REPORT
To         : Chief Executive Officer
From     : Consultant
Date      : 31/03/2017
Subject  : Profitability and Working capital management of Fadama Ltd for the year ending March 2017.
As requested, I have analyzed the profitability and working capital management of Fadama Ltd. My analysis is based on the Statement of financial Position, and the additional information given. A number of key measures have been calculated and these are set out in the attached Appendix.
Profitability
Sales have increased by 21% and cost of sales has risen by 46%, resulting in a fall of 3% in the gross profit. This could be explained by a strategy of lowering sales prices to boost volumes. If so, it did not succeed, either in terms of gross profit amount, or gross margin. However, operating costs have increased by just GH¢44,000 or 6% – much less than the percentage increase in revenue. As a result, the ratio of expenses as a percentage of revenue has fallen from 12.75% to 11.1%.
Working capital management

• Cash, including the short term investments, has reduced by GH¢10,000, a fall of 10%. However this is not material in the context of the large sums invested in non-current assets and paid out as dividends. Operating cash flow is healthy.
• A big improvement is evident in the inventory day’s ratio from 2016 to 2017. However it would seem reasonable to expect further improvement, as 6 months is rather a long time to be carrying inventory. Efficient production services must be introduced with effective marketing, selling and distribution of products.
• Trade receivables and payables are reasonable consistent, with a significant improvement noteworthy in the case of the payables days.
• Current ratios seem rather weak, however a cessation of dividends would be a simple way to boost cash flow should an emergency present.

Conclusion
Fadama Ltd’s profit margins can be improved by deliberately reducing the operating expenses for the year, intensive sales and marketing strategies to boost sales revenue. There are no apparent short-term liquidity problems but Fadama Ltd should find solution to reducing inventory days as this will reduce cost of holding inventory. The firm should also consider cessation of payment of dividends to improve liquidity.

    Schedule of changes to profit and OCI for the year

 (8 marks evenly spread using ticks)

                                                                                                                        (12 marks evenly spread using Ticks)

W1 – Property, Plant & Equipment
This piece of property should be revalued downwards by GH¢20 million (130-110). A downward revaluation in an IAS 16 (Property Plant & Equipment) asset should be charged to the revaluation reserve (and OCI) to the extent that a balance exists in that reserve relating to the same asset. Here, this amount is GH¢12 million. Any further revaluation loss should be charged to profit or loss. The extra GH¢8 million of loss should be so charged.
The Plant & Equipment transaction should be recorded as a sale as the agreement has been made, and all significant economic risks and rewards associated with the plant have been transferred to the new owner. Hence a loss on disposal of GH¢6 million (39-45) will be recorded in profit or loss. GH¢45 million will be derecognized from PPE, and a receivable of GH¢39 million recorded in current assets.
W2 – Equity Investments
Under IFRS 9, equity investments should be classified as “Fair Value” financial instruments, and remeasured to fair value at each reporting date. Any resulting gains or losses are taken to profit or loss unless the entity makes an irrevocable election to take them to OCI. The decision has been made by Okushe, hence the gain in value of GH¢20 million (380 – 360) should be taken to OCI as well as being reflected in the carrying value of the equity investments.
W3 – Debenture
Under IFRS 9 the amortised cost method is appropriate for this liability as there is no evidence to suggest the company is treating the liability as a trading instrument. Hence the annual finance charge should reflect the effective rate to maturity rather than the coupon rate. The correct finance cost should therefore be GH¢150m *6.5% = GH¢9.75 million instead of the recorded GH¢7.5 million. The additional GH¢2.25 million (9.75 – 7.5) should be charged as a finance cost to profit or loss and accrued as an additional non-current liability.
W4 – Warranty provision
The current liability for warranty provision needs to be updated at each reporting date to reflect best estimates available at that date. At 31 October 2017 best estimates suggest a provision of GH¢14 million is required, calculated as follows:
 GH¢
Minor repairs: (4,000 * GH¢500)         =  2 million
Major repairs: (1,200 * GH¢10,000)    =  12 million
                                                                  14 million

As the existing provision is recorded at GH¢12 million, an additional charge of GH¢2 million must be made to bring the provision up to the required GH¢14 million. This should be charged to profit or loss, and added to the existing provision.

• expenditures are being incurred,
• borrowing costs are being incurred and
• activities that are necessary to prepare the asset for its intended use or sale are in progress (may include some activities prior to commencement of physical production).

Credit to the Income Statement in the year in which the expenditure relates.
As this relates to the cost of employment it will be allotted to each year as an offset to the salaries or presented as a separate line item in statement of profit or loss.
GH¢80,000/3 years = GH¢26,667 in year 1 and 2 and the balance in year 3

Revenue based grant which will be credited in the year the related expenditure is incurred, i.e. the current year

The grant will be credited to the deferred income account and released over the 8 year economic life of the asset. On the balance sheet the unamortized balance of the grant will be treated as deferred income. GH¢120,000/8 years.
GH¢
Opening balance                 120,000
Income statement                15,000
Closing balance                  105,000
The asset will be depreciated over 8 years straight line. (GH¢600,000 – GH¢60,000) / 8 years.

Income Statement charge GH¢67,500.*
* Alternative method acceptable.

IAS 36 and IAS 16 require that an impairment that reverses a previous revaluation should be recognised through other comprehensive income to the extent of the amount in the revaluation surplus for the same asset. Any remaining amount should be recognised in the statement of comprehensive income. Thus:
Carrying value at 31 December 2011 is 45/50 X GH¢10m                  = GH¢9m
The revaluation reserve (GH¢16 – GH¢9)                                            = GH¢7m
The carrying amount at the 31 December 2016 is 40/45 x GH¢16      = GH¢14.2m
The recoverable amount at 31 December 2016                                     = GH¢5.8m
The total impairment charge is (GH¢14.2 -GH¢5.8)                             = GH¢8.4m
Of this, GH¢7m is a reversal of the revaluation reserve, so only GH¢1.4m is recognised through the statement of comprehensive income.

Note;
The recoverable amount of goodwill is given as GH¢400m. Hence goodwill must be reported at that amount. The difference between goodwill at acquisition (GH¢m510) and its recoverable amount (GH¢400m) is impairment loss GH¢110m).

Working (iv) Provision for Unrealised Profit
Eliminate intra-group sales and purchases (GH¢25m) in full from group revenue and group cost of sales.
Unrealised profit provision required = 50m * 30/100 * 2/5 = GH¢6m
[Dr Cost of sales, Cr Inventory in SOFP]
NCI is affected as Buzz was the internal selling company that recorded the gain.
Working (v) Intragroup income and expenses
Eliminate intragroup income and expenses GH¢4m from other income and operating expenses.

Working (vi)
Share of associate’s profit for year 219.6 * 4/12 * 40% = GH¢29.28m
Share of associate’s OCI 64.8 * 4/12* 40% = GH¢8.64 m
Working (vii) Sale of Land
This is a transaction between parent and associate. We should eliminate 40% of the profit earned on the transaction.

GH¢8m * 40% = GH¢3.2m. This should be eliminated from the “other income” heading (though it would be acceptable to show it as a deduction from “Share of results from associate”). It should NOT be time apportioned.

Advantages of Harmonization

• The first and most important advantage of harmonization of reporting standards is to achieve comparability in financial statements. Due to different sets of financial reporting standards, the way financial statements prepared and presented are different from each other which make it complicated to compare them. This is even more noticeable in multinational companies when they operate in more than just one country. If international harmonization is achieved, the level of international comparability also increases making it easier for companies to prepare the financial statements under one set of rules; investors who understand the financial statements due to the nature of IFRS and make well thought investment decisions.
• International Expansion
  Moving to a single set of global financial standards would also ease barriers to expansion for companies. If companies wish to expand overseas today, they need to consider international costs of compliance, which could mean adopting a completely new set of accounting records to meet statutory requirements in the new country. In some cases, this would nearly double the company’s accounting costs. For many small businesses, even the large rewards of moving overseas are dwarfed by these expansion costs.
• Central Authoritative Body
  From a policy-making standpoint, moving to a single set of global standards puts rule making into the hands of one body. Currently, accounting standards are set within each country by each standard-setting body, as well as by an international group. One set of standards would reduce disagreement between countries and international regulators, and it might also cut costs. In some countries, businesses are required to pay reporting fees that go to fund these standard-setting bodies. While the costs may not affect large companies, they can have a huge impact on a small business. Moving to a central authoritative body could reduce these costs drastically.
• There will be increased auditing efficiency and money saving as companies has to use only one set of reporting standards. This also serves to reduce trade barriers among countries allowing more access to international capital markets.
• Another advantage worth noting is the consistency to be achieved under IFRS as it was one of the objectives of IFRS as a single reporting standard. The consistency also contributes to better understanding between investors, lenders and other businesses as there will be the nature of predictability in place. Moreover, companies operating in different countries also can use their expertise and systems in all countries they are operating due to consistency of the reporting standards. Another benefit that derives from consistency is the time scale needed to implement in new countries as there will be no need to learn and adapt to new country specific rules except minor adjustments.                                                                     (Any 3)

Disadvantages of Harmonization

• Cultural Differences
  One of the criticisms of harmonized accounting standards is that the IASB has failed to fully take into account the cultural, political and social differences between countries. This is particularly relevant to their implementation in developing countries, where language barriers, attitudes toward accounting and other socio-cultural aspects may affect their interpretation and application. For example, when the harmonized standards were implemented in Jordan, they were first translated into Arabic. Even though technical accounting terms have been well-defined in Arabic, challenges arose when the English terminology was hard to interpret or used inconsistently and, therefore, difficult to translate accurately.
• Worldwide Acceptance
  National accounting standards are highly politicized and there is often a natural tendency to place the interests of the national economy ahead of those of the global economy. Private sector businesses and professional accounting bodies also have a vested interest in accounting practices and financial reporting. Pressure from these groups to change or reject certain standards can carry a lot of weight with political decision makers. Adopting international financial standards is met with additional challenges in developing countries. They often lack the resources and infrastructure to adapt national legal and legislative frameworks in which to house the standards, making proper implementation difficult.
• International Enforcement
  The success of harmonized financial reporting depends on individual governments enforcing adherence to the international standards once they have been implemented. In 2008, the French authorities allowed the bank Société Générale to transfer some of its losses from 2008 to 2007, meaning its financial statement for 2008 looked much better than the reality. This provoked an international outcry, not the least from the IASB. When exceptions are made, it undermines the integrity of the whole system and renders it ineffective.
• Training and Retraining
  When a country decides to harmonize with the international standards, its companies, accountants and auditors need to be retrained in the new standards and reporting procedures for financial statements. College and university programs in this field also have to undergo significant changes in order to educate new people entering the profession. Before any of this can happen, trainers and professors will require training so they can instruct professionals and students. This will require the development of new learning materials and curricula, new examinations for professional licensing and new accounting software and reporting systems. To further complicate matters, the adoption of harmonized standards has to be phased in, so for a number of years, two different systems are in operation. Such a complex transition requires a lot of safety mechanisms to ensure it achieves uniform results.
• Another disadvantage of harmonization is when there exists different economic environment as harmonization could be considered useless. If a particular country has its own practice in place, and even though they adapt to use one of the international reporting standards, it could be more harmful to the country rather than make anything good. This is because the irrelevant element of the new reporting standard may be of no use and therefore may even introduce ambiguity and complication to that country’s reporting standards.                                                                                       (Any 3)

• Historical cost is whereby assets are recorded at the amount of cash or cash equivalents paid or fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amounts of proceeds received in exchange for the obligation, or in some circumstances at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business..
• Current cost whereby assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently, and liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.
• Realisable (settlement) value is the amount of cash or equivalents that could currently be obtained by selling an asset in an orderly disposal. Settlement value is the undiscounted amounts of cash and cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.
• Present value is the presented discounted value of the future net cash flows in the normal course of business.