.                                                                                    Report
To                : Board of Directors of Shop First Plc
From            : Accountant
Date             : 10 January, 2021
Subject         : Analysis of the financial performance and position of Shop First Plc

Following the discussion we had on the above subject matter, this report is submitted for your perusal. The report looks at profitability, working capital management and gearing of the company for the year ended 31 December 2020, as against its comparative period. This report should be read with the attached appendix.

Profitability
There has been a fractional improvement in revenue in 2020 over 2019. This steady rise in revenue resulted largely due to discontinuation of the retail shop. The sold shop contributed 13.12% of the total revenue generated in 2020 against 19.18% in 2019. The company could however not keep its operational costs in line with the revenue changes as all the profitability measures have dropped in 2020. Management did poorly in controlling both direct trading costs and overheads as gross profit margin as well as net profit margin has fallen. A separate analysis carried out on margins between continuing and discontinued operations reveals that while the stopped operations may have significantly contributed to the poor operating margins especially because of the disposal loss recorded this part of the entity operated on better gross margins than the rest of the company. Hence, the company is likely not become any better after the sale of the operations if cost controls are not significantly tightened for the remaining operations.

The low margins have had hugely negative impact on returns made for providers of capital in 2020. Both ROCE and return on equity have slipped considerably even though the company has seen some noticeable improvements in net asset and inventory turnovers. Asset turnover shows that the firm turned its resources roughly three times into sales this year as against little over two times in 2019. Thus, the decline in profitability can be clearly attributed to high operating cost levels.

Working capital management
Overall, working capital has been effectively managed by Shop First Plc. With current ratio of 1.48 in 2020, Shop First Plc’s current assets provide a good cover for its short-term obligations. And this ratio is slightly up from 1.47 it had back in 2019. Current ratio measures how well a firm is positioned to apply current assets to pay off current liabilities when they mature. The current ratio of 1.48 implies that the company maintains GH¢1.48 of current assets to pay every GH¢1 of current debt owed. As a cushion, Shop First achieves a good inventory turnover rate and records a clear improvement over last year. This should reduce any fear of liquidity concerns. On inventory turnover of 7.42 (as against 5.95 in 2019), the company is able to empty its warehouse 7.5 times on average within 2020, as against approximately 6 times back in 2019. The strong liquidity situation is further helped by Shop First Plc being a retail firm which makes it more likely that it would convert resources into liquid assets at an accelerated rate. However, were the contingent liability to crystallize any time soon, it would have a damaging effect on liquidity by bringing it down below 2019’s level.

Gearing
This measures the extent to which the firm finances its operations with funds provided by external parties. Under this section, investors and lenders determine how much risk the firm exposes them to. The proportion of debts in the total long-term capital has seen a decline, as shown by its capital gearing ratio. While little more than half of the total resources in 2019 was provided by lenders, around six percent of total funds came from within for 2020. The reduction in debt used implies that the firm is facing lower financial risk now, and the company is looking healthy. But if profitability concerns are not overturned sooner than later, keeping even minimal level of gearing may be unsustainable.

Conclusion
The analysis above has revealed that Shop First Plc’ profitability has worsened and operational costs seem out of control. However, liquidity, efficiency and gearing levels do not raise any concerns. Management are therefore entreated to institute investigation into unearthing how best it can put costs under check and consolidate its strong position.

I am available to provide any further clarification, if so needed. Thank you

(Signed)
Accountant

Computation of 2020 ratios; 10 x 1 mark     = 10 marks
Report on the analysis                                    = 6 marks
Comment on the effects of the discontinued operations   = 4 marks

Composition of control according to IFRS 10

• Power over the investee to direct relevant activities
  The absolute size of Accra Ltd’ shareholding in Tema Ltd (40%) and the relative size of the other shareholdings alone are not conclusive in determining whether Accra Ltd has rights sufficient to give it power. However, the shareholder agreement which grants Accra Ltd the right to appoint, remove and set the remuneration of management responsible for the key business decisions of Tema Ltd gives Accra Ltd power to direct the relevant activities of Tema Ltd. This is supported by the fact that a two-thirds majority is required to change the shareholder agreement and, as Accra Ltd owns more than one-third of the voting rights, the other shareholders will be unable to change the agreement whilst Accra Ltd owns 40%.
• Exposure or rights to variable returns of the investee
  As Accra Ltd owns a 40% shareholding in Tema Ltd, it will be entitled to receive a dividend. The amount of this dividend will vary according to Tema Ltd’s performance and Tema Ltd’s dividend policy. Therefore, Accra Ltd has exposure to the variable returns of Tema Ltd.
• Ability to use power over the investee
  The fact that Accra Ltd might not exercise the right to appoint, remove and set the remuneration of Tema Ltd’s management should not be considered when determining whether Accra Ltd has power over Tema Ltd. It is just the ability to use the power which is required and this ability comes from the shareholder agreement.
• Conclusion
  The IFRS 10 definition of control has been met. Accra Ltd controls Tema Ltd and therefore Accra Ltd should consolidate Tema Ltd as a subsidiary in its group financial statements.                             (Any 2 points at 2.5 marks each = 5 marks)

.                                                                                                                                        (6 marks)

Steps to follow to appraise a scheme

• A scheme of capital reduction will affect the rights of the various parties who have a financial stake in the business including shareholders.
• The starting point is to construct a working showing how much cash could be raised in the event of liquidation and to whom that cash would be paid. This would provide an indication as to how much shareholders are to gain or lose.
• The scheme is designed to take this information into consideration. The party with the most to gain from the scheme (usually the shareholders) would have to demonstrate their commitment to the scheme by carrying the larger share of its cost.
• The scheme must meet the following criteria:
   The scheme must ensure that there is equitable share in allocating losses
   The scheme must return to the entity to profitability
   The losses to be incurred under liquidation must exceed the losses to be incurred under the capital reduction scheme
   The existing control structure must be maintained.

.     Present debt or liabilities should be settled under the capital reduction scheme

.     The scheme must provide adequate working capital.                                                   (Any 4 points @ 1.25 = 5 marks)

Integrity
You need to be honest and straightforward in exercising your integrity. Omitting income from staff sales will result in the financial statements being misleading. Again, this practice is dishonest, and what should be done is to formalise the current system employed for staff sales and funding of Christmas party.
Objectivity
The reputation of your company may be vulnerable, and you should discuss this ethical dilemma with your production managers and subsequently directors.

Professional competence and due care
You must ensure that the financial information that you produce for the company is in accordance with technical and professional standards.

Professional behaviour
You need to act professionally in such a way to protect your reputation as a Finance Director, and the accounting profession in general. In so doing, you need to consider relevant accounting standards and any applicable laws and regulations. You need to also determine the system currently employed for controlling and controlling staff sales and funding the directors’ Christmas party.

Conflict of interest
There appears to be conflict of interest. You must be objective in reporting fully on staff purchases of company goods.

Possible causes of action

• After bringing the issue to the attention of your partners and obtained the relevant details of the client’s system for accounting for staff sales, you should raise your concerns with the directors of the client company.
• You will also have to determine whether the financial statements of previous years are likely to be misleading and, if so, consider your responsibility (or that of your client) to inform the relevant authorities (including the tax authority).
• You should strongly advise the directors that a staff sales policy should be introduced to ensure that these sales are fully recorded in the company’s accounting system in the future.
• You should explain to the directors the implications of their actions, and that you are safeguarding the interests of the company and its staff in advising how the situation may be rectified.
• If the directors are co-operative, you should advise them of the recommended changes to the accounting system and how they might disclose the past undisclosed income to the tax authority.
• If the directors appear unwilling to change the system in respect of staff sales, you are obliged to disassociate yourself from any involvement with the company’s financial statements, and this will require you to resign as the company’s finance director.
• At any time, you may seek advice from your professional body.
• In view of this, you are obliged to consider your whistleblowing obligations, and may have to report the matter to one or more authorities. This will be in the public interest and does not amount to breach of confidentiality.
• As a last resort, you should document, in detail, the steps that you take in resolving your dilemma, in case your ethical judgement is challenged in the future.                                   (Any 5 causes of action to be taken @ 2 marks each = 10 marks)

Under IAS 24: Related Party Disclosures, disclosures are required in respect of an entity’s transactions with related parties. Related parties include parents, subsidiaries, members of key management personnel of the entity or of a parent of the entity and post-employment benefit plans. Where there have been related party transactions during the period, management discloses the nature of the relationship, as well as information about the transactions and outstanding balances, including commitments, necessary for users to understand the potential impact of the relationship on the financial statements. Disclosure is made by category of related party and by major type of transaction. Management only discloses that related party transactions were made on terms equivalent to those which prevail in arm’s length transactions if such terms can be substantiated.

Government-related entities are defined as entities which are controlled, jointly controlled or significantly influenced by the government. The financial crisis in the financial services sector in Ghana widened the range of entities subject to the related party disclosure requirements. This is not only peculiar in Ghana but many countries. The financial support provided by government to financial institutions in many countries meant that the government controls significantly influenced some of those entities.

A government-controlled bank would, in principle, be required to disclose details of its transactions, deposits and commitments with all other government-controlled banks and with the Bank of Ghana or central bank. However, IAS 24 has an exemption from all of the disclosure requirements of IAS 24 for transactions between government-related entities and the government, and all other government-related entities.

GHBank Limited is exempt from the disclosure requirements in relation to related party transactions and outstanding balances, including commitments, in relation to the following:
(a) a government which has control, joint control or significant influence over the reporting entity; and
(b) another entity which is a related party because the same government has control, joint control or significant influence over both the reporting entity and the other entity.

Those disclosures are replaced with a requirement to disclose:

• The name of the government and the nature of their relationship; and
• The nature and amount of any individually significant transactions; and
• The extent of any collectively significant transactions qualitatively or quantitatively.                           (1 mark per valid point up to a maximum of 5 marks)

Pension scheme
The defined benefit scheme for the year should have been recorded as follows:
.                                                                                                                               GH¢ million
Net obligation at 31 December 2019                                                                           120
Cash contribution into the scheme                                                                             (100)
Net finance cost for the year (GH¢120 million x 5%)                                                   6
Current service cost                                                                                                         55
Loss on curtailment                                                                                                         11
Gain on remeasurement                                                                                                (9)
Net liability at 31 December 2020                                                                              83

The benefits paid do not affect the net liability for the year. Since only the cash contributions have been recorded for the year, the net obligation should be increased by GH¢63 million (GH¢83 million – GH¢20 million). GH¢72 million should be expensed to profit or loss (W12) being the service cost component (current and curtailment) plus the interest charge. GH¢9 million should be credited to other components of equity being the gain on remeasurement.

Statement of profit or loss extract for the year ended (Extract)
.                                                                                                            GH¢ million
Defined benefit scheme (GH¢55 + GH¢6 + GH¢11)                               (72)

Statement of financial position extract                                           GH¢ million
Equity and liability:
OCI – remeasurment component                                                                9
Non-current liabilities:
Increased in defined benefit obligation                                                     63
.                                                                                                      3 marks for financial statement extracts
.                                                                                                      2 marks for reconciliation and movements

Jamila Ltd

• Goodwill in Jamila Ltd would originally be calculated as GH¢20 million (GH¢1,250 million – GH¢1,230 million). The net assets in Jamila Ltd are now GH¢1,292 million at 31st December 2020 (GH¢1,272 million per question and GH¢20 million goodwill).
• Since the group has a revaluation policy under IAS 16 Property, Plant and Equipment, the group must revalue the property plant and equipment of Jamila Ltd to fair value of GH¢340 million on classification as held for sale. A gain of GH¢10 million (GH¢340 million – GH¢330 million) would be recorded within other components of equity.
• The net assets of Jamila Ltd would now have a carrying amount of GH¢1,302 million including GH¢846 million for property, plant and equipment. On classification as held for sale, Jamila Ltd must be measured at the lower of carrying amount and fair value less costs to sell. An impairment arises of GH¢82 million (GH¢1,302 million – GH¢1,220 million).
• This will first be allocated to the goodwill of GH¢20 million. The remaining impairment of GH¢62 million is allocated to non-current assets to which the measurement requirements of IFRS5 Non-current Assets Held for Sale and Discontinued Operations apply. No impairment will therefore be allocated to the current assets of Jamila Ltd.

Calculations
The remaining impairment loss of GH¢62 million should be allocated to property, plant and equipment and other intangible assets in proportion to their respective carrying amounts as follows:
Property, plant and equipment GH¢62 million x (GH¢846m/ (GH¢846 million + GH¢428 million)) = GH¢41 million Other intangible assets GH¢ 62 million x (GH¢428 million/( GH¢846 million + GH¢428 million)) = GH¢21 million.

The assets and the liabilities of the disposal group should be separately presented within the current assets and current liabilities of the consolidated financial statements. GH¢1,796 million (GH¢805 million + GH¢407 million + GH¢584 million) or (GH¢836 + GH¢10 + GH¢428 – GH¢62 + GH¢584) will be included within current assets and GH¢576 million (GH¢322 million + GH¢254 million) within current liabilities.                                           (5 marks evenly spread using ticks)

• The discount rate used by Gyamfi Ltd has not been calculated in accordance with the requirements of IAS 36 Impairment of Assets. According to IAS 36, the future cash flows are estimated in the currency in which they will be generated and then discounted using a discount rate appropriate for that currency. IAS 36 requires the present value to be translated using the spot exchange rate at the date of the value in use calculation.
• Furthermore, the currency in which the estimated cash flows are denominated affects many of the inputs to the WACC calculation, including the risk-free interest rate.
  Gyamfi Ltd has used the 10-year government bond rate for its jurisdiction as the risk-free rate in the calculation of the discount rate. As government bond rates differ between countries due to different expectations about future inflation, value in use could be calculated incorrectly due to the disparity between the expected inflation reflected in the estimated cash flows and the risk-free rate.
• According to IAS 36, the discount rate should reflect the risks specific to the asset. Accordingly, one discount rate for all the CGUs does not represent the risk profile of each CGU. The discount rate generally should be determined using the WACC of the CGU or of the company of which the CGU is currently part. Using a company’s WACC for all CGUs is appropriate only if the specific risks associated with the specific CGUs do not diverge materially from the remainder of the group. In the case of Gyamfi Ltd, this is not apparent.

(Three points well explained @ 2 marks each = 6 marks)

A number of IASs are required to answer this question, which include the knowledge of IAS 16, IAS 36, IAS 12 and IAS 21

• Carrying amount of building at 31 March 2021 GH¢ (25 – 1 depreciation) million, i.e. 24 million dinars/2 = GH¢12 million. (0.5 mark)
• Recoverable amount of building at 31 March 2021 (17.5 million dinars/2.5 ) = GH¢7 million. (0.5 mark)
• Impairment loss to profit or loss = GH¢5 million (GH¢12 million – GH¢7 million)     (0.5 mark)
• The tax base and carrying amount of the non-current assets are the same before the impairment charge. After the impairment charge, there will be a difference of GH¢ 5 million. This will create a deferred tax asset of GH¢5 million x 25%, = GH¢1·25 million.
  As Gyamfi Ltd expects to make profits for the foreseeable future, this can be recognised in the financial statements.   (1.5 marks)

Statement of profit or loss for the year ended 31/3/2021 extract
.                                                                                                                                   GH¢ million
Impairment of building                                                                                                       (5)
Depreciation of building (25 dinnars/25 yrs = 1dinnar/2                                              (0.5)
.                                                                                                                                                  (1 mark)
Statement of financial position extracts as at 31/3/2021
Non-current assets:
Deferred tax assets                                                                                                             1.25
Building (12 – 5)                                                                                                                      7
.                                                                                                                                                   (1 mark)

The asset’s fair value in the overseas currency has declined for successive periods. However, no impairment loss is recognised in the year ended 31 May 2019 as there is no loss in the reporting currency (GH¢). The gain of GH¢1·5 million would be recorded in equity. However, in the year to 31 May 2020 an impairment loss of GH¢17·4 million will be recorded as follows:
Dr    Other components of equity                    1.5
Dr    Profit or loss                                            15.9

Cr    Financial asset through OCI                                              17.4