mines (Nigeria) Limited, was granted a mining title by the Mining Cadastre Office (MCO) for exploitation of limestone in Nkalagu in the south-eastern zone of Nigeria in 2008. In spite of so many challenges the company is facing, it has managed to remain afloat in business.

The company has, of recent, been having tax disputes with the relevant tax authority, and your firm of chartered accountants has been engaged to help resolve them. In the 2022 tax returns filed by the company, the major area of dispute between the company and the tax authority was disparity in the treatment of certified exploration and processing expenditure of ₦60,000,000 incurred during the course of the year.

Your firm is provided with the following extracts (and supporting documents) from the books of the company for the year ended December 31, 2021:

Additional Information:

Sundry income included ₦8,500,000 realised as profit from disposal of the old excavating machine.
Allowance for doubtful debts consisted of:
- Bad debts written off: ₦2,500,000
- General allowance for doubtful debts: ₦10,500,000
- Specific allowance for doubtful debts: ₦8,000,000
- Loan to customer written off: ₦5,000,000
Donation included ₦5,000,000 given to victims of environmental degradation, as part of the company’s social responsibility to the host community.
Legal fees included ₦750,000 paid as a penalty for late filing of tax returns.
The tax written down values of qualifying capital expenditure at the end of 2021 tax year were:
- Motor vehicles (2 years remaining): ₦25,000,000
- Furniture and fittings (utilised for 2 years): ₦22,500,000
- Mining expenditure (6 years remaining): ₦40,000,000

Required:

As the Manager (Tax Matters) assigned to handle this matter, you are to forward the report to your Senior Partner (Tax Matters) showing:

a. Computation of tax liabilities of the company for the relevant assessment year (14 Marks).
b. Comments on tax incentives available to a company in the mining of solid minerals in Nigeria (6 Marks).

Answer

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Tags: Allowable and Disallowable Expenses, Mining Taxation, Tax Incentives, Tax Liability Computation
Level: Level 3

Topic: Taxation of Specialized Businesses

ATAX – May 2022 – L3 – Q3 – Capital Gains Tax (CGT)

Address the principles of disposal under CGT Act, and compute CGT for transactions in Ikeja, Calabar, Abuja, and Kano.

Question

Disposal of assets is an important concept in the determination of capital gains tax payable. Section 6 of the Capital Gains Tax Act 2004 (as amended) specifically provides that a disposal of assets by a person occurs where any capital sum is derived from a sale, lease, transfer, an assignment, a compulsory acquisition, or any other disposition of assets, notwithstanding that no asset is acquired by the person paying the capital sum. In the same vein, Section 2 (4) of the Finance Act 2020 states the period for filing of self-assessment returns and when payment of the tax computed in respect of chargeable assets disposed of is to be made.

Nice-One Nigeria Limited, a manufacturing concern, with head office in Calabar and branches in Ikeja, Kano, and Abuja, has been in business for several years, reporting its accounts to December 31 of every year. The extracts from the books of accounts of the company during the year ended December 31, 2021, revealed the following transactions:

(i) Disposal of an option
On February 1, 2021, the company sold an option on a piece of land in Ikeja for the sum of ₦8,500,000 to Eco-Raheem Limited, which subsequently exercised the right by purchasing the land for ₦32,200,000.

(ii) Acquisition of asset in exchange for debt
On March 15, 2021, one of the company’s debtors in Calabar, Mr. Baba Tee, reached an agreement with the company by exchanging his piece of land, which was valued at ₦15,000,000, for the debt of ₦13,500,000. The company, on May 7, 2021, disposed of the land for ₦18,000,000. Incidental expenses incurred towards the disposal of the land were ₦250,000.

(iii) Disposal of a building
The company has a staff estate, which comprises five buildings in its Abuja branch. In order to source funds to construct a new staff estate in Kano, the company, on August 12, 2021, sold one of its buildings in the Abuja estate for ₦110,000,000. The cost of acquisition of the five buildings in the estate was ₦250,000,000. The cost of acquisition of the building sold was ₦75,000,000, while the remaining buildings unsold were professionally valued at ₦240,000,000. The company also incurred for the purpose of the disposal of the building, ₦400,000 on building repairs and a professional valuer’s fee of ₦1,100,000.

(iv) Disposal of industrial plants
One of the company’s industrial plants in the Kano branch, which cost ₦4,500,000, was disposed of on September 15, 2021, for ₦6,000,000. A new plant was bought for the purpose of the company’s operations the following month for ₦8,000,000. During the installation of the new plant, it was found that the plant could not efficiently satisfy the requirements of the company and it was subsequently sold on December 2, 2021, as “second-hand” for ₦7,300,000. The company incurred the sum of ₦25,000 as disposal expenses.

The Managing Director of the company is of the opinion that issues around the transactions undertaken by the company in the financial year are “technical,” which only competent professional accountants with experience in tax matters can conveniently handle. Accordingly, your firm of accountants was contacted to help provide tax advice on each of the above transactions.

Required:

You have been directed by your firm’s Head (Tax Matters) to take charge of the assignment and submit a report to him by the close of work in three days.

Your report should specifically cover:
(a) The principles of disposal as provided for in Section 6 of the Capital Gains Tax Act 2004 (as amended) (3 Marks).
(b) Computation of capital gains tax payable and when the tax due is to be paid to the relevant tax authority for the following stated transactions:
i. Disposal of an option in Ikeja branch (2 Marks).
ii. Acquisition of asset in exchange for debt in Calabar head office (3 Marks).
iii. Disposal of a building in Abuja branch (4 Marks).
iv. Disposal of industrial plants in Kano branch (8 Marks).

Answer

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Tags: Capital gains tax, CGT Act, Compliance, Disposal of assets
Level: Level 3

Topic: Capital Gains Tax (CGT)

ATAX – May 2022 – L3 – Q2 – Emerging Trends in Taxation

Discuss technology-driven tools, their impact, and challenges in tax practice and administration.

Question

Professional accountants engaged in tax practice or tax administration are often confronted with challenges due to the changing operating environment, particularly disruptive technologies. While clients demand cutting-edge services, many tax administrators in Nigeria still carry out their work manually.

In a seminar organised by ICAN, you highlighted that leveraging information technology could help tax practitioners and administrators enhance their work and remain relevant in today’s dynamic environment.

After the seminar, a principal partner of a traditional accounting firm approached you to organise a two-day in-house training for his staff on “Technological tools, impact, and challenges to tax practice and administration.”

Required:

Prepare a paper focusing on the following areas:
a. Identification and explanation of FOUR technology-driven tools that tax practitioners and administrators could use to enhance their work and reporting (8 Marks).
b. The impact of the identified technology-driven tools on tax practice and administration (8 Marks).
c. Challenges of technology-driven tools to tax practice and administration (4 Marks).

Answer

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Tags: IT in Tax Practice, Tax Administration, Tax Challenges, Tax Tools, Technology in Taxation
Level: Level 3

Topic: Emerging Trends in Taxation

ATAX – May 2022 – L3 – Q1 – Taxation of Companies

Determination of tax liabilities, treatment of donations, and exemptions of dividends based on CIT Act provisions.

Question

Dadinkowa Nigeria Limited has been in business since 2009 as a manufacturer of sugar cubes. The company sources its raw materials, sugar cane, from the Northern part of the country. However, due to local security challenges, the company has faced supply disruptions since 2016.

Additionally, the company has disagreements with tax authorities regarding the treatment of certain items (e.g., donations and dividend income) in their financial statements and returns. High overhead costs, especially energy expenses, have worsened operational challenges.

At a recent board meeting, the directors proposed either a temporary closure or relocating to a neighboring country if conditions do not improve in the next fiscal year. The General Manager shared this with you during your visit as the company’s tax consultant, seeking your advice to address these issues.

A scheduled meeting with the Managing Director requires you to prepare a comprehensive tax report addressing:

Determination of the company’s tax liabilities for the relevant tax year.
Analysis of the treatment of donations and exemptions of dividend income under the Companies Income Tax Act (CITA).

The profit or loss account for the year ended December 31, 2021, is as follows:

Profit or Loss Account:

Extract from the company’s statement of financial position as at December 31, 2021 revealed:

The following additional information was made available:

(v) Interest on loan was paid on a facility obtained from a licensed Nigerian deposit money bank at commercial interest rate.
(vi) General and administrative expenses were made up of:

(vii) Donations and subscriptions
Included in donations was N12,000,000 paid to a fund created by the Federal Government for victims of communal crisis that took place where the company is situated.
(viii) The tax written down values of the qualifying capital expenditure (QCE) items as at December 31, 2020 were:

(ix) Additions to QCEs during the year ended December 31, 2021 were:

(x) Unrelieved capital allowances brought forward were N15,200,000.
(xi) Unabsorbed losses from previous years were:

Required:

As the company’s Tax Consultant, you are to draft a report to the Managing Director for the scheduled meeting expected to hold next week. This is expected to address the following:
a. Determination of the company’s tax liabilities for the relevant tax year. (20 Marks)
b. Comment, in line with the provisions of Companies Income Tax Act Cap C21 LFN 2004 (as amended) on:
i. The treatment of donations made by the company during the year under review (5 Marks)
ii. Exemption of dividends from taxation (5 Marks)

Answer

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Tags: Allowable and Disallowable Expenses, Capital allowances, Dividend Exemptions, Donations, Tax Incentives, Taxation of Companies
Level: Level 3

Topic: Taxation of Companies

CR – May 2021 – L3 – Q7b – Regulatory Environment for Corporate Reporting

Discuss the content required in the Governance Report of corporate entities as mandated by SEC Nigeria.

Question

The Securities and Exchange Commission, Nigeria (SEC) requires that the annual report of all quoted companies should include a corporate governance statement. To this effect, general requirements for the content of the Governance Report are clearly spelt out.

Required:

Discuss the content of the Governance Report of corporate entities. (5 Marks)

Answer

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Tags: Annual Reports, Corporate Governance, Governance Reporting, SEC Nigeria
Level: Level 3

Topic: Regulatory Environment for Corporate Reporting

CR – May 2021 – L3 – Q7a – Ethical Issues in Corporate Reporting

Discuss unethical organizational acts and recommend the actions the Chief Accountant should take in a scenario of misrepresentation in financial reporting.

Question

Femmy PLC operates in a city where a major insurance company has just announced a restructuring that will lay off 4,000 employees. For Femmy PLC, accounts receivable represents one of the major assets of the company. Although the company’s annual uncollectible accounts are not out of line, they are material in size. The company is about to submit its application for a bank loan. Sales and net income have declined in the past year, and some customers are falling behind in settling their accounts.

A steady financial performance is necessary to be able to secure the anticipated bank loan. Therefore, management felt there is the need to underestimate the uncollectible accounts this year to show a small growth in earnings. They believe that future successful years will average out the losses.

More so, since the company has a history of success, the adjustments are seen as mere accounting measures and estimates. The Chief Accountant viewed management’s action as unethical.

Required:
i. Discuss the meaning of unethical acts by organizations. (5 Marks)
ii. What should the Chief Accountant do under this circumstance? (5 Marks)

Answer

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Tags: Earnings Management, Financial Reporting Ethics, Professional Ethics, Unethical Accounting Practices
Level: Level 3

Topic: Ethical Issues in Corporate Reporting

CR – May 2021 – L3 – Q6 – Regulatory Environment for Corporate Reporting

Discuss the rationale for different regulatory frameworks and analyze sources of corporate financial reporting regulations in Nigeria.

Question

International Financial Reporting Standards (IFRS) are sets of accounting standards, and it is unrealistic to assume that these standards could not replace those based around rules. However, where a rule-based system has been in operation, there is likely to be an expansion of ethical challenges for both accountants and auditors involved with financial statements if a principles-based approach is adopted. Therefore, regulatory authorities need to ensure ethical practices to achieve high-quality financial statements. This is drawing attention to the need for closer or greater monitoring. Apart from this fact, corporate financial reporting regulations have been in operation before the advent of IFRS.

Required:

a. Appraise the rationale behind different regulatory frameworks for corporate financial reporting. (8 Marks)

b. Analyze in detail the various sources of regulations for corporate financial reporting in Nigeria. (7 Marks)

Answer

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Tags: Corporate Reporting Regulations, Ethical Challenges, IFRS, Nigeria, Regulatory Frameworks
Level: Level 3

Topic: Regulatory Environment for Corporate Reporting

CR – May 2021 – L3 – Q5 – Regulatory Environment for Corporate Reporting

Discuss the benefits and criticisms of principle-based accounting standards and the consequences of transitioning from rule-based to principle-based standards.

Question

The debate over principle-based and rule-based accounting standards has increased as the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) seek to converge accounting standards for global uniformity. There have been divergent opinions as to whether rule-based standards are superior to principle-based standards and whether principle-based standards pose greater ethical challenges to accountants than rule-based standards.

Required:

a. What are the major benefits and basic criticisms of principle-based accounting standards? (10 Marks)

b. What are the consequences of transiting from rule-based to principle-based accounting standards? (5 Marks)

Answer

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Tags: Accounting Ethics, Accounting Standards Debate, Global Convergence, Principle-Based Standards, Rule-Based Standards
Level: Level 3

Topic: Regulatory Environment for Corporate Reporting

AAA – May 2023 – L3 – Q1 – Audit Reporting

Evaluate criteria and communication of Key Audit Matters, including actions if none exist.

Question

Romeo and Juliet Plc is an indigenous company incorporated on March 5, 2012. The entity operates in the oil sector of the economy, which has experienced severe income decline over the past years. The global oil prices hit a record low of about $28 per barrel in 2019 and 2020, further plunging the company and the industry into a downward slide in income generation. The company is also affected by foreign exchange difficulties faced by most companies in the country resulting from increased regulation of foreign exchange. Regular cases of oil theft, pipeline vandalism, and insecurity have also affected the operations of major international oil companies, which are the entity’s major customers. As a result of the above, the company recorded the following in its books of account:

Financial losses: The company has made consistent losses from the financial year ended December 31, 2017, to date.
Current liability position: The company’s current liabilities exceeded its current assets.
Negative net operating cash position: The company has maintained a negative net operating cash position from December 31, 2017, to date.

Furthermore, the company’s performance has worsened as a result of a decrease in sales and an increase in expenses.

The largest proportion of the current liabilities is the intercompany borrowings, which accounted for 62% (2020 – 45%) of the total current liability balance. The borrowings stood at N1.5 billion, N1.6 billion, and N2 billion for the financial years ended December 31, 2019, 2020, and 2021, respectively. The finance costs in relation to the borrowings stood at N230 million in the year ended December 31, 2021 (2020- N214 million).

The company has currently defaulted on a number of its contractual obligations with its directors, and there was no directors’ remuneration in the current year due to its continuous loss-making position.

At the pre-audit meeting with management of Romeo and Juliet Plc, your firm (the auditors) were informed that, in the year, the company was involved in a business combination with another oil company. To pay for the cost of acquisition, an additional intercompany loan was obtained because of the poor financial position of the company. In addition, the company’s major investment in an associated company was disposed of. The business acquisition proposal has all necessary regulatory approvals. It was approved at the meeting of the directors and annual general meeting of the company in the previous year and disclosed in the company’s prior year financial statements as business matters.

After the meeting with management, you have started the preparation for the year-end audit, and in compliance with regulatory requirements and auditing standards, a Key Audit Matter should be inserted on the opinion page.

Required:

(a) Evaluate the criteria that will help the engagement team determine what qualifies as a matter requiring significant auditor’s attention and can be classified as a Key Audit Matter. (8 Marks)

(b) Discuss the factors that will determine matters of most significance to be communicated to those charged with governance. (10 Marks)

(c) Discuss the criteria for what must be included in the description of a Key Audit Matter on the audit opinion. (6 Marks)

(d) Evaluate what should be done, assuming that you have determined that there are no Key Audit Matters to be reported in the above scenario. (6 Marks)

Answer

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Tags: Audit opinion, Communication with Governance, ISA 701, Key Audit Matters, Risk Assessment
Level: Level 3

Topic: Audit Reporting

FM – May 2023 – L3 – Q7 – Mergers and Acquisitions

Evaluate the share price of Obong plc under different growth scenarios and advise on the takeover bid. Explain EMH and its implications for the market.

Question

Obong plc recently received a takeover bid from Abdul plc. If the bid for Obong plc is successful, it will provide Abdul plc the needed competitive edge in research and development to expand its laboratories into the production of the COVID-19 vaccine.

The shareholders of Obong plc will only accept an offer that meets a required return of 14% on their current shareholdings.

Obong plc recently paid a dividend of N20, and this is expected to grow at a rate of 7% for the foreseeable future.

Required:

a. Estimate the share price of Obong plc today. (2 Marks)

b. If Obong plc accepts the bid from Abdul plc, it is estimated that the new growth rate will rise to 12% for the first 3 years and thereafter stabilize at 7%. Calculate the new share price to the shareholders of Obong plc. (2 Marks)

c. As a financial advisor, recommend to the shareholders of Obong plc whether the offer from Abdul plc should be accepted. (2 Marks)

d. According to Efficient Market Hypothesis (EMH), it is believed that the market would react instantly and accurately to the merger announcement between Obong plc and Abdul plc.
Define briefly the THREE forms of EMH and their implications to the market. (9 Marks)

Answer

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Tags: Dividend growth model, Market Efficiency, Share Price Estimation, Takeover Analysis
Level: Level 3

Topic: Mergers and acquisitions

FM – May 2023 – L3 – Q6 – Dividend Policy

Evaluate the comments in Neko Plc's annual report regarding dividend policy, share price, cost reduction, and tax minimization strategies.

Question

Neko Plc has issued the following statement as part of its annual report:
“This company aims at all times to serve its shareholders by paying a high level of dividends and adopting strategies that will increase the company’s share price. Satisfying our shareholders will ensure our success. The company will reduce costs by manufacturing overseas wherever possible and will attempt to minimize the company’s global tax bill by using tax haven facilities.”

Required:
a. Discuss the validity and implications of each of the comments and strategies in the above statement. (10 Marks)

b. Produce a short note outlining how the company should estimate its dividend capacity. (5 Marks)

Answer

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Tags: Cost Minimization, Dividend Capacity, Shareholder Value, Tax Haven Strategies
Level: Level 3

Topic: Dividend Policy

FM – May 2023 – L3 – Q5b – Corporate Governance and Financial Strategy

Discuss ways to motivate managers to align with and achieve stakeholder objectives.

Question

b. Discuss FOUR ways to encourage managers to achieve stakeholder objectives. (6 Marks)

Answer

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Tags: Corporate Governance, Managerial Incentives, Performance Measurement, Stakeholder Objectives
Level: Level 3

Topic: Corporate Governance and Financial Strategy

FM – May 2023 – L3 – Q5a – Strategic Performance Measurement

Evaluate TAXIM Plc’s financial performance in achieving profit growth, EPS growth, and shareholder return objectives.

Question

The following financial information relates to TAXIM Plc, a listed company:

Year	2021	2020	2019
Profit before interest and tax (₦m)	18.3	17.7	17.1
Profit after tax (₦m)	12.8	12.4	12.0
Dividends (₦m)	5.1	5.1	4.8
Equity market value (₦m)	56.4	55.2	54.0

TAXIM Plc has 12 million ordinary shares in issue and has not issued any new shares in the period under review. The company is financed entirely by equity.

The annual report of TAXIM Plc states that the company has three financial objectives:

Objective 1: To achieve growth in profit before interest and tax of 4% per year.
Objective 2: To achieve growth in earnings per share of 3.5% per year.
Objective 3: To achieve total shareholder return of 5% per year.

TAXIM Plc has a cost of equity of 12% per year.

Required:
Analyse and discuss the extent to which TAXIM Plc has achieved each of its stated objectives. (9 Marks)

Answer

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Tags: EPS Growth, Financial objectives, Profit Growth, Shareholder Return
Level: Level 3

Topic: Strategic Performance Measurement

FM – May 2023 – L3 – Q4 – Financing Decisions and Capital Markets

Evaluate the implications of equity financing decisions, analyze pre-emptive rights, estimate share price, and explore factors affecting price movement.

Question

The directors of Kenny plc wish to make an equity issue to finance an ₦800 million expansion scheme, with an expected net present value of ₦110 million. It is also to re-finance an existing 15% term loan of ₦500 million and pay off a penalty of ₦35 million for early redemption of the loan.

Kenny has obtained approval from its shareholders to suspend their pre-emptive rights and for the company to make a ₦1,500 million placement of shares, which will be at the price of 185 kobo per share. Issue costs are estimated to be 4 per cent of gross proceeds. Any surplus funds from the issue will be invested in commercial paper, which is currently yielding 9 per cent per year.

Kenny’s current capital structure is summarised below:

₦ million
Ordinary shares (25 kobo per share)	800
Share premium	1,120
Revenue reserves	2,310
Total Equity	4,230
15% term loan	500
11% bond	900
Total Capital	5,630

The company’s current share price is 190 kobo, and bond price is ₦102. Kenny can raise bond or medium-term bank finance at 10 per cent per year.

The stock market may be assumed to be semi-strong form efficient, and no information about the proposed uses of funds from the issue has been made available to the public.

Taxation may be ignored.

Required:

a. Discuss FOUR factors that Kenny’s directors should have considered before deciding which form of financing to use. (6 Marks)

b. Explain what is meant by pre-emptive rights, and discuss their advantages and disadvantages. (4 Marks)

c. Estimate Kenny’s expected share price once full details of the placement, and the uses to which the finance is to be put, are announced. (8 Marks)

d. Suggest two reasons why the share price might not move to the price that you estimated in (c) above. (2 Marks)

Answer

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Tags: Equity Issue, Market Efficiency, NPV, Pre-emptive rights, Share Valuation
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – May 2023 – L3 – Q3 – Investment Appraisal Techniques

Evaluate Tinco Limited's expansion project using financial metrics, assess sensitivity to contribution and tax rate changes, and incorporate capital allowances.

Question

Tinco Limited (TL) is considering an expansion project. The project will involve the acquisition of an automated production machine costing ₦11,000,000 and payable now. The machine is expected to have a disposal value at the end of 5 years, which is equal to 10% of the initial expenditure.

The following schedule reflects a recent market survey regarding the estimated annual sales revenue from the expansion project over the project’s five-year life:

Level of Demand	₦’000	Probability
High	16,000	0.25
Medium	12,000	0.50
Low	8,000	0.25

It is expected that the contribution to sales ratio will be 50%. Additional expenditure on fixed overheads is expected to be ₦1,800,000 per annum. TL incurs a 20% tax rate on corporate profits. Corporate tax is paid one year in arrears.

TL’s after-tax nominal (money) discount rate is 15.5% per annum. A uniform inflation rate of 5% per annum will apply to all costs and revenues during the life of the project. All of the values above have been expressed in terms of current prices.

You can assume that all cash flows occur at the end of each year and that the initial investment does not qualify for capital allowances.

Required:

a.
i. Evaluate the proposed expansion from a financial perspective. (10 Marks)
ii. Calculate and interpret the sensitivity of the project to changes in:

The expected annual contribution (3 Marks)
The tax rate (2 Marks)

b.
You have now been advised that the capital cost of the expansion will qualify for written down allowances at the rate of 25% per annum on a reducing balance basis. Also, at the end of the project’s life, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.

You are required to calculate the financial impact of these allowances. (5 Marks)

Answer

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Tags: Capital Budgeting, Discount rate, NPV, Sensitivity Analysis, Tax Allowances
Level: Level 3

Topic: Investment Appraisal Techniques

FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Question

You are a Financial Analyst at Tayo Research Group (TRG). You begin valuing Aba Hotels Plc (AHP), a thinly and infrequently traded stock currently selling at 217 kobo, cum 2021 dividend.

For estimating AHP’s required return on equity, TRG uses the capital asset pricing model (CAPM) approach, but you think its equity beta of 1.20 is not reliable because of the stock’s extremely thin trading volume. You have therefore obtained the beta and other pertinent data for Eko Hotel Plc (EHP) – (See Table 1), a midsized company in the same industry with high liquidity trading on the Nigerian Stock Exchange.

Table 1: Valuation Data for EHP

Parameter	Value
Asset beta	0.763
Debt beta	0.150
Debt ratio (D/D+E)	0.60
Effective tax rate (%)	30%

Summarised financial data for AHP is shown below:

Statement of Profit or Loss Account

Year	2019	2020	2021*
Sales (₦’000)	305,500	357,600	409,200
Taxable income (₦’000)	40,500	49,000	56,700
Taxation (₦’000)	(14,175)	(17,150)	(19,845)
Post-tax income (₦’000)	26,325	31,850	36,855
Dividend (₦’000)	(9,340)	(10,228)	(11,200)
Retained earnings (₦’000)	16,985	21,622	25,655

Statement of Financial Position

Year	2021*
Non-current assets (₦’000)	216,800
Current assets (₦’000)	158,000
Current liabilities (₦’000)	(104,800)
Net assets (₦’000)	270,000
Ordinary shares (₦0.50 par value)	80,000
Reserves (₦’000)	130,000
15% Bond 2026 (₦100 par value)	60,000

(*2021 figures are unaudited)

Other Relevant Information:

It has been estimated that the debt/equity ratio of AHP is 0.16 and the beta of its debt is 0.2.
The risk-free rate is 12% and the market risk premium is 5%.
AHP has an effective tax rate of 35%.
As a result of recent capital investment, stock market analysts expect post-tax earnings and dividends to increase by 25% for two years and then revert to the company’s existing growth rates.

Required:

a. Stock market analysts sometimes use fundamental analysis and sometimes technical analysis to forecast future share prices.
What are fundamental analysis and technical analysis? (4 Marks)

b. Using the dividend valuation model, estimate what a fundamental analyst might consider to be the intrinsic (or realistic) value of the company’s shares.
Comment upon the significance of your estimate for the fundamental analyst. (12 Marks)

c. Explain whether your answer to (b) above is consistent with the semi-strong and strong forms of the efficient markets hypothesis (EMH), and comment upon whether financial analysts serve any useful purpose in an efficient market. (4 Marks)

Answer

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Tags: CAPM, Dividend valuation, Efficient Markets, Fundamental Analysis, Technical Analysis
Level: Level 3

Topic: Business Valuation Techniques

FM – May 2023 – L3 – Q1b – Mergers and Acquisitions

Discuss the typical factors included in takeover regulations across countries.

Question

b. The regulation of takeovers varies from country to country.

Outline the typical factors that such a regulation includes. (4 Marks)

Answer

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Tags: Fair Valuation, Shareholder Rights, Takeover Regulation, Transparency
Level: Level 3

Topic: Mergers and acquisitions

FM – May 2023 – L3 – Q1a – Business Valuation Techniques

Evaluate ZL's valuation using multiple methods and recommend whether KK should acquire ZL. Discuss takeover regulation factors.

Question

KK, a company quoted on the Stock Exchange, has cash balance of ₦230 million which are currently invested in short-term money market deposits. The cash is intended to be used primarily for strategic acquisitions, and the company has formed an acquisition committee with a remit to identify possible acquisition targets. The committee has suggested the purchase of ZL, a company in a different industry that is quoted on the AIM (Alternative Investment Market). Although ZL is quoted, approximately 50% of its shares are still owned by three directors. These directors have stated that they might be prepared to recommend the sale of ZL, but they consider that its shares are worth ₦220 million in total.

Summarised financial data:

Economic data:

Risk-free rate of return: 6% p.a.
Market return: 14% p.a.
Inflation rate: 2.4% p.a., expected to remain stable.

Expected effects of the acquisition:

50 employees of ZL would immediately be made redundant at an after-tax cost of ₦12 million. Pre-tax annual wage savings are expected to be ₦7.50 million (at current prices) for the foreseeable future.
Some land and buildings of ZL would be sold for ₦8 million (after tax).
Pre-tax advertising and distribution savings of ₦1.50 million per year (at current prices) would be possible.
The three existing directors of ZL would each be paid ₦1 million per year for three years for consultancy services. This amount would not increase with inflation.

Required:

a. Calculate the value of ZL based upon:
i. The use of comparative P/E ratios (3 Marks)
ii. The dividend valuation model (4 Marks)
iii. The present value of relevant operating cash flows over a 10-year period (10 Marks)
iv. Provide an evaluation of each of the three valuation methods in (i) to (iii) above. (7 Marks)
v. Recommend whether KK should go ahead with the offer for ZL. (2 Marks)

Answer

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Tags: Consolidated Statement of Financial Position, Ethical considerations, Goodwill, Non-Controlling Interest, Pension obligations
Level: Level 3

Topic: Business Valuation Techniques

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Additional Information:

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ATAX – May 2022 – L3 – Q1 – Taxation of Companies

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Discuss the content required in the Governance Report of corporate entities as mandated by SEC Nigeria.

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Discuss unethical organizational acts and recommend the actions the Chief Accountant should take in a scenario of misrepresentation in financial reporting.

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CR – May 2021 – L3 – Q6 – Regulatory Environment for Corporate Reporting

Discuss the rationale for different regulatory frameworks and analyze sources of corporate financial reporting regulations in Nigeria.

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Discuss the benefits and criticisms of principle-based accounting standards and the consequences of transitioning from rule-based to principle-based standards.

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Evaluate criteria and communication of Key Audit Matters, including actions if none exist.

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FM – May 2023 – L3 – Q7 – Mergers and Acquisitions

Evaluate the share price of Obong plc under different growth scenarios and advise on the takeover bid. Explain EMH and its implications for the market.

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FM – May 2023 – L3 – Q6 – Dividend Policy

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FM – May 2023 – L3 – Q5a – Strategic Performance Measurement

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FM – May 2023 – L3 – Q4 – Financing Decisions and Capital Markets

Evaluate the implications of equity financing decisions, analyze pre-emptive rights, estimate share price, and explore factors affecting price movement.

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FM – May 2023 – L3 – Q3 – Investment Appraisal Techniques

Evaluate Tinco Limited's expansion project using financial metrics, assess sensitivity to contribution and tax rate changes, and incorporate capital allowances.

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FM – May 2023 – L3 – Q2 – Business Valuation Techniques

Analyze AHP’s intrinsic value using fundamental and technical analysis, apply the dividend valuation model, and evaluate EMH implications.

Table 1: Valuation Data for EHP

Statement of Profit or Loss Account

Statement of Financial Position

Other Relevant Information:

Required:

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FM – May 2023 – L3 – Q1b – Mergers and Acquisitions

Discuss the typical factors included in takeover regulations across countries.

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FM – May 2023 – L3 – Q1a – Business Valuation Techniques

Evaluate ZL's valuation using multiple methods and recommend whether KK should acquire ZL. Discuss takeover regulation factors.

Summarised financial data:

Economic data:

Expected effects of the acquisition: