Case study november 2011 marks plan ICAEW

CASE STUDY – NOVEMBER 2011 EXAMINERS’ COMMENTS AND MARK PLAN Contents Page Part 1: Executive summary Introduction Overview of performance Part 2: The Case Study examination Scenario for the paper (Advance Information) Analysis of Advance Information Information provided in the Exam Paper Examination requirements Analysis of Exam Paper Information Summary of grades available 11 Part 3: Commentary on candidates’ performance Professional skills 12 Executive summary 15 Requirement 1: Review of 4D‟s 2011 financial performance 15 Requirement 2: Impact of audit adjustments and meeting with NP Bank 16 Requirement 3: Evaluation of proposal from Foment 16 Overall paper 17 Part 4: Appendices Appendix 1: Analysis of 30 September 2011 financial statements 18 Appendix 2: Calculation of audit adjustments and impact on bank covenants 19 Part 5: Marking Key Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 PART 1: EXECUTIVE SUMMARY Introduction This report covers the November 2011 Case Study exam It is issued in conjunction with two illustrative scripts st and related Examiners‟ commentaries The first script was in the quartile of all assessed scripts; the second failed the exam In reviewing these scripts, it is important to be aware that it is rare for a script to be uniformly „good‟ or uniformly „bad‟ A successful script will present appropriate coverage of all requirements but may include errors of calculation or logic; an unsuccessful script may contain one or two appropriate sections and/or some good points but be let down by poor or incomplete text elsewhere Attached to this report are appendices with examples of the sort of work that candidates did, or might have done, under „financial analysis‟ The two illustrative scripts offer further insights in the area of financial analysis Overview of performance 73.9% of all candidates sitting the paper passed, compared with 75.2% in July 2011 and 76.0% in November 2010 The pass rate reflects the fact that this case was of a similar standard to all recent case studies The main departure from previous cases was that the examiners had introduced factors in both Requirements and which made those requirements slightly less predictable However, as in other case studies, the majority of candidates demonstrated the required level of competence in performing the financial analysis in Requirement 1, although weaknesses were apparent in considering and analysing EBITDA and the non-current asset analysis was often simplistic In Requirement candidates performed the necessary calculations to determine the proposed audit adjustments adequately but then faltered in interpreting and presenting the statement of cash flows in a positive way in the context of a breach in one of 4D‟s loan covenants and the imminent meeting with the bank Requirement was a reasonably straightforward consideration of a new proposal, with most strong candidates presenting a clear analysis of the issues involved and demonstrating their competence Weaker candidates failed to provide an appropriately balanced consideration of the issues they were required to address All three requirements had a similar grades profile and there was little evidence of any real time pressure for candidates, with most reports containing an Executive Summary which covered all aspects of the assessment The Advance Information (AI) informs candidates that the 4DVD Limited (4D) case concerns a company operating in the film and DVD industry 4D earns its revenue from the commissioned production of film and animation output for commercial and public sector clients, on a contract basis A major component of 4D‟s success has been the creation of the Spindles safety animation series for the Department for Education (DfE) and sales of associated DVDs and related merchandise Until September 2009 4D had experienced steady growth but the results for 2010 showed a decline in overall revenue Since October 2003 4D has had a long-term bank loan which is subject to covenant terms which the company has always met although the headroom had declined in 2010 From the management accounting information in the Exam Paper (EP) it could be seen that the decline in overall revenue had continued, but that the loan and interest repayment schedule had been met and that the company had adequate cash resources The 4D case requirements in the EP followed on from the information provided in the AI They comprised: (1) an analysis of the 12-month financial statements to 30 September 2011 against specifically defined yardsticks (overall revenue and gross profit, EBITDA and the trend in 4D‟s revenue streams as well as an analysis of the non-current assets in the light of recent disposals at a significant loss); (2) an analysis of a series of proposed audit adjustments and their impact on the loan covenants, together with an analysis of the statement of cash flows, in a positive way, in preparation for a meeting with the bank and; (3) an evaluation of the risks and benefits to 4D of a substantial new advertisement proposal from a client, Foment plc As in previous case studies the exam rubric specifically told candidates that an executive summary was to be provided and that the report should be balanced between the three elements Tutor firms have commented that this was “an innovative Case Study set in the current economic climate” and that “although this paper was harder to predict than some recent ones” the analysis required was “commercial” and a “good test of [candidates’] professional skills” The Examiners concur with these views Successful candidates followed the instructions contained in the rubric and produced well-balanced, relevant answers to the three main requirements, as well as appropriate appendices and concise, relevant executive summaries The majority of scripts were balanced, clear and focused, dealing with the requirements set including appropriate appendices Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 Candidates who failed did so for a number of different reasons Most candidates failed because they answered a requirement as they saw fit and did not address the issue in the manner requested A very small number failed because of poor exam technique by not planning their time appropriately such that they failed to finish a section or the executive summary All failures should be set against what was a universal agreement amongst tutor firms reviewing the 4D case, that the requirements were “clear and unambiguous” Requirement assessed the ability of the candidates to perform specific financial statement analysis Successful candidates provided clear analysis in line with the requirements Weaker candidates had difficulty with different aspects of the financial statement analysis The biggest failure was by not providing all analysis against the bigger picture of economic decline and the key fact of the disposal of non-current assets at a significant loss This was particularly so in considering EBITDA, which many candidates failed to identify correctly, or at all, opting instead for an analysis of operating profit (clearly pre-prepared) as their substitute Good candidates identified the size of the loss and its potential impact on the financial results and also raised the question of the value of remaining assets, as well as the possible impact of overvalued assets and overstated profits on the bank covenants Most weak candidates did not mention the very material loss on disposal, but just glided straight past the figure Other problems for weak candidates were in demonstrating the ability to provide an appropriate analysis of the trend in revenue streams with the recurring problem of not looking at absolute figures and only offering percentage changes without providing a yardstick figure for comparison As always in financial statement analysis, strong candidates demonstrated their professional competence Weaker candidates demonstrated a lack of analytical understanding, combining this with poor judgement and often banal conclusions These are fundamental weaknesses in a vital basic professional skill Requirement assessed the candidates‟ ability to calculate the impact of proposed audit adjustments on the financial covenants relating to the bank loan as well as presenting 4D‟s current finances in a positive way for the meeting with the bank, by a review of the statement of cash flows Most candidates correctly calculated the audit adjustments in terms of financial impact Problems occurred for weaker candidates in presenting the impact of these adjustments on the loan covenants Some candidates expressed the shortfall against a specific covenant in percentage terms only, thereby never identifying what the actual financial impact was – or what figure might be the subject of discussion with the bank Unfortunately some candidates confused the existing covenant condition relating to non-current assets with the newly suggested covenant relating to net current assets and therefore believed, incorrectly, that this covenant had been breached However, the most significant failures in this requirement related to the analysis of the statement of cash flows Many weaker candidates simply did not provide any specific analysis of the statement of cash flows – let alone in a positive way Many merely restated 4D‟s opening and closing bank balances Strong candidates demonstrated clear judgement, reasoned conclusions and recommendations; weaker candidates did not demonstrate these skills Requirement assessed the candidates‟ skills in evaluating the creation of a substantial new advertising campaign for a client, Foment plc, addressing the risks and benefits for 4D The majority of candidates made a reasonable attempt at answering this requirement and there was little evidence of time pressure in either the length or quality of answers Successful candidates wrote clear answers which integrated the AI and EP information Weaker candidates accentuated the commercial problems of the proposal by making erroneous assumptions outside the scope of the proposal Most of the weaknesses evident in answering this requirement suggested poor preparation and an inability to integrate AI and EP information particularly regarding ethical issues such as the regulation of advertising to children In the 4D case study the majority of scripts had an even spread of grades between the three requirements, indicating a structured, well-balanced and planned approach to answering the case As in all case study exams the top scripts provided really impressive answers All successful candidates demonstrated the ability to assimilate, analyse and assess the case information and write a relevant appropriate report Only a very small minority of the scripts showed any evidence of actual time pressure Overall the examiners consider that 4D was a topical case study, set in the current economic climate, with appropriately relevant elements which allowed good candidates the opportunity to demonstrate their professional and commercial skills It exposed the weaknesses of the under-prepared candidate and those who could not think „in situ‟ in response to (as one tutor firm described them) the “tutor proof twists” included in the requirements It also exposed those who did not demonstrate adequate professional skills in their answers As was stated by one of the tutor firms: “Students were not asked to anything that they should have considered to be unusual, unfair or outside their capabilities” This assessment should provide assurance to member firms that students qualifying as ACAs have been properly assessed and possess the range of skills and abilities required in the workplace Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 PART 2: THE CASE STUDY EXAMINATION Scenario for the paper (Advance Information) The case study relates to 4DVD Limited (4D), an owner-managed company which operates in the film making and DVD production industry, specialising in animation output It is located and operates in Gloucester in the UK Four weeks prior to the examination, candidates were provided with a 48-page package of information, containing a series of exhibits relating to 4D These comprised 14 exhibits: 10 11 12 13 14 About you, your employer and the subject company (4DVD Limited [4D]) The film industry Film and DVD making 4DVD Limited (4D) Email dated 12 January 2011 from James Magnet to you: Financial information 4DVD Limited management accounts: Summary for the years ended 30 September 2006-10 Loan Agreement dated October 2003 between 4D and NP Bank plc Email dated 12 April 2011 from James Magnet to Ali Monet: Financial review Revenue: commissioned film projects and income Revenue: sales of DVDs and merchandise Revenue: corporate DVD production Revenue: advertisement production Advertising regulation News and website articles Analysis of Advance Information (AI) By studying and analysing this Advance Information an overall picture of 4D could be established (Additional commentary by the examiners is provided in italics and in brackets.) Exhibit provides a brief background to Penbury Chartered Accountants (Penbury) and one of its clients, 4DVD Limited (4D), in which the candidate (Ali Monet) is working on a one-year secondment 4D is a film, DVD and broadcast production company which specialises in short film and animation work on a commission basis for both public and private sector clients.(This exhibit places the candidate inside the organisation 4D, the subject of the case, and indicates the candidate’s previous experience.) Exhibit gives a brief overview of the film industry, the economics of film production and distribution, and the type of output that the company such as 4D might produce It also provides background information on the specialised and short film market including the production of animation output for different markets including, amongst others, education and in the creation of advertisements (The information in this exhibit provides broad background of the film industry, sufficient to prevent further research by candidates.) Exhibit provides information on film and DVD making including the key personnel involved in film production as well as the various different ways in which films can earn money for their creators This exhibit describes the „one-off‟ production process and non-recurring nature of film production work (This exhibit provides sufficient information on the process of film production to avoid the need for further research on behalf of candidates.) Exhibit provides brief information on 4D‟s operations and more detailed information on its background and the directors who formed this business in October 2000 and their respective roles The main activities, or revenue streams, are identified A number of these activities are clearly related in terms of their production process although they are aimed at different clients: commission income from film production and broadcast work; corporate client work; production of advertisements; and animation output This latter activity is one of the key strengths of 4D, especially with the creation of the Spindles characters and the development and delivery, since 2004, of a national schools safety programme funded by the Department for Education (DfE) based on the Spindles family Linked to these DVD production activities are sales of DVDs and sales of merchandise, related mainly to the Spindles animation series The company is located in a modernised warehouse in Gloucester and also rents a second warehouse for post-production editing and inventory storage In terms of competition 4D operates in a crowded market where the technical barriers to entry can be low.(The details of the key personnel and the history of success of the business and its operations imply that 4D has the management team, the inhouse creative skills and the established products to be successful.) Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 Exhibit is an email from James Magnet (4D‟s FD) to Ali Monet accompanying 4D‟s management accounts for the past five years, to 30 September 2010 This email provides details about timing of the production of 4D financial information each year, including audit work and any adjustments proposed by the auditors Rigour Briggs It also identifies the existence of a loan agreement with the NP bank plc which is subject to a number of covenant conditions – which 4D has always met This email also indicates that one of the tasks “with which you could be involved may well be to act as a liaison person on behalf of 4D with the auditors” Exhibit provides pages of management accounts and notes, for the years to 30 September 2010 These accounts (which are in line with the audited accounts) provide the following key information:         4D has achieved good revenue growth from 2006 to 2009 of over 20% per year However, in 2010 there was a 9% decrease in revenue (Given the general economic recession and the nature of 4D’s business this decline could be expected.) 4D‟s gross margins on total revenues have changed over time: 45% (2006); 43% (2007); 41% (2008); 39% (2009); 37% (2010) (This declining GP% indicates weakening control over costs, or general downward pressure on revenues, or alteration in sales mix over time towards less profitable revenue streams.) Overheads as a percentage of revenue have remained almost static at around 34-35% each year (This indicates that these costs have been increasing in line with activity between 2006-2009, which may indicate slack control However, the decrease in line with activity in 2010 indicates that 4D may be taking control of these costs in a difficult year) Operating profit percentage declined steadily in the years: 11% (2006); 10% (2007); 8% (2008); 5% (2009); 3% (2010) (This decline may prove to be important given the details of the bank covenant loan conditions relating to interest cover in Exhibit 7.) Net finance expense has varied over time but has generally been in steady decline in line with the reducing amount of the loan outstanding The statement of financial position shows that 4D has a significant investment in non-current assets (see Notes to the accounts below) The company also holds inventories consistent with its sales of DVDs and merchandise There is an increasing level of accounts receivable (see below) which may indicate poor credit control, or an alteration in the terms and conditions of activities The level of accounts payable appears to be significant (see below) (The other noteworthy points are (i) a steady decrease in the noncurrent loan in line with the loan agreement; and (ii) a variable cash and cash equivalents balance and intermittent overdraft which indicate possible difficulties in short-term financial planning.) The statement of cash flows shows significant cash being generated from operations in all years up until 2009 with a reduction to £858k in 2010 However, the company uses the cash to invest heavily in the purchase of non-current assets each year and to pay finance expenses as well as the annual repayment of the loan principal (and taxes) As a result the company‟s cash and cash equivalents at the end of the year oscillate between positive and negative balances at the bank There is a relatively small inflow in terms of proceeds from disposal of non-current assets – and there has been a consistent history of losses on these disposals The company pays no dividends (This statement requires detailed reading and understanding, particularly for 2010 when the company appears to have been affected by the recession.) From the Notes to the accounts the following information can be seen: o Revenue: the detailed trends in revenue streams can be identified From initial analysis it would appear that the commissions of films activity continue to expand right through to 2010, whereas all other revenue streams are in a state of decline, some (advertisement production) from as early as 2008 o Cost of sales does not permit the identification of the comparative margins on each revenue stream Some costs can clearly be linked to some specific activities (DVDs, merchandise and materials together with web promotional and delivery costs can probably be linked to sales of DVDs and merchandise) but other costs cannot be set against specific revenue streams, which emphasises the interconnected nature of operational activities o Overheads/administrative costs provide information which shows that the largest single cost within this heading is salaries and wages (including, probably, those of at least two directors) (The fact that this cost moves in line with revenues may indicate poor control when revenues were increasing but the company has tightened control in the recession.) o Non-current assets information is provided for all years since the beginning of October 2005 The details of the different depreciation rates provided indicate a significant difference between the write-off of studio equipment (10 – 20%, reducing balance) and computer equipment (50%, reducing balance) (A review of the history of disposals of different categories of assets from this schedule, plus the statement of cash flows, indicates a history of losses on disposal on the studio equipment, which might raise questions on the depreciation policy, net profits and valuation of noncurrent assets.) Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 o o o Inventories information shows that the majority of inventories relate to DVDs and merchandise goods In earlier years this figure as a percentage of sales of DVDs and merchandise goods rose out of proportion to activity However, in 2009 and 2010 there has been much stricter control over such inventory levels Work-in-progress is also included in the inventory figure Accounts receivable: the majority of this figure relates to trade receivables and these have been rising faster than total revenues and in 2010 were taking twice as long to collect (55 days) as in 2006 (26 days) (This indicates either poor credit control or changing terms and conditions in generating revenue.) Accounts payable: less than half of the total amount in accounts payable comprises trade payables Included in the figure are other payables and accruals, taxation and social security and, importantly, a significant figure for deferred income (more than 25% of accounts payable each year) (As in any case study all the financial information should be read and fully analysed by candidates, ahead of the exam itself, in order to understand the detailed financial story and current financial position of the business.) Exhibit comprises details of the loan agreement with NP Bank plc dated October 2003 Amongst other details the terms of the initial total loan (£2m) the period (20 years) and repayment schedule (£100k on 30 September each year) together with the interest rate (8% minimum) are all provided The loan agreement also provides details of the covenant conditions: (1) relating to the book value of tangible non-current assets (must be maintained at 110% of the value of any outstanding loan and accrued interest); (2) the cover for the net finance expense against operating profit (must be kept at 300%) Compliance with these financial covenants shall be calculated by reference to the most recent published audited annual financial statements Any noncompliance with the financial covenants would require 4D either (i) to provide further security, by way of directors‟ personal guarantees and provide additional analysis or (ii) to repay immediately any facilities outstanding, being the amount by which the Loan is “exposed” as a result of any shortfall against any conditions identified above (This is clearly an important exhibit The implications of these covenant conditions mean that a calculation must take place each year to see whether the conditions are being complied with, or by how much 4D fails to meet them – the bank will impose its sanctions based on the degree of non-compliance.) Exhibit is an email from James Magnet to Ali Monet which provides additional background information about 4D‟s activities and where 4D is currently positioned It explains how the business has been affected by the recession but how some revenue streams are holding up better than others Within this exhibit there are also details of work-in-progress and deferred income, showing both how the transactions are recorded and how the balances are made up as at 30 September 2010 [Exhibits – 12 are attachments to this exhibit.] (This will prove to be an important exhibit as both of these areas of the accounts are dealt with in the EP As a side note it could be seen from some of the names on the list of organisations shown making up the balance on work-inprogress and deferred income that 4D has some impressive and substantial clients.) Exhibit explains more about 4D‟s commissioned film projects and income including the success of the Spindles safety animations, particularly with regard to the UK's national children's safety programme The wellbalanced working relationship with the DfE is explained, together with details of awards gained, and the 2009 BBC Christmas project featuring the Spindles characters in a themed mini-series of four five-minute animations A schedule of attributable costs for a single five-minute production is included This schedule was prepared as part of the negotiation for the fee with the BBC, with the production personnel costs priced as though 4D would have to buy them in for the project The timeframe for this £1m project is also given in that the work did not start until October 2009, at the earliest, and the 20 minutes of animation output had to be completed in order to be available for the BBC to plan and present in its Christmas schedule 4D retained the rights of further distribution of the Spindles animation films (In this exhibit there is a lot of information concerning 4D’s acute commercial awareness Its successful negotiation on price uses figures which could be justified in the marketplace, but which are certainly higher than in-house costs on a daily basis – implying that 4D’s profit from this series was much higher than appears on first analysis Its retention of the rights over the Spindles animations is an important safeguard over future revenue In addition the fact that it could deliver this work on time to meet the Christmas deadline emphasises both the artistic ability and the project management skills of the production team.) Exhibit 10 provides information on the sales of DVDs and merchandise The success of DVD sales is clearly linked to the success of the Spindles series and the same applies to the sales of merchandise which is mainly a range of goods based on the Spindles The company protects the Spindles brand from inappropriate associations with other products (This exhibit emphasises the importance and popularity of Spindles and the market which exists for its branded goods.) Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 Exhibit 11 deals with revenue from corporate DVD production As well as describing the spectrum of work which 4D produces under this heading the contribution earned from a typical commercial corporate project is also provided This contribution schedule indicates that this activity can be very profitable (From information provided elsewhere 4D has suffered a decline in activity and revenue in corporate DVD production caused by the general economic downturn – this started in 2008.) Exhibit 12 provides information concerning advertisement production revenue The fees and costs associated with the production of an original commercial advertisement (1 minute of film) suggest that this is a very profitable activity (a contribution of nearly 50%) However the warning is provided that it is difficult to identify the exact costs from reducing advertisement because so much depends on the inspiration needed to produce the idea which meets with the client's approval (The main problem for 4D is that its revenue from advertisement production reached its peak in 2007 and has been declining significantly ever since.) Exhibit 13 concerns the regulation governing advertising and, in particular, advertising to children This protection is essential in two main categories: (i) “children's products and services” – those of more or less exclusive interest to children; and (ii) “products and services of interest to children” – those likely to appeal to children but which are not of exclusive interest to them Advertisements must neither directly exhort them to buy a product or service nor encourage them to ask their parents, guardians or other persons to buy or enquire about a product or service for them (It is clear that 4D’s Spindles products could fall into both categories and so the company must pay special attention to all relevant advertising regulations.) Exhibit 14 comprises a series of news reports concerning different topical items:     The first article (Exhibit 14a) discusses the issues surrounding product placement on UK television together with the fact that television broadcasters will be allowed longer advertising breaks during free-to-air TV drama broadcasting – increasing to 12 minutes per hour from its current limit of minutes (The implication is that there will be an increase in demand for companies which can either help this product placement or who could produce advertisement films and DVDs.) The second article (Exhibit 14b) describes the problems relating to the commercialisation of childhood and the exploitation of children as consumers at key times of the year as well as those forced to work producing toys in harsh conditions It also provides advice to companies caught up in any adverse situations and how they should deal with the issues arising (This article serves as a possible warning for organisations involved in the manufacture and sale of children’s products.) The third article (Exhibit 14c) gives a guide to the production of cost-effective corporate videos by adapting an internally produced corporate DVD to create a positive corporate story for external purposes (This article emphasises how easy it is to produce a corporate DVD at a fraction of the price that companies such as 4D might charge.) The final article (Exhibit 14c) deals with: (i) the difficulty children have in distinguishing between advertising and reality, and also that in Sweden there is a ban on advertisements aimed at children under 12; (ii) the problems caused by children's identities increasingly being defined by their consumer habits, and that advertisers are targeting younger and younger children; (iii) the fact that children love to collect things which some marketing strategies seek to exploit (This article emphasise the issues associated with marketing and selling children’s products.) Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 Information provided in the Exam Paper The Exam Paper information contained nine pages of additional information by way of six exhibits The new documents provided to candidates were:       Exhibit 15 – email dated November from James Magnet (Finance Director of 4D) to Ali Monet: Financial review and report for 4D board Exhibit 16 – 4D management accounts for the year to 30 September 2011 (4 pages) Exhibit 17 – email dated November 2011 from Don Briggs, partner, Rigour Briggs Chartered Accountants to the 4D Board: Proposed adjustments to 4D‟s management accounts for the year ended 30 September 2011 Exhibit 18 – (i) email dated November from Colin Boyd, NP Bank plc to James Magnet and Stephanie Shan of 4D: Review of management accounts for all clients with loans exceeding 10 years; together with (ii) Stephanie Shan‟s related email of November 2011 to 4D Board Exhibit 19 – email dated 31 October 2011 from John Jones of Foment plc to the 4D Board: New advertising campaign Exhibit 20 – recent news articles relating to (i) junk food advertising and (ii) Foment plc interim results Examination requirements You are required by James Magnet to prepare a draft report to the Board of 4D dealing with following: A review of the 4D‟s results for the year to 30 September 2011, as presented in Exhibit 16, and of its investment in non-current assets at that date Your review of 4Ds 2011 results should cover the overall revenue, gross profit and EBITDA compared with 2010 It should also include an analysis of the trend in each of 4D's revenue streams You should additionally comment on 4D's investment in non-current assets as at 30 September 2011 in the light of the recent studio closure and equipment disposals A calculation and assessment of the financial impact of the points raised in the email from the auditors (Exhibit 17) You should calculate the impact of the proposed adjustments on 4D's draft management accounts, and you should also assess the resulting adjusted accounts against both the financial covenant conditions in the Loan Agreement with NP Bank plc (Exhibit 7) and the newly-imposed condition (Exhibit 18) Please also suggest how 4D might explain its current finances in a positive way at the proposed meeting with NP bank, by providing a review of 4D‟s 2011 statement cash flows and its year-end cash position An evaluation of the email from John Jones of Foment plc (Exhibit 19) requesting us to create a substantial new advertising campaign for Foment plc, using the Spindles characters You should address all the risks and benefits of this request – including any possible ethical concerns – and the impact for 4D both currently and in the future On the instruction page you are told the report should be balanced across the three detailed requirements and must also include an executive summary The time allocation suggested to candidates was: Reading and planning Performing calculations and financial analysis Drafting the report hour hour hours With a total of nine pages of information to read in the Exam Paper, time should have been spent reading quickly through all the new material (Exhibits 15 – 20), in order to understand the range of information contained in those exhibits It would then have been essential to read Exhibit 15 carefully to understand the requirements before starting a detailed read of the four pages of financial information provided in Exhibit 16 Using the new financial information it would then be essential to assess the 2011 results in the light of previous information and reflect on any preparatory analysis already carried out The exact financial analysis required focuses on an evaluation of overall revenue, gross profit and EBITDA (which will require calculating/identifying) as well as revenue streams and 4D‟s investment in non-current assets in the light of the recent studio closure Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 and equipment disposals Similarly the impact of the auditors‟ proposed adjustments will have to be calculated and the resulting adjusted accounts assessed (this will require the identification of the impact of the adjustments in financial/numeric terms) 4D‟s statement cash flows and its year-end cash position will have to be reviewed in order to be explained in a positive way at the proposed meeting with NP bank (this positive explanation will be important in any negotiation with the bank) The third requirement requires an evaluation of the proposal from Foment plc addressing the risks and benefits of this request With good planning well-prepared candidates should have been able to complete these three tasks, and write an executive summary, within the time available to produce a well-balanced report Analysis of Exam Paper (EP) information From reading the new exhibits candidates should have established that:       Exhibit 15 identifies the fact that 4D is currently passing through “a period of uncertainty and change”, and that ”in July, as a result of under-utilisation and the need to save costs”, 4D closed its second studio and “disposed of surplus and technologically obsolete studio equipment” (This sets the context for the financial analysis of 4D’s management accounts and the further work which follows.) Exhibit 16 comprises four pages showing the management accounts for the year to 30 September 2011: an income statement; a statement of financial position and a statement of cash flows, together with accompanying notes These notes include: details of revenues split into main business activities; details of cost of sales; a schedule of overheads/administrative expenses; details of the non-current assets; inventories; accounts receivable; accounts payable – similar in format to the information presented in the AI (Exhibit 6) The information should have posed no problem for any candidate to assimilate (This would have been a highly predictable exhibit although the actual figures would not have been known in advance However the analysis has to be made in the context of a continuing decline in revenue and the large losses which had been incurred on the disposal of studio equipment Analysis of 4D’s results to 30 September 2011 should have been anticipated and detailed analysis on AI figures for 2010 and earlier years would have been essential preparatory work.) Exhibit 17 (email from the auditors to the 4D Board) proposes adjustments to the draft management accounts relating to inventory and deferred income Both of these areas of the accounts had been identified in the AI (Exhibit 8) and this should have meant that candidates would have been aware of these accounting topics James Magnet had also suggested that one of Ali Monet‟s tasks would be “to act as liaison person” with the auditors and so the issue of having to consider any auditor proposals may have been anticipated The adjustments appear relatively uncontroversial and although there may be some room for discussion the calculation of the adjustments and the impact on the financial statements should have been straightforward (This exhibit, which related specifically to Requirement 2, although not predictable, should have been very easy to comprehend and assimilate not just from within the case but also from professional experience.) Exhibit 18 comprises an email from Colin Boyd of NP Bank confirming a meeting to introduce a new bank manager and to discuss 4D‟s draft management accounts, together with a subsequent internal email from Stephanie Shan responding to this email and the audit adjustments Both emails add an important complicating context to the adjustments proposed by the auditors from Exhibit 17 Stephanie Shan has assessed the situation very succinctly, as she sees it, by her questioning whether to make the audit adjustments ahead of the meeting with the bank, and her stating the need to present as strong a case as possible Her observation that “this meeting will need to be handled very carefully” is interpreted by James Magnet (Exhibit 15) as the need for 4D to “explain its current finances in a positive way at the meeting with NP Bank” (This exhibit places a commercial context and a tight timeframe on the consideration of the audit adjustments It is also important to note that in both the email from the bank and in the response from Stephanie Shan it is a new (additional) covenant condition relating to net current assets that is being imposed not an adjusted previous covenant condition Candidates were being required to consider these practical issues in a context of potential conflict.) Exhibit 19: this email from John Jones of Foment plc concerning a new advertising campaign is a short and easy-to-understand request It suggests a very large sum (£6m) for a series of 10 short scenario advertisements with “an advance payment of 25% of whatever total fee is finally agreed upon” This is an impressive financial proposal but it will require 4D to use the Spindles characters in an animated advertisement to deliver this contract (This email poses a number of difficult questions for 4D because the trade-off between the potential revenue and the possible damage to the Spindles brand has to be fully evaluated.) Exhibit 20 comprises two newspaper articles: One presents the arguments against junk food adverting and the negative impact on children; the second is a brief synopsis of Foment‟s recently-published interim results The latter identifies that Foment has been through a turbulent time and that because of the absence of provision for doubtful debts on its operations in the Middle East it may be overstating its profits Foment is Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 also involved in a heavy investment programme in southern Italy which is draining cash from the business (This exhibit identifies different problems and concerns which would affect the Foment proposal and which would need to be included as factors in the decision to be made.) The information provided in the EP follows on from the financial and commercial story told in the AI 4D‟s total revenue has continued to decline with the overall trajectory influenced by the recession There have been substantial disposals of studio equipment at a significant loss The auditors are proposing adjustments to the management accounts As a consequence of all these factors the amount of headroom on the bank loan has reduced and may reduce further This development of a number of previously established factors concerning 4D‟s business mean that different analytical techniques must be used in order to provide business advice to the 4D board The financial information provided to 30 September 2011 requires a clear focus on financial statement analysis – a basic professional skill and one which candidates must demonstrate The calculation and assessment of the impact of the auditors‟ proposed adjustments requires structured financial data analysis together with a broader, professionally aware perspective, on the appropriate preparation for the meeting with the bank The basis for consideration of the issues affecting the new Foment advertising campaign proposal requires a balanced review of financial and strategic, as well as non-financial and ethical, factors This commercial review includes a sceptical and ethical review of the issues The individual requirements clearly describe the route which should be followed in developing the report For Requirement the financial statement analysis of 4D‟s management accounts for the year to 30 September 2011 had to be focused on specific key features The fact that the requirement is cross-referenced to Exhibit 16 was to emphasise to candidates that their analysis was to be conducted on the unadjusted figures given in that exhibit For the 12 months income statement the analysis should be of revenues, gross profit and, given the significant losses on disposal of non-current assets, EBITDA It should also include the analysis of revenues by stream as well as 4D‟s investment in non-current assets (one of the factors in the loan agreement) The financial statement analysis was intended to make candidates focus on the commercial reality of the business given the continuing recession: this financial analysis should have been a speedy exercise numerically, but it then had to be developed with a clear commentary based on the focused numerical analysis Requirement requires some basic financial data analysis to calculate the audit adjustments, as proposed in Exhibit 17, to the management accounts provided, and then the newly-adjusted financial statements have to be evaluated against the loan agreement financial covenant to assess whether 4D complies or not In the event of non-compliance, which is broadly hinted at by Stephanie Shan, then the company must explain its current finances in a positive way at the bank meeting This requires the ability to present a clear explanation of each component of the statement of cash flows This whole process of calculation, evaluation, comparison and eventual consideration of the positive elements of 4D‟s results would require a logical and professional as well as fully integrated analytical approach Requirement requires a balanced analysis of the Foment advertising campaign proposal The requirement builds on the broad advertising regulatory information presented in the AI, further developed by the newspaper article in the EP and the importance of the clean image associated with the Spindles brand The counterbalance is the sheer size of the financial proposal from Foment The question is really whether 4D should sell its Spindle soul for this very big bag of income from an animated advertisement The most important element of this requirement is to maintain a balanced approach in terms of financial benefits (and risks) and the non-financial and (potentially) ethical issues identified Candidates had to identify all issues, integrate AI and EP and evaluate 4D‟s options Copyright © ICAEW 2011 All rights reserved Page 10 of 20 CASE STUDY – NOVEMBER 2011 frequently missed the issues of the impact of depreciation and losses on disposals); they provided a simple overall percentage calculation of the increase, or the decrease, in non-current assets (without reflecting on additions and disposals, depreciation policies and the impact on NCA book values) Fundamentally their analysis appeared not to be conducted in the context of the events and parameters surrounding the business These critical weaknesses meant that their analysis was below the standard required in this section Requirement 2: Impact of audit adjustments and meeting with the bank This topic assessed the candidates‟ ability to calculate the impact of proposed audit adjustments on the financial covenants relating to the bank loan as well as presenting 4D‟s current finances in a positive way for the meeting with the bank, by a review of the statement of cash flows Most candidates correctly calculated the proposed audit adjustments and their impact on the income statement, the statement of financial position and the statement of cash flows Problems occurred for weaker candidates in assessing and presenting the impact of these adjustments on the loan covenants Some candidates expressed the shortfall against a specific covenant in percentage terms only, thereby never identifying what the actual financial impact was – or what figure might be the subject of discussion with the bank Given that the directors of 4D would need to go to the bank meeting armed with this information it was a serious oversight Some weaker candidates worked on the assumption that it would be best to calculate the maximum audit adjustment which would still allow all loan covenants to be met and then set about attempting to “negotiate” with the auditors to reach their target figure – an interesting if erroneous action which said more about the candidates than they realised Unfortunately some candidates confused the existing covenant condition relating to non-current assets with the new suggested covenant relating to net current assets and therefore believed, incorrectly, that this original covenant had been breached However the most significant failures in this requirement related to the analysis of the statement of cash flows Many weaker candidates simply did not provide any specific analysis of the statement of cash flows – let alone in a positive way Many merely restated 4D‟s opening and closing bank balances, something the bank would already be totally familiar with and which would make very little impact in any meeting What was required was an item-by-item explanation of each line in the statement of cash flows explaining what it meant in terms of positive information for 4D and therefore by extension for the bank Unfortunately many weaker candidates resorted to a standard form of working capital analysis by calculating, and commenting on such factors as inventory turnover, debtor days etc which was not appropriate As a result of the poor analysis of the statement of cash flows the judgement demonstrated by weaker candidates was therefore also of a very poor standard Successful candidates demonstrated clear judgement and reasoned conclusions and recommendations Requirement 3: Evaluation of proposal from Foment This topic assessed the candidates‟ skills in evaluating the creation of a substantial new advertising campaign for a client, Foment plc, and in addressing the risks and benefits for 4D The majority of candidates made a reasonable attempt at answering this requirement and there was little evidence of time pressure in either the length or quality of answers In answering this requirement it was necessary to integrate background and regulatory information from the AI with the specific proposal information from the EP, in the context of 4D‟s current financial operations Successful candidates wrote clearly integrated answers Weaker candidates focused on the financial information provided and then accentuated the commercial problems of the proposal by making erroneous assumptions outside the scope of the proposal A large number of weaker candidates assumed that the products which Foment was proposing to sell were bound to be unhealthy, and responded accordingly – in fact there is no evidence of this These candidates also failed to understand that in terms of being able to deliver this series of advertisements 4D was not beginning from a standing start: it had the experience, the skills and a huge backlog of material to draw upon in order to deliver this advertising campaign In addition, given the declining trend in its business, 4D probably also had spare capacity and human resources at its disposal – or else given the potential sum involved it could certainly buy in everything required Unfortunately in this section some candidates also made basic mathematical errors or else assumed an unrealistic contribution based on the previous cost of delivering a different advertisement product In addition many weaker candidates failed to identify and address the main ethical issues identified in both the AI and EP in an appropriate manner Most of the weaknesses evident in answering this requirement suggested poor preparation and an inability to integrate AI and EP information particularly regarding the regulatory aspects of advertising to children Copyright © ICAEW 2011 All rights reserved Page 16 of 20 CASE STUDY – NOVEMBER 2011 There was some evidence that a small minority of weaker candidates failed to manage their time appropriately because their answers to this requirement were less well written but this problem was not widespread Overall paper Most candidates produced a well-structured document and also wrote sufficiently clearly and legibly The majority of candidates made good use of appendices, but as always some produced what appeared to be rewrites of previously prepared schedules Most scripts met the requirements and were appropriate for board use, but a significant minority made statements which added no value and which the board would not have considered appropriate for their use In the 4D case study the majority of scripts had an even spread of marks between the three requirements indicating a structured, well-balanced and planned approach to answering the case As in all case study exams the top scripts provided really impressive answers All successful candidates demonstrated the ability to assimilate, analyse and assess the information in the 4D case and write a relevant appropriate report Candidates who failed did so for a number of different reasons Most candidates failed because they answered a requirement as they saw fit and did not address the issue in the manner requested or within the context of the information provided Others failed because a lack of skill or knowledge meant that they answered a topic in a superficial way A very small number failed because of poor exam technique by not planning their time appropriately such that they failed to finish a section or the executive summary Copyright © ICAEW 2011 All rights reserved Page 17 of 20 CASE STUDY – NOVEMBER 2011 Appendix 1: Review of results to 30 September 2011 and investment in non-current assets Income statement Year ended 30 September Change Change % £000s 2011 2010 £000s £000s Revenue (12.6) (2,009) 13,928 15,937 Cost of sales (17.4) 1,744 (8,295) (10,039) Gross profit (4.5) (265) 5,633 5,898 Overheads/administrative costs (2.9) 159 (5,252) (5,411) (21.8) (106) Operating profit 381 40% Gross profit % 487 37% EBITDA calculation Operating profit 381 487 Cost of sales: dep'n & losses on disposals 897 390 Overhead: dep'n & losses on disposals 352 378 1,249 768 1,630 1,255 EBITDA 12% EBITDA as % of revenue 8% Alternatively add back statement of cash flow figures: Depreciation 574 722 Losses on disposals 675 46 1,249 768 586 698 Investment in NCA in the year Original cost of disposals (total) Total net investment in NCA 1,763 574 1,610 2,314 (1,239) 2,977 4,216 Sales of DVDs (533) 4,078 4,611 Sales of merchandise (496) 2,638 3,134 Fees for corporate DVD production (496) 1,917 2,413 Fees for advertisement production 861 1,889 1,028 429 535 13,928 15,937 % of total 21.4 % of total 26.5 Note Revenue change Commissions of films Hiring out studio and equipment Commissions (106) % change (29) Sales of DVDs (12) 29.3 28.9 Sales of merchandise (16) 18.9 19.7 Fees for corporate DVD production (21) 13.8 15.1 Fees for advertisement production 84 13.6 6.5 (20) 3.1 3.4 100.0 100.0 Hiring out studio and equipment Copyright © ICAEW 2011 All rights reserved Page 18 of 20 CASE STUDY – NOVEMBER 2011 Appendix 2: Audit adjustments and financial covenants Income statement Year ended 30 September 2011 Existing Adjs Adjusted £000s £000s Revenue 13,928 Deferred income (Exh 17) Cost of sales (8,295) Inventory (see (W1) below) Gross profit 5,633 Overheads/administrative costs Operating profit 13,898 (145) (8,440) 5,458 (5,252) 381 Net finance expense (114) Existing covenant = 300% x above (342) Profit before taxation (30) (5,252) OK 206 FAIL (114) 267 92 Operating profit meets the first covenant before adjustments (£381k) but not after; shortfall (£206k - £342k) = £136k to be "repaid" or negotiated (W1) Inventory (Exh 17) Per a/cs Adj Adj £000s £000s 60 DVDs 325 % 20 Merchandise goods 400 15 Materials for models 71 - - Other 27 - - 141 n/a Work-in-progress 964 Copyright © ICAEW 2011 All rights reserved 65 20 145 Page 19 of 20 CASE STUDY – NOVEMBER 2011 Statement of financial position Existing As at 30 September 2011 Adjs £000s Adjusted £000s £000s Possible NCA write-down (say) (200) 1,410 Provision (as above) (145) 819 Non-current assets Tangible assets 1,610 1,610 Net current assets Current assets Inventories 964 Accounts receivable Cash and cash equivalents Current liabilities Loan due in less than one year 2,218 2,218 419 419 3,601 3,456 OK (100) Accounts payable (100) (1,105) Bank overdraft (30) Deferred income (as above) 2,396 (1,135) - OK (175) 2,221 Loan Amounts due in more than one year Loan due in less than one year 1,100 OK Outstanding interest OK 100 1,200 Existing covenant = 110% x above 1,320 New covenant = 150% x above 1,800 Statement of cash flows Original Adj Adj Invent Def Inc £000s £000s £000s Profit before tax Adjustments for: 267 (145) (30) Depreciation 574 574 Losses on disposal of non-current assets 675 675 Net finance expense 114 114 1,630 1,455 Cash flows from operating activities Change in inventories Change in accounts receivable Change in accounts payable Cash generated from operations Copyright © ICAEW 2011 All rights reserved 81 145 £000s 92 226 377 377 30 (719) 1,369 Adjusted – – (689) 1,369 Page 20 of 20 November 2011 - 4DVD LIMITED First Marking DATE CANDIDATE NO TIME MARKER NUMBER ES Req Req Req Overall TOTAL 11 12 11 42 CC SC IC ID NA Total SUPERVISOR SIGNATURE CHECKER SIGNATURE Changes made? Framework ID = Insufficiently Demonstrated IC = Insufficiently Competent SC = Sufficiently Competent CC = Clearly Competent 1 or or - Range Executive summary Review of 4D's 2011 financial performance Impact of audit adjustments and meeting with the bank Use of appropriate numbers - total revenue and GP - EBITDA (not unadjusted OP £381k) - trend / mix analysis - NCA Use of appropriate numbers - audit adjustments - loan covenant - cashflow Financial analysis - total revenue and GP - EBITDA - trend / mix analysis - NCA Analysis - impact of adjustments on accounts - adjustments may be negotiable - cashflow review (F) NA (max IC if no numbers) ID IC SC CC (F) NA (max IC if no numbers) ID IC SC CC Implications of financial analysis - Spindles declining - GP% up due to change in revenue mix - loss on disposals distorts 2011 figures - loss on disposals may imply under-depreciation Evaluates key points - 2011 profit artificially low due to disposals - WIP/def income must be adjusted - availablity of cash to cover shortfall repayment (not whole loan) Draws conclusions / makes recommendations - EBITDA shows healthy underlying position - further NCA impairment may affect bank covenant - review depreciation policy Draws conclusions / makes recommendations - breach of interest cover occurs - needs positive spin for bank - important not to mislead bank (F) NA (F) NA ID IC SC CC ID IC SC CC Evaluation of proposal from Foment Commentary on Foment proposal - key risks (brand damage / timescale / resources / Foment finances) - key benefits (financial / access to new markets) Ethical issues - potentially unhealthy products / obesity - exploitation of child-friendly image - regulatory issues (F) NA ID IC SC CC Evaluates key points - Spindles in decline - impact on other work - proposal will reassure bank Draws conclusions / makes recommendations - clear decision - with (acceptable) justification - commercial recommendation (F) NA ID IC SC CC CC SC IC ID NA Total REQUIREMENT - Review of 4D's 2011 financial performance ASSIMILATING & USING INFORMATION STRUCTURING PROBLEMS & SOLUTIONS Uses relevant AI & EP information - Revenue Financial analysis on revenue Total revenue down 12.6% / £2,009k Revenue stream / trend analysis - film commissions - largest decline - DVD / merchandise - declining from peak in 2009 - corporate - continuing decline - adverts - increase after several years of decline - studio hire - decline from peak in 2009 Revenue streams 2011-2010 (need 3) - film commissions down 29% / £1,239k - DVD sales down 12% / £533k - merchandise down 16% / £496k - corporate down 21% / £496k - adverts up 84% / £861k - studio hire down 20% / £106k Sales MIX comments - commissions - significant / declining (21% v 26%) - DVD - largest / stable (29%) - merchandise - stable / small decline (19%) - corporate - stable / declining share (14%) - adverts - increasing / doubled (14% v 7%) - studio hire - insignificant (3%) / will reduce in 2012 Numerical trend analysis (including pre 2010) Calculation of a sales mix percentage (R) NA ID IC SC CC (F) NA ID IC SC CC Uses relevant AI & EP information - GP / EBITDA / NCA Financial analysis on margins GP down £265k (4%) / GP% up (40% v 37%) GP down but GP% up (linked) Adds back depn (£574k) to OP for EBITDA GP% improvement could be due to good cost control Adds back loss on disposal (£675k) to OP for EBITDA (Or COS £897k + O/H £352k) NCA investment down £112k / 16% Compares EBITDA (£1,630k / £955k) v 2010 Compares EBITDA% v 2010 (12%v8% or 7%v8%) Comments on margins by revenue stream (R) NA ID IC SC CC (R) NA ID IC SC CC Identifies business issues Financial analysis on NCA 4D products are discretionary spend Significant loss on disposal £675k BBC / DfE cutbacks Losses on disposal have arisen every year Increasing use of animation in adverts Comment on decline in investment Growth in advertising market (including on-line) Compare with bank covenant (134% v 110%) Own research - Aardman moving abroad - no tax subsidy for animation - overseas competition / subsidised - (R) NA ID IC SC CC (R) NA ID IC SC CC APPLYING JUDGEMENT CONCLUSIONS AND RECOMMENDATIONS Implications of financial analysis on revenue Draws conclusions (under a heading) Revenues distorted by Spindles Christmas series Conclusion on revenue / revenue streams Business is largely one-off / non-recurring projects Decline in popularity of Spindles Conclusion on GP / GP% Interdependence between revenue streams Rise in advertisement revenue good in current climate Conclusion on EBITDA Conclusion on NCA (R) NA ID IC SC (R) NA CC ID IC SC Implications of financial analysis on GP / EBITDA Makes recommendations Only a small fall in GP for large fall in revenue Grow high margin / advertising streams Change in mix has increased GP% (films adverts ) CC Ensure management accounts include GP by stream Good control over specific production costs (COS) Need full impairment review Not possible to accurately calculate stream GPs Review depreciation rates Loss on disposal distorts 2011 figures Need to maintain investment for quality of output (R) NA ID IC SC CC (R) NA ID IC SC CC Implications of financial analysis on NCA Losses on disposal may imply under-depreciation Quick sale may have increased 2011 loss on disposal Profit / remaining assets may be overstated Change to book value impacts bank covenant CC SC IC (R) NA ID IC SC CC ID NA Total 11 REQUIREMENT - Impact of audit adjustments and meeting with the bank ASSIMILATING AND USING INFORMATION STRUCTURING PROBLEMS & SOLUTIONS Uses EP to calculate impact on accounts Loan covenant before adjustments Reduction of revenue by £30k NCA: 134% v 110% / £1,610k v £1,320k Increase in COS of £145k Profit: 334% v 300% / £381k v £342k Increase in current liabilities of £30k Net current assets: 200% v 150% / £2,396k v £1,800k Write down of inventory by £145k on balance sheet All conditions met (or consistent with own analysis) (R) NA (R) NA ID IC SC CC ID IC SC CC Impact of adjustments on loan covenants NCA: no change / not affected by adjustments Profit: 181% v 300% / £206k v £342k Net current assets: 185% v 150% / £2,221k v £1,800k (or tax adjusted figures) Only breach is of interest cover (or consistent with own analysis) Exposed amount (£136k) repayable to bank Covenant conditions for 2011 NCA >110% of outstanding loan Profit > 300% of net finance expense Net current assets > 150% of outstanding loan (R) NA ID IC SC CC Need for unmodified audit report Positive overview of cashflow Significant cash generated from operations (£1,369k) (R) NA Significant loss on disposals (£675k) does not affect cash ID IC SC CC Eliminated opening overdraft (£96k) Positive change in cash (£503k) / strong cash position (£419k) (R) NA ID IC SC CC Identifies business issues Commentary on cashflow Imminent meeting with the bank to discuss figures Maintaining investment in NCA / important for business Recent change in main bank contact Reduction in inventory explained Directors not want to provide personal guarantees Reduction in AR explained Banks more risk-averse in current climate Reduction in AP explained Increase in working capital discussed (R) NA ID IC SC CC (R) NA ID IC SC CC APPLYING JUDGEMENT CONCLUSIONS AND RECOMMENDATIONS Positive presentation for the bank Draws conclusions Historical strength - first time breach of covenants - always paid capital/interest on time Concludes on audit adjustments / shortfall - effect of adjustments gives exposure / shortfall of £136k - adjustment of errors alone (£50k) will cause breach (£11k) - breach triggers requirement for quarterly accounts Cause of current breach - profit artificially low due to disposals - BUT should be a one-off issue (closure of 2nd studio) Concludes on cashflow - concludes on ability to repay shortfall (not whole loan) - still generating sufficient cash to meet liabilities Impact of audit adjustments on 2011 figures - reduced profit but cashflow still strong (F) NA ID IC SC CC (F) NA ID IC SC CC Review of proposed audit adjustments Makes recommendations Consider if audit adjustments appropriate / necessary Emphasise positive view / good credit risk WIP (£20k) / def income (£30k) - errors to be adjusted Inform bank of Foment proposal DVDs adjustment estimated (£65k) - could challenge Interim reviews of covenant compliance Merchandise full write-off (£60k) - may be over-prudent Develop good relationship with new bank manager Refusal to adjust may lead to modified audit report Do not put undue pressure on auditors (unethical) Continue to control / monitor working capital (R) NA ID IC SC CC (R) NA ID IC SC CC Considers ethical / professional issues Final accounts not yet ready (normally weeks) 4D could be tempted not to mention adjustments Consider appropriateness of positive spin on figures Tell bank about adjustments / must not mislead them (R) NA ID IC SC CC CC SC IC ID NA Total 12 REQUIREMENT - Evaluation of proposal from Foment ASSIMILATING & USING INFORMATION STRUCTURING PROBLEMS & SOLUTIONS Uses AI & EP effectively Risks of Foment proposal Spindles mature product / declining market Tainting of brand / reputation if product unsuitable Foment proposal Very short timescale / Christmas adverts need to be on TV now ASA guidelines re advertising to children Needs creative directors / large time input Press cuttings (Foment / obesity) Lack of studio space / equipment Currently only a proposal not a contract Foment might face future financial difficulty Could lose Foment as a client if reject proposal (R) NA ID IC SC CC (R) NA ID IC SC CC Describes wider context Benefits of Foment proposal Increase in advert market / animation / new media Significant new project (20% of current revenue / £6m) Product placement / increase in adverts per hour Up-front £1.5m would aid cashflow Increasing level of complaints about adverts Potentially very profitable Link to current loan covenant issue (R2) Could be prestigious to win / promote 4D brand Own research - Potential for further work with Foment Good experience for management and creative team (R) NA ID IC SC CC (R) NA ID IC SC CC Existing ethical aspects of Spindles Spindles current target audience is young children Spindles are associated with safety films 4D / Spindles have good public image / loyal fan base 4D previously refused to link Spindles to mobile phones (R) NA ID IC SC CC APPLYING JUDGEMENT CONCLUSIONS AND RECOMMENDATIONS Evaluates risks Draws conclusions May prevent further work with BBC / DfE Concludes on proposal - there are major reputational risks - there are major financial benefits - exploit potential of Spindles before end of life-cycle Will be expensive to meet deadlines eg freelance rate May be late delivery penalties Impact on existing work Contract may be too large for 4D to handle Costs involved in negotiating this contract (eg legal) Concludes on ethical issues - potentially controversial / ethically questionable - pre-clearance with ASA helps mitigate risk Over-reliance on Foment / risk of future non-payment (R) NA ID IC SC CC (F) NA ID IC SC CC Evaluates benefits New revenue reverses previous trend downwards Favourable cashflow terms covers WIP on project Potential margin range 30-50% Opens up new markets Makes recommendations May rekindle demand for Spindles products Need to negotiate a final contract (R) NA ID IC SC CC Agree stage payments to minimise risk Assesses ethical issues - products Need more details on Foment's products Unclear if products are actually unhealthy Review Foment's financial position Adverts may be aimed at inappropriate age group Protect 4D product rights over Spindles characters Trading on child-friendly image for commercial purposes Foment would want to achieve 'pester-power' Tension between Foment's ethical standards and 4D's (R) NA ID IC SC CC (R) NA ID IC SC CC Assesses ethical issues - regulation Must comply with ASA guidelines concerning children Must be aware of increased monitoring of adverts Overseas advertising will add to regulatory burden CC Difficult to control where and when adverts are aired SC IC (R) ID NA Total NA ID IC SC CC 11 Overall paper Structure and style Appropriate appendices ES sufficient but not excessive length Calculations easy to follow / numbers clearly derived Clear structure / not repetitive Generally neat / clearly laid out Sufficient appropriate headings Calculations should not be in text of report Suitable (formal) language for audience / logical flow Calculations from appendices used in report Recognises internal report / no disclaimer Legible Reasonable spelling / grammar (R) NA ID IC SC CC NA ID IC SC CC SC IC ID NA Total CC ... workplace Copyright © ICAEW 2011 All rights reserved Page of 20 CASE STUDY – NOVEMBER 2011 PART 2: THE CASE STUDY EXAMINATION Scenario for the paper (Advance Information) The case study relates to.. .CASE STUDY – NOVEMBER 2011 PART 1: EXECUTIVE SUMMARY Introduction This report covers the November 2011 Case Study exam It is issued in conjunction with... by not planning their time appropriately such that they failed to finish a section or the executive summary Copyright © ICAEW 2011 All rights reserved Page 17 of 20 CASE STUDY – NOVEMBER 2011 Appendix