Wednesday November 2011 (4 hours) CASE STUDY CANDIDATE NUMBER DO NOT TURN OVER UNTIL YOU ARE TOLD TO DO SO When instructed: a b check that your question paper contains all the required pages The Institute’s consecutive page numbering may be found under the base line at the foot of each page; enter your candidate number in the box provided above Number each page of your answer consecutively using the space provided at the top right of each sheet Ensure that your candidate number is written on each page of your answer After the instruction to stop writing at the end of the paper, you will be given five minutes to assemble your answer in this folder Fasten your complete script inside this folder using the hole in the back page and the tag provided Do not include your question paper in the folder Answer folders and examination stationery, used or unused, must not be removed from the Examination Hall Question papers may, however, be retained by candidates Your answer must be submitted on the paper provided by the ICAEW in the Examination Hall Any pre-prepared papers, or papers comprising annotated exhibits from the case material, included in your answer WILL NOT be marked by the examiners ICAEW USE ONLY Copyright ©The Institute of Chartered Accountants in England and Wales 2011 151195 BLANK PAGE November 2011 Case Study: 4DVD Limited List of exhibits The following exhibits were included in the material provided as Advance Information: 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 you: Financial review Revenue: commissioned film projects and income 10 Revenue: sales of DVDs and merchandise 11 Revenue: corporate DVD production 12 Revenue: advertisement production 13 Advertising regulation 14 News and website articles The following items are newly provided: 15 Email dated November 2011 from James Magnet to you 16 4D Limited: Draft management accounts for the year to 30 September 2011 17 Email dated November 2011 from Don Briggs, partner, Rigour Briggs Chartered Accountants to the 4D Board 18 Email dated November 2011 from Colin Boyd of NP Bank plc to James Magnet and Stephanie Shan together with Stephanie’s email dated November to the 4D Board 19 Email dated 31 October 2011 from John Jones of Foment plc to the 4D Board 20 News articles ICAEW/CS/N11 of 17 BLANK PAGE ICAEW/CS/N11 of 17 4DVD LIMITED Case Study requirement You are Ali Monet, a final-year trainee Chartered Accountant on secondment to 4DVD Limited (4D), a UK-based company engaged in DVD and film production You work within the finance department and report to James Magnet, the Finance Director Requirement You are required to prepare a draft report for the 4D Board, as set out in the email dated November 2011 from James Magnet to you (Exhibit 15) Your report should comprise the following four elements: An executive summary Your responses to the three detailed requirements set out in Exhibit 15, including financial appendices (as required) State clearly any assumptions that you make All workings should be attached to your answer Your report should be balanced across the three detailed requirements, and the following time allocation is suggested: Reading and planning Performing calculations and financial analysis Drafting report hour hour hours Marks allocation All of the marks in the Case Study are awarded for the demonstration of professional skills, allocated broadly as follows: Applied to the four elements of your report (as described above) Assimilating and using information Structuring problems and solutions Applying judgement Drawing conclusions and making recommendations Applied to your report as a whole Demonstrating integrative and multidisciplinary skills 20% 30% 25% 20% 95% 5% 100% Approximately 15% of the marks are awarded for the executive summary and 10% for the appropriate discussion of ethical issues within your answer to the requirements In planning your report, you should be aware that not attempting one of the requirements will have a significantly detrimental effect on your chances of success, as will not submitting an executive summary In addition, as indicated above, all four skills areas will be assessed under each of the four elements of your report Accordingly, not demonstrating your judgement and failing to include appropriate conclusions and/or recommendations in each element of your report will affect your chances of success ICAEW/CS/N11 of 17 BLANK PAGE ICAEW/CS/N11 of 17 EXHIBIT 15 From: To: Subject: Date: James Magnet Ali Monet Financial review November 2011 EMAIL 4D is currently passing through a period of uncertainty and change In July, as a result of under-utilisation and the need to save costs, we closed our second studio and disposed of surplus and technologically obsolete studio equipment In addition, we are obliged to take note of changes within NP Bank – the provider of our long-term loan – and its assessment of 4D’s financial affairs We have also received a new commercial proposal from one of our existing corporate clients which may help both our immediate and longer-term business future For your information I am attaching the following: 4D’s draft management accounts for the year to 30 September 2011 (Exhibit 16) An email from our auditors (Exhibit 17) An email from our bank, and responding email from Stephanie Shan (Exhibit 18) An email from one of our established clients, Foment plc (Exhibit 19) Two recent news articles (Exhibit 20) Please draft a report for the Board comprising the following: A review of 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 4D’s 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 noncurrent 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 (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 of 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 I look forward to receiving your draft report ICAEW/CS/N11 of 17 BLANK PAGE ICAEW/CS/N11 of 17 EXHIBIT 16 4D Limited: Draft management accounts for the year to 30 September 2011 Income statement Year ended 30 September 2011 Notes £000s Revenue Cost of sales Gross profit Overheads/administrative costs Operating profit Net finance expense Profit before taxation Taxation Profit for the year after taxation Statement of financial position As at 30 September 2011 13,928 (8,295) 5,633 (5,252) 381 (114) 267 (80) 187 Notes £000s Non-current assets Property, plant and equipment Current assets Inventories Accounts receivable Cash and cash equivalents 1,610 1,610 964 2,218 419 3,601 Total assets 5,211 Shareholders' equity Ordinary share capital Retained earnings Total shareholders' equity Non-current liabilities Loan 10 2,896 2,906 1,100 1,100 Current liabilities Accounts payable Loan Total current liabilities Total shareholders' equity and liabilities ICAEW/CS/N11 1,105 100 1,205 5,211 of 17 Statement of cash flows Year ended 30 September 2011 £000s Cash flows from operating activities Profit before tax Adjustments for: Depreciation Losses on disposal of non-current assets Net finance expense 267 Change in inventories Change in accounts receivable Change in accounts payable Cash generated from operations Taxation paid Net finance expense Net cash from operating activities Investing activities Purchase of non-current assets Proceeds from disposal of non-current assets Net cash used in investing activities Financing activities Repayment of long-term loan Net cash used in financing activities Net change in cash and cash equivalents Cash and cash equivalents at start of year Cash and cash equivalents at end of year ICAEW/CS/N11 of 17 574 675 114 1,630 81 377 (719) 1,369 (107) (114) 1,148 (586) 41 (545) (100) (100) 503 (84) 419 Notes to the accounts £000s Note Revenue Commissions of films Sales of DVDs Sales of merchandise Fees for corporate DVD production Fees for advertisement production Hiring out studio and equipment 2,977 4,078 2,638 1,917 1,889 429 13,928 Note Cost of sales DVDs, merchandise & materials Web, promotional & delivery costs Production personnel & freelance Studio costs Depreciation & loss on disposals 2,917 342 2,205 1,934 897 8,295 Note Overheads/administrative costs Salaries & wages Motor, travelling & subsistence Advertising Staff training General office costs Repairs & maintenance Depreciation & loss on disposals ICAEW/CS/N11 2,905 404 489 23 897 182 352 5,252 of 17 Note Non-current assets Cost At October 2010 Additions Disposals At 30 September 2011 Improvements Studio to property equipment £000s £000s 722 3,151 246 (1,552) 722 1,845 Computer equipment £000s 1,250 340 (211) 1,379 Motor vehicles £000s 104 104 TOTAL £000s 5,227 586 (1,763) 4,050 Depreciation At October 2010 On disposals Charge for the year At 30 September 2011 425 72 497 1,531 (863) 157 825 896 (184) 334 1,046 61 11 72 2,913 (1,047) 574 2,440 Carrying amount At 30 September 2011 225 1,020 333 32 1,610 £000s Note Inventories DVDs Merchandise goods Materials for models Other Work-in-progress Note Accounts receivable Trade receivables Other receivables and prepayments Note Accounts payable Trade payables Other payables and accruals (including taxation & social security) Deferred income ICAEW/CS/N11 325 400 71 27 141 964 2,075 143 2,218 614 304 187 1,105 10 of 17 EXHIBIT 17 EMAIL From: Don Briggs, partner, Rigour Briggs Chartered Accountants To: The 4D Board Subject: Proposed adjustments to 4D’s management accounts for the year ended 30 September 2011 Date: November 2011 This email summarises my telephone conversation of November 2011 with James Magnet, following the audit work which has been conducted on the 2011 4D accounts We propose that adjustments be made to the draft management accounts with respect to the following: Inventories Our work on 4D’s inventories (gross figure £964k before any provisions) has indicated that provisions should be created in respect of slow-moving, damaged or obsolete items as at 30 September 2011, as follows: DVDs: A sample review of DVDs held in inventories revealed that approximately 20% of the value of these DVDs related to Spindle safety programmes which have been updated or superseded by new DVDs produced during the past 12 months We propose that 4D make a full provision for these obsolete items Merchandise goods: From audit work conducted it appears that the packaging surrounding a quantity of merchandise goods (approximately 15% of items in this category) was damaged during the relocation of inventories which occurred following the closure of the second studio in July 2011 From discussions with your personnel it is apparent that restoring the packaging will be a costly, time-consuming process In our opinion, because these items cannot be sold in such a condition, a full provision should be made for them Materials for models: No adjustment is proposed Other: No adjustment is proposed Work-in-progress: From your records it would appear that a sum representing work done on a project for a client has been included in work-in-progress (at a cost of £20,000) when in fact the related revenue was correctly recognised in September 2011 We propose that work-in-progress be reduced accordingly Deferred income The start of one project relating to one client (Aura Insurance) was delayed due to external circumstances – it has since started in October 2011 However, in September 2011, 4D recognised revenue for the sum of £30,000 in accordance with the contracted completion date and transferred that amount from deferred income into revenue In our opinion this amount should be reinstated as deferred income as at 30 September 2011 because work had not begun on this contract ICAEW/CS/N11 11 of 17 BLANK PAGE ICAEW/CS/N11 12 of 17 EXHIBIT 18 EMAIL From: To: Subject: Date: Colin Boyd, NP Bank plc James Magnet and Stephanie Shan, 4D Limited Review of management accounts for all clients with loans exceeding 10 years November 2011 This email is to confirm the conversation with James Magnet this morning As we discussed, a new manager, Clare Vision, has been appointed who will be dealing with the affairs of 4D starting from today – it would be appropriate for a handover meeting to take place as soon as possible – and we agreed that Friday 11 November at 11:00 would suit all parties As we also discussed, the bank is undertaking a general review of all outstanding corporate loans for clients such as 4D with loans exceeding 10 years As a result of this review, the bank has decided to impose a new covenant condition on all such clients – namely, that their net current assets should be maintained at 150% of the outstanding loan and accrued finance expenses James informed me this morning that the 4D draft management accounts for 30 September 2011 are already available and, given that they exist, it would seem to be a good opportunity for Clare to use them, both to understand 4D’s current accounts and to review its finances against the existing and new covenant conditions in the Loan Agreement Clare and I look forward to meeting both of you next Friday EMAIL From: To: Subject: Date: Stephanie Shan The 4D Board 4D’s meeting with NP Bank plc to discuss the draft management accounts November 2011 The Board is aware that the auditors are proposing that adjustments be made to our draft management accounts before published accounts can be produced (this is normally by midDecember) James was not aware of these proposed adjustments when he spoke with Colin Boyd I am not sure whether we need to make the adjustments proposed by the auditors ahead of the meeting which James and I are due to have with Colin Boyd and Clare Vision – the adjustments are almost certainly not favourable to our position A delay in making the proposed adjustments may give us some time to present a stronger case based on events in the run-up to Christmas – traditionally our best trading period of the year James will ask Ali Monet to calculate the impact of the proposed audit adjustments and to assess the resulting adjusted accounts against the financial covenant conditions – including the additional condition mentioned above That work will clarify our position My concern is that although 4D has never breached the terms or conditions of the Loan Agreement, and has always met the bank’s entire repayment schedule on the due dates, this meeting will need to be handled very carefully I know that none of the directors wants to provide a personal guarantee for the NP Bank loan ICAEW/CS/N11 13 of 17 BLANK PAGE ICAEW/CS/N11 14 of 17 EXHIBIT 19 EMAIL From: To: Subject: Date: John Jones, Foment plc The 4D Board New advertising campaign 31 October 2011 As a result of our long-standing working relationship and the excellent standard of the work which you have always produced for Foment plc, both in filming our annual conference and for the numerous training videos you have created, we are writing to ask you to consider a new significant project Foment plc is about to launch a new series of soft drinks and iced products aimed at the young people’s market, both in the UK and abroad, and we would like you to consider helping us to develop the advertising campaign for these products which would incorporate your “Spindles” characters We are fully aware that your “Spindles” characters are instantly recognisable by young people and that we would need to pay a significant premium for their use As a result, we are prepared to offer £6m (subject to negotiation) for the development of a series of 10 short scenario advertisements to be created and run over the next 24 months Because we are confident that if you agree to such a proposal you would produce an excellent campaign for us, we would be prepared to make an advance payment of 25% of whatever total fee is finally agreed upon as a gesture of our confidence in your output Obviously we would expect your three creative directors to be heavily involved in this groundbreaking advertising campaign – we will need all of their formidable skills to maximise the success of the work Another positive element for our campaign would be that the international aspect could easily be developed by superimposing the appropriate language and voice onto the “Spindles”, thus allowing us a truly universal dimension to the campaign If 4D Limited is interested in this proposal, we would welcome the opportunity to meet and discuss the details in the near future, because we would like the advertising campaign to be started in time for Christmas 2011 John Jones For Foment plc ICAEW/CS/N11 15 of 17 BLANK PAGE ICAEW/CS/N11 16 of 17 EXHIBIT 20 THE JOURNAL OF CONSUMER AWARENESS OCTOBER 2011 Junk food advertising and nutrition concerns According to recent research most advertising on children's television is for fast foods, soft drinks, candy and pre-sweetened cereals – while commercials for healthy food make up only 4% of those shown Fast food chains spend more than $3 billion a year on advertising, much of it aimed at children To target children directly, the fast food industry uses more than traditional commercials Restaurants offer incentives such as contests, games and free toys, together with other merchandise related to films, television shows and even sports leagues Increasing use is made of characters from wellknown shows to promote products in what is known as a “crossover” promotion, and product placement for fast food products is commonplace in many films and television shows Groups representing the interests of children have condemned the increasing trend in fast food “crossover” promotions As one critic has stated, “America’s fast food culture has become indistinguishable from the popular culture of its children” Most parents in Western European countries would probably agree The results of all this aggressive marketing of fast food, soft drinks and sweets to children is a generation of overweight – if not actually obese – children Investor Weekly News 25 October 2011 Foment interim results Foment plc announced its half-year results to 30 September 2011 with a mixture of good and bad news During what has been a turbulent time for this food and soft drinks conglomerate, it has managed to hold its operating profit at the same level as for the equivalent six-month period in 2010 – at £4.8m – despite revenue dropping from £46.2m to £44.5m However, Foment has not made any significant provision for the doubtful debts which have probably been incurred on its business operations in a number of Middle-East countries which have been experiencing turmoil since the spring of 2011 When questioned on these matters at the recent press conference, a spokesperson for Foment plc referred to these problems as “temporary” and “not material”, despite the fact that in the year to 31 March 2011 around 20% of its total revenue was generated from this region There is also the fact that Foment has been investing heavily in new production facilities in southern Italy with the specific purpose of being closer to its developing markets in the Middle East – and this has been draining cash from the previously successful business Putting aside these issues, Foment plc announced an unchanged interim dividend, which will have pleased its investors who might have been anticipating that Foment would follow its competitors in reducing its interim dividend in these difficult market conditions ICAEW/CS/N11 17 of 17 ... 30 September 2011 Date: November 2011 This email summarises my telephone conversation of November 2011 with James Magnet, following the audit work which has been conducted on the 2011 4D accounts... newly provided: 15 Email dated November 2011 from James Magnet to you 16 4D Limited: Draft management accounts for the year to 30 September 2011 17 Email dated November 2011 from Don Briggs, partner,... Email dated November 2011 from Colin Boyd of NP Bank plc to James Magnet and Stephanie Shan together with Stephanie’s email dated November to the 4D Board 19 Email dated 31 October 2011 from John