Series: MAY 2018

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  • 15 Marks

AT – May 2024 – L3 – SC – Q7 – Double Taxation Reliefs and Credits

Explain treaty shopping, strategies to mitigate it, ECOWAS common external tariff features, and trade defense measures.

Abakali Limited is a company engaged in the manufacturing of three variants of beverages. The products of the company are well received by consumers, as the company now controls about 55% of the domestic market. The “chocolate” brand is the top earner for the company. According to a recent newspaper review, “it has the same quality as those imported into the country from the western world.”

The Board of the company, at one of its meetings, decided to enter the West African market in 2024 and, by 2026, the European market, through:

  1. Establishment of depots in major cities of four neighboring countries (Republic of Benin, Togo, Ghana, and Niger) with goods transported by road.
  2. Incorporation of a branch in a European country, initially serving as a depot, but within two years, full production will commence.

As emphasized by one of the directors, the main challenge the company must address is the strategy to mitigate the negative impact of high tax rates (in Europe and West African countries) on profits to achieve better returns on investment.

A director, previously employed by an international company, suggested using “treaty shopping” as a tax planning strategy for locating the branch office in Europe. He also pointed out that the Economic Community of West African States (ECOWAS) common external tariff framework provides a solution to different tax regimes in the sub-region.

Most Board members are not familiar with “treaty shopping” or the ECOWAS common external tariff framework, and they have requested professional advice on these matters.

The Managing Director has approached your professional accounting firm for guidance on the key issues raised in the meeting.

Required:

As the officer designated to handle this task, write a report to your Principal Partner for review before sending it to the client. The report should address the following concerns of the client:

a. Explanation of the concept and practice of “treaty shopping” (6 Marks)

b. Discussion on the strategies employed by various countries in curbing treaty shopping in international transactions (2 Marks)

c. Discussion on the features of the ECOWAS common external tariff framework (4 Marks)

d. Comment on the trade defense measures put in place to guide the operations of the common external tariff framework (3 Marks)

(Total 15 Marks)

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  • 20 Marks

AT – May 2024 – L3 – SB – Q2 – Taxation of Specialized Businesses

Calculation of hydrocarbon tax payable by New Rain Petroleum and analysis of tax implications for deep offshore investment.

New Rain Petroleum Company Limited has been operating in the onshore and shallow water areas of the Niger Delta region for over fifteen years. The company was granted a petroleum mining lease license in January 2021. In its bid to improve profitability, the company’s management intends to apply for a license to operate in the deep-sea area starting from 2025. The decision of the management is expected to be presented to the company members at the 2023 annual general meeting, scheduled in the second half of 2024.

The following financial data were extracted from the book of accounts of New Rain Petroleum Company for the year ended December 31, 2023:

Income N’ million
Fiscal value of crude oil sold 191,100
Value of condensate from associated gas 84,474
Value of natural gas liquid from associated gas 55,328
Other incidental income 151
Realized exchange gain 38
Gross total income 331,091
Expenses/Deductions N’ million
Royalty incurred and paid 86,200
First exploration wells cost 6,800
First two appraisal wells costs 18,700
Joint cost – terminalling 12,000
Gas reinjection wells cost 3,420
Salaries and wages 9,300
Power cost 1,650
NDDC charge 125
Concessional rentals 60,430
Depreciation of assets 13,860
Allowance for doubtful debts 2,400
Host community trust fund contribution 4,800
Stamp duty 16
Staff welfare 350
Travelling 180
Donations and subscription 6
Decommissioning and abandonment 1,300
Environmental remediation fund contribution 1,250
General expenses 500
Finance costs 1,750
Total Expenses 225,037
Net Profit 106,054

Additional Information:

  1. Data on Crude Oil, Condensate, and Natural Gas Sales:
    Category Quantity (million barrels) Actual Price (USD) Fiscal Price (USD)
    Crude oil 5.25 70 72
    Condensate from associated gas 3.61 45 44
    Natural gas liquid from associated gas 2.80 38 40
  2. Omitted Record:
    • A balancing charge of N1,500,000 was made from the disposal of an old oil equipment platform, which was omitted from the records.
  3. Allowance for Doubtful Debts:
    Type of Provision N’ million
    Specific provisions 900
    General provisions 1,500
    Total 2,400
  4. Donations and Subscription:
    Recipient N’ million
    Recognized orphanage homes 3.0
    Host community’s cultural group 2.0
    Subscription to oil and gas association 1.0
    Total 6.0
  5. General Expenses:
    Expense N’ million
    Penalty for gas flare 250
    Printing of stationery items 140
    State government levy 110
    Total 500
  6. Agreed Capital Allowances:
    Category N’ million
    Brought forward 167
    For the year 2,105
    Total 2,272
  7. Production Allowance:
    Type of Operation N’ million
    Onshore operations 900
    Shallow water operation 1,700
    Total 2,600
  8. Exchange Rate: The exchange rate averaged N520 to 1 USD during the year.
  9. Assumption: Tax liabilities are to be paid in domestic (Naira) currency.

Required:
As the company’s Tax Manager, you are to advise the management, in accordance with the provisions of the Petroleum Industry Act 2021, on:

a. Hydrocarbon tax payable for the relevant assessment year (18 Marks)
b. Tax implications if the company decides to invest in deep offshore areas (2 Marks)

(Total 20 Marks)+

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  • 30 Marks

AT – May 2024 – L3 – SA – Q1 – Tax Administration and Dispute Resolution

Provide professional tax advice for the management of Soft Farm and Agro-Allied Ltd, focusing on deductible interest, adjusted profit, and tax liabilities.

Soft Farm and Agro-Allied Limited, a subsidiary of Emperor Agro Incorporated, Italy, was incorporated in Nigeria in January 2018. Soft Farm and Agro-Allied Limited produces palm kernel for domestic use and export to the European market. The Managing Director of the company has just received a letter from the head office (parent company) about an impending visit due to poor business performance (below the group’s return on investment benchmark of 25%) since the business commenced, despite financial and technical support from the parent company.

In January 2022, the parent company granted a loan of N100 million to Soft Farm and Agro-Allied Limited for business expansion.

The Board has scheduled a special meeting for next month to consider the financial report of Soft Farm and Agro-Allied Limited for the year ended December 31, 2022, and to review past financial reports and tax assessments. As the newly engaged Tax Consultant to the company, you have been invited to participate in the meeting to provide a professional opinion on tax-related issues.

The Financial Accountant has been directed by the Managing Director to provide you with financial statements for all periods under review, books of accounts, returns filed with tax authorities, and other supporting documents.

From your preliminary review of the financial report for the year ended December 31, 2022, you noted an item that requires further discussion with management. This issue relates to interest paid on a loan obtained from the parent company.

Extract from Financial Statements for the Year Ended December 31, 2022

Item N’000
Gross turnover:
– Domestic sales 147,500
– Export sales 200,100
– Other operating income 3,300
Total Gross Turnover 350,900
Deduct:
– Staff salary 122,600
– Ground rent paid to State government 3,200
– Motor running expenses 1,750
– Audit and accountancy fees 1,000
– Repairs and maintenance 5,800
– Depreciation of assets 38,240
– Rent paid 1,850
– Power and lighting 5,400
– Legal cost 5,000
– Rates (water) 2,100
– Allowance for doubtful debts 10,500
– Donations 4,000
– Interest and other finance costs paid 15,600
– Income tax provision 23,400
– General expenses 5,900
Total Deductions 246,340
Net Profit 104,560

Additional Information:

  1. Export Sales:
    20% of export sales were made to the parent company at the prevailing international market price.
  2. Other Operating Income:
    Description N’000
    Dividend received (net) 2,700
    Profit from disposal of non-current asset 600
    Total 3,300
  3. Repairs and Maintenance:
    Description N’000
    Repairs of plantation equipment 1,200
    Repairs to premises (non-industrial building) 900
    Expansion to warehouse (industrial building) 3,700
    Total 5,800
  4. Rent Paid:
    This amount is for accommodation for the newly employed General Manager, whose basic salary is N4,800,000.
  5. Legal Cost:
    Description N’000
    Cost of income tax appeal 850
    Cost of debt collection 1,300
    Cost of acquiring new lease 1,700
    Renewal of old lease 1,150
    Total 5,000
  6. Allowance for Doubtful Debts:
    Description N’000
    Specific provisions 5,230
    General provisions 7,870
    Bad debts recovered (2,600)
    Total 10,500
  7. Donations:
    Recipient N’000
    Palm Oil Research Institute 1,400
    National Library 600
    Cocoa Research Institute of Nigeria 1,000
    Women Society of the host community 1,000
    Total 4,000
  8. Interest and Other Finance Costs Paid:
    In January 2022, the company obtained a loan facility of N100 million from the parent company for business expansion at a competitive interest rate of 12% per annum. The loan duration is 10 years, with interest payable for the first three years, and principal and interest repayments due from the fourth year onward. The balance in the financial statements includes other finance costs and bank charges paid to domestic banks on various accounts.
  9. General Expenses:
    Description N’000
    Wedding gift to staff 350
    Fine imposed on company driver for traffic offense 150
    Haulage expenses 3,200
    Transport and travelling 2,200
    Total 5,900
  10. Schedule of Prior Years’ Turnover and Assessable Profits:
    Year Ended December 31 Turnover (N’000) Assessable Profit (N’000)
    2018 154,400 78,750
    2019 198,600 95,120
    2020 310,300 142,800
    2021 314,900 166,900
  11. Schedule of Qualifying Capital Expenditure Incurred:
    Date of Acquisition Asset Type Amount (N’000)
    August 31, 2017 Plantation equipment 4,600
    August 31, 2017 Industrial building 12,000
    August 31, 2017 Non-industrial building 9,000
    January 1, 2018 Motor vehicles (3) 8,400
    January 1, 2018 Furniture and fittings (10) 1,500
    February 14, 2021 Motor vehicles (2) 5,600
    June 12, 2022 Furniture and fittings (10) 2,000
    July 8, 2022 Research and development 7,000

Required:

As the Tax Consultant to the company, draft a report to the Managing Director of Soft Farm and Agro-Allied Limited, in line with the provisions of the Companies Income Tax Act Cap C21 LFN 2004 (as amended). The report should provide professional advice on the following:

  1. Treatment of Excess Amount of Deductible Interest Paid (6 Marks)
  2. Adjusted Profit of the Company for the Year Ended December 31, 2022 (7 Marks)
  3. Tax Liabilities for All Relevant Assessment Years (17 Marks)

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  • 7 Marks

AAA – May 2018 – L3 – SC – Q7b – Forensic Auditing

Outline anti-money laundering requirements for the auditor of Banana Follow Me Limited due to high cash-based transactions and overseas transfers.

Management of Banana Follow Me Limited plans to invest in factory equipment and fittings to attract more customers, using sufficient cash reserves for these capital expenditures. A significant risk associated with money laundering exists due to the high volume of cash transactions and regular overseas bank transfers.

Required:

i. Discuss THREE requirements of an anti-money laundering programme which the auditor of Banana Follow Me Limited should have in place for detecting and reporting suspicion of money-laundering.

(6 Marks)

ii. State ONE example of the criminal offenses connected with money laundering. (1 Mark)

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  • 8 Marks

AAA – May 2018 – L3 – SC – Q7a – Audit Reporting

Prepare a management representation letter for Banana Follow Me Limited and outline anti-money laundering requirements for the audit team.

You are the accountant to Banana Follow Me Limited and the audit of the financial statements for the year ended December 31, 2016 is currently ongoing. The company is a cocoa processing entity with various factories across the country. During the year end audit, the auditors, Akinfenwa & Company. (Chartered Accountants), observed that the company purchased
200,000 units of XYZ Plc. shares during the year and that the company had not recognised dividends on these shares as at year end. Upon enquiry, the Managing Director of the company explained that the
shares were purchased ex-dividend and had promised to provide suitable representations to confirm this. The auditors have verified this and are 106 satisfied with the explanation but expect representation letter which includes all other relevant representations from the company.

Required:

As the accountant to Banana Follow Me Limited, prepare the management representation letter to be issued to the company’s auditors, Akinfenwa & Company, confirming representations for the financial statements for the year ended December 31, 2016.

 

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  • 15 Marks

AAA – May 2018 – L3 – SC – Q6 – Risk Management in Audits

Identify and explain audit procedures to assess the going concern of Reliance Ventures Limited and steps if going concern assumption is invalid.

Reliance Ventures Limited has been trading in imported goods for many years. The company’s fortune has started to diminish as a result of the current economic environment. Your firm has been the auditor of the company in the last three years. You have noticed that the shareholders’ equity of the company has been eroded and is currently in deficit. This condition has raised significant doubt on the entity’s ability to continue as a going concern.

Required:

  1. Identify and explain FOUR audit procedures to be performed by the audit team to determine the going concern status of the company. (10 Marks)
  2. Discuss FOUR of the steps that the auditor should take if he considers that the going concern assumption is invalid whereas management considers it to be valid. (5 Marks)

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  • 15 Marks

AAA – May 2018 – L3 – SC – Q5 – Use of Experts in Audits

Evaluate objectivity factors and audit procedures to assess the reliability of a management-employed expert’s work in QQ Limited's financial statements.

The management of QQ Limited had engaged an expert valuer, Segun & Company, in the valuation of its investment property situated at Ojo Oniyun Street, Victoria Island for disclosure in the financial statements as at year-end.

Required:

  1. Discuss the factors to be considered when assessing the objectivity of the expert employed by management. (5 Marks)
  2. Explain the procedures to be performed by the auditor to assess whether the work of the management expert provides sufficient and appropriate evidence for the audit of the financial statements. (10 Marks)

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  • 20 Marks

AAA – May 2018 – L3 – SB – Q4 – Ethical Issues in Auditing

Educate staff on IFAC’s Code of Ethics principles, types of independence, and general sources of ethical threats in accounting.

You are the HR partner in Ekemode & Company (Chartered Accountants). As part of the continuous training program of your firm, you are to organize an in-house seminar to educate the staff of your firm on Rules of Professional Conduct. You have decided to emphasize the IFAC’s Code of Ethics for Professional Accountants published by the International Ethics Standard Board for Accountants (IESBA), which was recently adopted by ICAN into their localized code called “The Professional Code of Conduct and Guide for Members.”

Required:

a. Explain briefly the FIVE fundamental principles of the IFAC’s Code of Ethics for Professional Accountants. (7½ Marks)

b. Explain independence of mind and independence of appearance to the staff. (5 Marks)

c. Explain briefly THREE general sources of threat to the fundamental principles of the IFAC’s Code of Ethics for Professional Accountants. (7½ Marks)

(Total 20 Marks)

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  • 20 Marks

AAA – May 2018 – L3 – SB – Q3 – Auditor’s Legal Liability

Evaluate necessary IT general and application controls for a fully computerized hotel to ensure data integrity and security.

A new hotel opened for operations on February 1, 2016, in Abuja. The directors at their board meeting in September 2016 selected December as the hotel’s year-end. Also, from the conception of the hotel, it was decided to fully computerize the hotel and its operations. This will make the hotel stand out and attract clientele in the federal capital territory where there are many other hotels with strong competition.

The room doors are electronically operated and use electronic cards for opening. If a customer does not specify his/her duration and has the lock properly programmed, the door will lock at 12 noon, requiring the customer to go back to the reception for access. Furthermore, all accounting and other processes are computerized.

The IT company that handled the computerization agreed to leave a member of staff who will train the hotel’s staff for three months and ensure that the system operates efficiently. Management believes that the staff will familiarize themselves with the system within that period. The server handles all doors, accounting processes including billing, and the determination of room occupancy rate on a daily basis. Various units of the hotel have desktop units which key employees use in both ordering and communication between themselves. The server is located next to the operations manager’s office, who is responsible for overseeing it in addition to other duties.

The last quarterly report on the hotel activities was not consistent with expectations, and the occupancy rate did not match turnover. The management of the hotel approached your firm of chartered accountants to be engaged as auditors to the hotel. Your review and interactions as the leader of the audit team revealed the information disclosed above.

Required:

Evaluate and apply the relevant general and application controls necessary to be installed in the hotel’s information environment.
(Total 20 Marks)

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  • 20 Marks

AAA – May 2018 – L3 – SB – Q2 – Auditor’s Legal Liability

Discuss the expectation gap, strategies to address it, and the role of professional skepticism in auditing financial statements.

Audit firms have been castigated over the years by the public whenever their clients have any financial or operational crises. The potential liability of auditors has also become an important topic in recent years due to the growing complexity of the business and legal environment and an increase in legal actions against auditors. One reason put forward to explain the high number of legal actions against auditors is the “expectation gap.”

Required:

a) Explain “expectation gap” and describe its THREE main elements. (5 Marks)

b) Discuss the strategies that could assist in closing the expectation gap. (10 Marks)

c) i. Explain briefly the concept of professional skepticism. (2 Marks)
ii. Evaluate the importance of professional skepticism in the audit of financial statements. (3 Marks)

(Total 20 Marks)

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  • 30 Marks

AAA – May 2018 – L3 – SA – Q1 – Audit of Complex Entities

Evaluate materiality reassessment, audit findings, and joint audit implications for Honey Group’s financial statements.

You are a manager in Puposola & Company (Chartered Accountants) responsible for the audit of the Honey Group (the Group), a quoted company. The Group’s main activity is steel manufacturing and it comprises of a parent company and three subsidiaries. Your firm currently audits all components of the Group. You are working on the audit of the Group’s financial statements for the year ended June 30, 2017. This morning, the audit engagement partner left a note for you.

“Hello

I have gone through the draft consolidated financial statements and accompanying notes which summarise the key audit findings and some background information.

Although, at the planning stage, materiality was initially determined to be N900,000, and was calculated based on the assumption that Honey Group is a high-risk client due to its listing status. However, due to a number of issues that arose during the audit, there is a need to revise the materiality level for the financial statements as a whole. The revised level of materiality should now be N700,000.

Thank you.”

The Group’s draft consolidated financial statements, with notes referenced to key audit findings, are shown below:

Draft Consolidated Statement of Comprehensive Income

Note June 30, 2017 Draft (N’000) June 30, 2016 Actual (N’000)
Revenue 98,795 103,100
Cost of sales (75,250) (74,560)
Gross profit 23,545 28,540
Operating expenses (14,900) (17,500)
Operating profit 8,645 11,040
Share of profit of associate 1,010 900
Finance costs (380) (340)
Profit before tax 9,275 11,600
Taxation (3,200) (3,500)
Profit for the year 6,075 8,100
Other comprehensive income for the year, net of tax:
Gain on property revaluation 800 —–
Actuarial losses on defined benefit plan (1,100) (200)
Other comprehensive loss (300) (200)
Total comprehensive income for the year 5,775 7,900

Notes: Key Audit Findings on Statement of Comprehensive Income

  1. Revenue has been stable for all components of the Group with the exception of one subsidiary, Copesink Company, which witnessed a 25% decrease in revenue.
  2. Operating expenses for the year to June 2017 is shown net of profit on a property disposal of N2 million. Our evidence includes agreeing the cash receipts to the bank statement and sale documentation, and we have confirmed that the property has been removed from the non-current asset register. The audit junior noted when reviewing the sale document that there is an option to repurchase the property in five years’ time, but did not discuss the matter with management.
  3. The property revaluation relates to the Group’s head office. The audit team has not obtained evidence on the revaluation, as the gain was immaterial based on the initial calculation of materiality.
  4. The actuarial loss is attributed to an unexpected stock market crash. The Group’s pension plan is managed by Axial Company, a firm of independent fund managers who maintain the necessary accounting records relating to the plan. Axial Company has supplied written representation as to the value of the defined benefit plan’s assets and liabilities at June 30, 2017. No other audit work has been performed other than to agree the amount reported in the financial statements to supporting documentation supplied by Axial Company.

Draft Consolidated Statement of Financial Position

Note June 30, 2017 Draft (N’000) June 30, 2016 Actual (N’000)
ASSETS
Non-current assets
Property, plant and equipment 81,800 76,300
Goodwill 5,350 5,350
Investment in associate 4,230 4,230
Non-current assets held for sale 7,800 –
Total non-current assets 99,180 85,880
Current assets
Inventory 8,600 8,000
Receivables 8,540 7,800
Cash and cash equivalents 2,100 2,420
Total current assets 19,240 18,220
Total assets 118,420 104,100
EQUITY AND LIABILITIES
Equity
Share capital 12,500 12,500
Revaluation reserve 3,300 2,500
Retained earnings 33,600 29,400
Non-controlling interest 4,350 4,000
Total equity 53,750 48,400
Non-current liabilities
Defined benefit pension plan 10,820 9,250
Long-term borrowings 43,000 35,000
Deferred tax 1,950 1,350
Total non-current liabilities 55,770 45,600
Current liabilities
Trade and other payables 6,200 7,300
Provisions 2,700 2,800
Total current liabilities 8,900 10,100
Total liabilities 64,670 55,700
Total equity and liabilities 118,420 104,100

Notes: Key Audit Findings on Statement of Financial Position

  1. The goodwill relates to each of the subsidiaries in the Group. Management has confirmed in writing that goodwill is stated correctly, and our other audit procedure was to arithmetically check the impairment review conducted by management.
  2. The associate is a 30% holding in Jamil Company, purchased to provide investment income. The audit team has not obtained evidence regarding the associate as there is no movement in the amount recognised in the statement of financial position.
  3. The non-current assets held for sale relate to a trading division of one of the subsidiaries, which represents one third of that subsidiary’s net assets. The sale of the division was announced in May 2017, and is expected to be complete by December 31, 2017. Audit evidence obtained includes a review of the sales agreement and confirmation from the buyer obtained in July 2017, that the sale will take place.
  4. Two of the Group’s subsidiaries are partly owned by shareholders external to the Group.
  5. A loan of N8 million was obtained in October 2016 at an interest rate of 2%, payable annually in arrears. The terms of the loan have been confirmed from the loan agreement provided by the bank. There was no repayment of the loan in the books as at prior year end.

Required:

a. Explain why auditors may need to reassess materiality as the audit progresses. (4 Marks)

b. Assess the implications of the key audit findings for the completion of the audit.

Note: Your assessment must consider whether the key audit findings indicate a risk of material misstatement. Where the key audit findings refer to audit evidence, you must also consider the adequacy of the audit evidence obtained, but you do not need to recommend further specific procedures. (18 Marks)

c. Discuss TWO advantages and TWO disadvantages of a joint audit being performed on the financial statements. (8 Marks)

(Total 30 Marks)

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  • 15 Marks

FM – May 2018 – L3 – SC – Q7 – Corporate Governance and Financial Strategy

Corporate governance issues in relation to non-executive directors, shareholder-director conflicts, and bond covenants.

Nkata Plc. is a large publicly quoted company. The directors are currently debating a number of issues, including the following: (i) The role of non-executive directors in corporate governance. (ii) Conflict of interest between directors and shareholders. (iii) Bond covenants usually imposed by lenders.

Required:

a. Discuss the role of non-executive directors in the corporate governance of a listed public company.
(4 Marks)

b. Identify and discuss three areas where the interests of shareholders and directors may conflict, leading the directors to pursue objectives other than maximizing shareholders’ wealth.
(6 Marks)

c. Identify five examples of covenants that might be attached to bonds and discuss briefly the advantages and disadvantages of each to companies.

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  • 15 Marks

FM – May 2018 – L3 – SC – Q6 – Mergers and Acquisitions

Key factors for target selection and consideration form in acquisition decisions for Okpara Plc.

Okpara Plc. is a large publicly quoted company in the eastern part of Nigeria. It operates in the home appliances industry with significant market share. In a recent strategy meeting, the directors decided to pursue aggressive growth through mergers in other parts of the country and along the ECOWAS sub-region.

Required:

Prepare a report to the Board of Directors of Okpara Plc. to address the following matters:

a. Six factors to be considered when choosing a target for acquisition.
(9 Marks)

b. Four factors which a bidding company should take into account in deciding the form of consideration to be offered.
(6 Marks)

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  • 15 Marks

FM – May 2018 – L3 – SC – Q5 – Financial Risk Management

Use of forward rate agreements and interest rate management tools for borrowing concerns in Katangwa Limited.

Katangwa Limited will need to borrow ₦50 million in three months’ time for a period of six months. The company is concerned that interest rates are expected to rise over the next few months.

Interest rates and forward rate agreements (FRAs) are currently quoted as follows:

  • Spot 5.75 – 5.50
  • 3 – 6 FRA 5.82 – 5.59
  • 3 – 9 FRA 5.94 – 5.64

Required:

a. Explain how a forward rate agreement (FRA) may be useful to the company. Illustrate this on the basis that interest rates: i. Rise to 6.50% ii. Fall to 4.50%

(8 Marks)

b. Compare the use of interest rate futures with FRA in this instance. (4 Marks)

c. Explain how interest rate guarantees or a short-term interest rate cap could be used. (3 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q4 – Portfolio Management

Analyze SF Plc.'s portfolio beta and assess whether the short-term investment strategy is optimal.

Sunmola Funds (SF) Plc. has a portfolio of short-term investments in the shares of four quoted companies.

Company Holding
Tomiwa (T) 100,000 shares
Pascal (P) 155,000 shares
Binta (B) 260,000 shares
Yetunde (Y) 420,000 shares

You have the following additional information:

Company Beta Market Value Per Share (Kobo) Expected Total Return on Investment p.a (%)
T 1.55 280 21.0
P 0.65 340 12.5
B 1.26 150 18.0
Y 1.14 9.5 18.5

The market risk premium is 10% per year, and the risk-free rate is 6% per year.

Required:

a. Estimate the Beta of SF Plc.’s short-term investment portfolio. (4 Marks)

b. Recommend, giving your reasons, whether the composition of SF Plc.’s short-term investment portfolio should be changed using relevant calculations. (10 Marks)
Hint: Consider the alpha values of the shares and the propriety of investing short-term funds in equity.

c. Explain THREE factors that a financial manager should take into account when investing in marketable securities. (6 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q3 – Working Capital Management

Calculate the optimal re-order quantity, compare suppliers, and evaluate limitations in Kehinde's inventory management.

Kehinde is a wholesaler who buys and sells a wide range of products, including electrical component TK. Kehinde sells 24,000 units of TK each year at a unit price of N2,000. Sales of TK normally follow an even pattern throughout the year. To prevent stock-outs, Kehinde keeps a minimum inventory of 1,000 units. Further supplies of TK are ordered whenever the inventory falls to this minimum level, and the time lag between ordering and delivery is small and can be ignored.

At present, Kehinde buys all his supplies of TK from Ajoke Limited and usually purchases them in batches of 5,000 units. His most recent invoice from Ajoke Limited was as follows:

Item Amount (N’000)
Basic price: 5,000 units of TK at N1,500 per unit 7,500
Delivery charges:
– Transport at N50 per unit 250
– Fixed shipment charge per order 100
Total 7,850

Kehinde also estimates an ordering cost of N50,000 per order, comprising administrative costs and sample checks, which does not vary with the order size.

Kehinde stores TK in a warehouse rented at N500 per square metre per annum, with excess capacity sublet at N400 per square metre annually. Each unit of TK in inventory requires 2 square metres of space. Other holding costs are estimated at N1,000 per unit per annum.

Kehinde has recently learned that another supplier, Ema Limited, offers discounts for large orders. Ema Limited’s pricing structure is as follows:

Order Size Price per unit (N)
1 – 2,999 1,525
3,000 – 4,999 1,450
5,000 and over 1,425

In other respects (delivery charges and order lead time), Ema Limited’s terms match those of Ajoke Limited.

Required:

a. Calculate the relevant:
i. Cost per order
ii. Holding cost per unit per annum (4 Marks)

b. Irrespective of your answers in (a) above and assuming a cost per order of N150,000 and holding cost per unit per annum of N1,800, calculate the optimal re-order quantity for TK and the associated annual profit Kehinde can expect from the purchase and sale, assuming that he continues to buy from Ajoke Limited. (6 Marks)

c. Prepare calculations to determine if Kehinde should buy TK from Ema Limited instead of Ajoke Limited, and in what batch size. (7 Marks)

d. Discuss the key limitations of the method of analysis you used. (3 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q2 – Investment Appraisal Techniques

Evaluate two corporate bonds for investment based on price, yield to maturity, and duration.

Kazaure Limited has a cash surplus of N20m, which the financial manager is keen to invest in corporate bonds. He has identified two potential investment opportunities in two different companies which are both rated A by the major credit rating agencies.

Bond A: The issuer plans to raise an N500m 2-year bond with a coupon rate of 10%. The bond is redeemable at a premium of 8% to nominal value.

Bond B: The issuer plans to raise an N800m 3-year bond with a coupon rate of 12% and redeemable at par.

The annual spot yield curve for government bonds is:

Term Spot Yield
1-Year 9.50%
2-Year 10.40%
3-Year 10.50%

Extract from a major credit rating agency’s website:

Rating 1-Year Spread 2-Year Spread 3-Year Spread
AAA 6 16 28
AA 15 25 40
A 20 30 50

Required:

a. For a nominal value of N1,000, calculate the theoretical issue prices of the two bonds and indicate how many of each of the bonds Kazaure Limited can buy, assuming it invests in only one of them. (5 Marks)
Note: Calculate issue prices to the nearest Naira.

b. Irrespective of your answer in (a), assume Bond A is issued at ₦1,054 and Bond B is issued at N1,026. Calculate the yield to maturity of each bond at the time of issue. (5 Marks)

c. Calculate the duration of each bond. What does duration measure? (6 Marks)

d. If you expect interest rates to increase in the market, which of the two bonds, A or B, would you like to buy and why? (4 Marks)
Note: No calculation is required.

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  • 30 Marks

FM – May 2018 – L3 – SA – Q1 – Investment Appraisal Techniques

Evaluate the NPV of Plateau Plc.'s project, assess sensitivity, discuss political risk, and explore real options for the project.

Plateau Plc. (PT) is a Nigerian company that manufactures and sells innovative products. Following favourable market research that cost N4,000,000, PT has developed a new product. It plans to set up a production facility in Kano, although its board had contemplated setting up the facility in an overseas country. The project will have a life of four years.

The selling price of the new product will be N5,900 per unit, with sales in the first year to December 31, 2019, expected to be 120,000 units, increasing by 5% per annum thereafter. Relevant direct labour and material costs are expected to be N3,400 per unit, and incremental fixed production costs are expected to be N60 million per annum. The selling price and costs are stated in December 31, 2018 prices and are expected to increase at a rate of 3% per annum. Research and development costs to December 31 will amount to N25 million.

Investment in working capital will be N30 million on December 31, 2018, and this will increase in line with sales volumes and inflation. Working capital will be fully recoverable on December 31, 2022.

The company will need to rent a factory during the life of the project. Annual rent of N20 million will be payable in advance on December 31 each year and will not increase over the life of the project.

Plant and machinery will cost N1 billion on December 31, 2018. The plant and machinery are expected to have a resale value of N300 million (at December 31, 2022, prices) at the end of the project. The plant and machinery will attract 20% (reducing balance) capital allowances in the year of expenditure and in every subsequent year of ownership by the company, except in the final year when there will be a balancing allowance or charge.

Assume a corporate tax rate of 20% per annum in the foreseeable future and that tax flows arise in the same year as the cash flows which gave rise to them.

The directors are concerned by rumours in the industry of research by a rival company into a much cheaper alternative product. However, the rumours suggest that this research will take another year to complete, and if successful, it will take a further year before the alternative product comes on the market.

An appropriate weighted average cost of capital for the project is 10% per annum.

Required:

a. Calculate, using money cash flows, the NPV of the project on December 31, 2018, and advise the company whether to proceed with the project or not.
(15 Marks)

b. Calculate and interpret the sensitivity of the project to a change in:

  • (i) The annual rent of the factory (2 Marks)
  • (ii) The weighted average cost of capital (4 Marks)

c. If the board of PT decided to set up the manufacturing facility overseas, advise the board on how political risk could change the value of the project and how it might limit its effects. (4 Marks)

d. Discuss briefly FOUR real options available to PT in relation to the new project. (5 Marks)

(Total 30 Marks)

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  • 15 Marks

AT – May – 2018 – L3 – SC – Q7 – Tax Incentives and Reliefs

Information on corporate tax reliefs and incentives, with specific focus on start-ups and export-oriented businesses in Nigeria.

Mr. Nwatakaibeya, who studied in Germany and had been working there for over 20 years, finally returned to Nigeria in 2015. He has saved some funds to start a new business and incorporated Nwatakaibeya Investments Limited in January 2016. However, since his return, he has been overwhelmed by reports of start-up and existing businesses that shut down due to harsh economic conditions.

He has read in newspapers that, as part of the government’s commitment to improve the ease of doing business in Nigeria, the Federal Government has periodically reviewed and enhanced reliefs and incentives available to corporate taxpayers. This has given him hope, and he is eager to gather more information to avoid potential challenges.

Given his concerns about the current business environment in Nigeria:

a. Explain briefly SIX reliefs and incentives available to corporate taxpayers. (12 Marks)
b. Outline THREE conditions a company must fulfill to qualify for tax incentives for export-oriented business. (3 Marks)

(Total 15 Marks)

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  • 15 Marks

AT – May – 2018 – L3 – SC – Q6 – Companies Income Tax (CIT)

Tax computation for Obi Airlines Limited operating in Ethiopia, including Total Profits and tax liabilities in Nigeria for income sourced from Nigeria.

Chief Bonny Chizaram is the Chairman/CEO of Chizaram group of companies. The conglomerate operates in several states of Nigeria, with business interests in supply of building materials, transport, and banking.

In 2012, under the Chairman’s directive, the group decided to diversify its business into some African countries by establishing Obi Airlines Limited, incorporated in Ethiopia.

On May 25, 2016, as Chief Chizaram was in the executive lounge of Murtala Mohammed International Airport, Lagos, awaiting departure, he met his long-time friend and business colleague, Chief Roger Menkiti, who is also an entrepreneur.

During their discussion, Chief Menkiti expressed interest in understanding the benefits of investing in Ethiopia, with concerns about Companies Income Tax and Tertiary Education Tax payable in Nigeria if he started an airline business in Ethiopia.

The financial results of Obi Airlines Limited for the year ended December 31, 2015, are as follows:

Description Amount (₦)
Income from passenger flights on other routes 213,668,750
Income from cargo loaded into aircraft on other routes 218,280,000
Income from passenger flights from Nigeria 54,401,275
Income from cargo loaded into aircraft from Nigeria 49,938,180
Total Income 536,288,205
Deduct:
Depreciation 1,974,125
Staff salaries 14,373,968
General provision 215,050
Other expenses 579,913
Total Deductions 17,143,056
Net Profit 519,145,149

Additional Information:

  1. Capital allowances were agreed with the relevant authority at 110% of the depreciation charged.
  2. Other expenses include disallowable expenses amounting to ₦425,000.

Required:

As the Tax Consultant, prepare computations showing:

a. Total Profits of Obi Airlines Limited for Nigerian tax purposes. (12 Marks)
b. Companies Income Tax Liability for the relevant year of assessment. (2 Marks)
c. Tertiary Education Tax Liability. (1 Mark)

(Total 15 Marks)

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