Case study july 2013 illustrative script 2 ICAEW

SECOND ILLUSTRATIVE SCRIPT AND EXAMINERS’ COMMENTS The commentary below follows the order and numbering of the script, with reference to the topics in the marking key It should be read in conjunction with the review of the First Illustrative Script and full Examiners’ Report for this session Examiners’ comments – overview This script failed the exam: it has not achieved sufficient passing grades It has also not received any ‘NA’ grades – meaning that it has touched on every single area on the marking key but in too many cases it has not offered sufficient breadth and/or depth Interestingly, it is slightly longer than the first script, but it differs markedly in the effectiveness with which it has used the word count Perhaps its main – and avoidable – shortcoming is in the effort spent on irrelevant figures at Requirement 1, which in turn has reduced the time available for the rest of the report A careful reading of Exhibit 13, together with the self-discipline not to follow blindly a preconceived approach, could have been all the difference between a fail and a comfortable pass for this student Executive summary The executive summary is fairly comprehensive but tails off when addressing Requirement It comprises a section for each of the three main requirements, with subsections at the end of each headed ‘Conclusion’ and ‘Recommendation’ (the singular forms are significant) In the section on Requirement 1, self-consciously headed ‘FS [financial statement] analysis’, the candidate begins by summarising unadjusted revenue growth by reference to industry benchmarks, and then adjusted revenue growth, in both cases for both Palate as a whole (totally unnecessary) and TN (see also ‘Appendices’ below) The figures quoted for cost of sales and gross profit are again for the company and the individual business unit The explanations for changes here are somewhat superficial, as is the paragraph on HLSF The (sole) conclusion merely restates the start of Exhibit 14, while the recommendation is adequate For the VIS contract, the candidate opens with the key (correct) figures, continuing with brief, but sufficient, commentary on the wider context and some of the underlying assumptions The conclusion and recommendation are short but to the point and so have gained some credit For Requirement 3, the coverage is somewhat random with no structure, and as a result no passing grades have been earned Overall, the executive summary – as with many candidates in the lowest quartile – shows signs of having been rushed at the end of the four hours Review of TN business unit [Requirement 1] The candidate has approached this requirement methodically, with successive sections on revenue, cost of sales, gross profit and HLSF However, consistently with the executive summary and Appendices, this section is repeatedly marred by the inclusion of irrelevant analysis on the company as a whole While the candidate may have expected this to be asked for in the exam, the requirement is unequivocal that only TN should be reviewed – and the overwhelming majority of candidates recognised this The felony is compounded in this case by the candidate’s decision to discuss unadjusted figures as well as adjusted ones Again, Exhibit 13 signalled very clearly what was to be done Fortuitously, amid a morass of figures, the candidate has managed to extract the correct ones, as well as identifying most of the key underlying business issues, and thus has received credit under the first two skills columns The candidate goes on to consider the three largest clients (which mercifully are unaffected by the adjustments) but does not quantify the key movements for each one individually In doing this, (s)he looks at an important KPI – revenue per visitor – and attempts to explain the reason for the difference © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 in direction of the changes for TG Music Festival and V Park The candidate also assesses the ‘Other’ caption within the client breakdown at Note of the accounts and links this cleverly to industry data and other facts provided in the Advance Information The section on cost of sales is confused and confusing It appears to explain movements for TN as a whole by reference to some of the issues specific to HLSF identified at Exhibit 15 In so doing, it fails to address the details of the two major categories (food & consumables, wages) In reviewing gross profit – again on both adjusted and unadjusted bases – the candidate concludes that HLSF is responsible for most of the growth At best, this analysis can again be described as confused: at worst, it is totally missing the point of the question – namely to review TN’s results without HLSF All in all, it is a rather jumbled collection of sentences Having already made numerous references to HLSF, the script now presents a section that reviews this client on a stand-alone basis While this does make some relevant points, the structure is again muddled; and, as a result, the candidate has been unable to step back and reflect on the overall pattern of results across the three years and what they might be telling Palate Finally, by once again mixing adjusted and unadjusted numbers, the conclusions to this section are unclear and the recommendations are too brief to be of value to Palate’s management Evaluation of VIS tender [Requirement 2] This part of the report covers all the key aspects of the requirement, including practical considerations, but in a number of places it just fails to develop the analysis in enough detail to gain passing grades This section starts by restating the (correct) contract revenue and GP figures calculated in Appendix and then goes straight on to address the assumptions It actually covers more ground than most scripts (for instance by considering take-up rates) but does not always provide sufficient detail For example, the comment “Staff and student numbers are estimates, which may prove inaccurate, leading to loss or increase of revenue in future” could and should have been linked to data for existing clients (Exhibit 7) and previous new school openings (Exhibit 12(ii)) Similarly, the estimated gross margins could have been compared with those currently achieved by LA business unit Like the majority of other candidates, this script does not carry out any sensitivity analysis, though it does display some awareness of the impact of possible changes in figures (eg, “If 2008’s level of 8% is reached, this would eat up all of the GP in year 1”) However this candidate mentions more practical considerations than many scripts, dealing with broader risks and benefits of the contract and applying professional scepticism in certain places For example, it recognises the potential upside from conference catering; dining-room capacity constraints; estimated take-up rates in the context of local competition; and (within ‘Recommendations’) financial stability, which Palate must be able to prove as part of the tender process It could have earned more passing grades here by considering other key issues, such as the cashflow from the contract, the very short timetable and the overall likely impact on Palate’s reputation The conclusions cover the main aspects of the tender and include relevant figures Under ‘Recommendations’, the candidate has failed to identify key priorities, for example in relation to contract terms and the overall basis of assumptions used Response to HH issues [Requirement 3] Like many scripts, this one offers a scattergun approach to the requirement, when it would have been easier (and far more beneficial) to follow the structure laid out at Exhibit 13 The candidate has again © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 scored highly for Assimilating and Using Information, but unfortunately has not made effective use of this case context in developing the answer Instead of tackling each of Ogilvie’s points in turn, (s)he launches straight into ‘Ethical issues’ Indeed, other than ‘Conclusions’ and ‘Recommendations’, this is the only subheading within the section, reflecting the fact that the candidate has again misread the instructions at Exhibit 13 and so has discussed only those issues that appear to have an ethical impact Consequently, some of the Ogilvie issues are not mentioned anywhere in the script – ironically including one with a clear ethical dimension (Spanish fruit) In addition, for those issues that are addressed, the discussion is not developed sufficiently into an assessment of the implications and the actions to be taken Thus for example in relation to substitute meat, the candidate does not consider what it means for Palate and what it should to prevent a similar situation in future More generally, there is no recognition that Ogilvie’s review took place at a single HH location and that its findings could have consequences for the other sites (including the proposed new customer restaurants) A positive effect of the ethical focus is that the candidate has discussed the question of Ogilvie’s independence more thoroughly than most candidates, commenting shrewdly that “staff may be biased as they want to present their own company in a better light” However, some of the other observations here go a little too far (“The use of own staff as ‘mystery diners’ may be unfair” and “if the report is found to be indeed free from bias, George Watson may be liable of [sic] wrongly accusing independent reviewer and this may lead to litigation”) Conclusions here are again brief and recommendations lack commerciality (“Consider donating food passed [sic] ‘best before’ to charity” – public-spiritedness gone too far) or accuracy (“Ensure relationship with HH is not damaged by open conversation” – not exactly a model sentence structure) Overall paper: Appendices The candidate has included two Appendices, one each for Requirements and Appendix sets out clearly the movements (both £ and %) in revenue, cost of sales and gross profit However, there is a significant amount of wasted effort here as the candidate has provided data for the whole of Palate and all three business units, not just (as required) for TN alone – and both adjusted and unadjusted figures, with no workings to show the adjustments In the circumstances, it is remarkable that the relevant numbers are correct: with proper planning, the candidate could have both saved time and adopted a more logical approach that would have reduced the risk of losing marks in a section that candidates would be expected to master In addition, there are no figures in relation to visitor numbers and just GP% figures for HLSF Overall, this appendix encapsulates why the candidate has failed the exam In Appendix 2, the candidate has produced a correct calculation but has not labelled it clearly enough and has not gone on to conduct any sensitivity analysis Overall paper: Report As highlighted above, the script does not contain enough subheadings Other defects here are an inelegant mix of zero, one and two decimal places for the figures for Requirement 1, plus jargon, spelling errors and clumsy grammar too numerous to single out © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 SECOND ILLUSTRATIVE SCRIPT From: To: Title: Date: Phil Robert Palate Board of Directors Draft Report – Palate 2013 24 July 2013 Executive Summary 1.1 FS Analysis Overall revenue has enjoyed a reasonable growth of 2.05% to £21,081k and TN’s revenue has also see a significant increase of 4.7% to £6,633k This is pleasing in the context of general recession and expected industry decline of 4.5% to 2013 However, when stripping out the 2012 and 2013 HLSF results, the performance becomes much worse, with overall revenue declining by 1.9% to £20,267k and TN’s revenue declining by 8.2% to £5,819k Overall, costs of sales has decreased by 2.3%, showing good cost control strategy and TN’s cost of sales decreased even more by 7.2% without considering the rise of costs due to incorrect weather forecast at HLSF in 2013 Overall, gross profit increased slightly by 0.94% to £2,573k despite revenue falling by 1.9% This shows good cost control management Maybe due to shift from cost-plus contracts to fixed cost contracts in the recession TN’s GP however dropped significantly by 12.8% to £940k This decline is quicker that its revenue, indicates a rise in cost of sales and inability to pass on all costs HLSF has had a bad year; with revenue down significantly by 46% from 2012 and 9% from 2011’s level, and GP margin down from 2012’s 28.9% and 2011’s 24.4% to only 8.8% in 2013 Conclusion: 2013 management accounts showed a seemingly good result overall for TN However, when stripping out one-off impact from HLSF, the results are much more disappointing Recommendation: TN should focus more on new business development and ensure that sufficient and appropriate research on weather, visitor numbers is conducted before events 1.2 VIS contract is very attractive in the first years, contributing to a total revenue of £1.1 million according to estimates Total GP for years is estimated to be £136,808 reaching up to £95k in year This independent school contract is a strategic fit to Palate and is in line with the board’s strategic review to expand in the education sector However a number of estimates such as meal take-up rates and food inflation may prove to be inaccurate and reduce profit © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 Conclusion: Palate should tender for the contract and should act quick Recommendation: Palate should emphasize on quality and positive financial results (working capital cycle) in the tendering process 1.3 Food labelling is a key ethical issue, will lead to health damage Failure to meet sustainability target results in breach of contract which will affect continuance of the HH contract Reduced quality food risks health and damages relationship with HH Palate should ensure food labelling is correct and engage independent auditors to review Conclusion: Ethical issues need to be fixed as soon as possible e.g incorrect food labelling Recommendations: Engage independent auditors to review operations TN Analysis 2.1 Revenue Based on the unadjusted management accounts, total revenue has increased reasonably by £423k (2.05%) to £21,081k to 31 May 2013 The second largest was in TN following LA (5.4%) which increased by £296k (4.7%) in the year, now representing 31.5% of total revenue which is a slight increase from the 30.68% in 2012 However, if stripe out the impact of 2012 and 2013 HLSF on the 2013 results, TN’s revenue has actually seen a decline of £518k, a significant 8.2% drop from 2012 As a result, the total revenue is down £391k, changed from a positive increase to a negative decline of 1.9% The revenue from the biggest clients in TN has seen a decrease of £130k (3.2%) while revenue from the ‘other’ contracts is up by a significant £246k (18.7%) Revenue per visitor for V Park has increased from 2012’s £6.89 to £7.61 in 2013 while TGMF dropped from 2012’s £3.81 to £3.62 in 2013 This indicates that concession based contract with V Park gives Palate freedom to raise price to cover the costs of inflation; while TGMF’s decline may have been due to the Nostalgia weekend in August 2012 where food and drinks were charged at 2002 prices However, this should not be a concern, as it’s a one-off TN’s revenue is completely dependent on the growth of ‘other’ contracts © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 If stripe out impact of 2012 and 2013 HLSF, ‘other’ contracts would have declined by £442k (19.4%), revenue for TN as a whole would have dropped by 8.2% and overall revenue would have dropped by 1.9% This means that all other activities are actually declining, although this is in line and still lower than the industry expectation of 4.5% to 2013, this is worrying as 2012 to 2013 is expected to grow by 2.6% (IBIS world) due to the impacts of the Olympics and the Queen’s Diamond Jubilee, and disappointingly when compared with 2012’s revenue increase of 8.6% This may mean that Palate has won little work in relation to these events This may also mean that Palate hasn’t invested or focused enough on new business development 2.2 Cost of Sales On the unadjusted accounts, it seems that overall cost of sales gas gone up by 1.2% with TN increasing the most by £256k (4.9%) However, when stripping out impact of 2012 and 2013 HLSF, the cost of sales for TN and overall both have gone down by 7.2% and 2.3% respectively This is mainly due to the added costs for more hot food, more staff and extra mobile kitchen equipment hire as a result of the forecasted cold weather This implies that TN’s work is very much affected by weather Weather can determine visitor number, cost of food and consumables (due to demand and supply) Therefore, correct budgeting and research is important 2.3 Gross Profit (GP) Unadjusted accounts show that overall GP has gone up significantly by 7.9% with TN’s GP increasing considerably by 3.7% However, when adjusted for 2012 and 2013 HLSF, overall GP increased 0.94%, keeping the similar level with 2012 and TN’s GP dropped significantly by 12.8% £138k) This shows that HLSF contributes all the growth in TN’s GP and majority of growth overall GP margin overall however still increased slightly to 12.7% from 2012’s 12.34%, with GP margin for TN dropped from 2012’s 17.01% to 16.2%, however, this is still a very good margin compared to the industry average of 6.8% (IBIS world) This means that HLSF contract, although impacted heavily on the revenue growth, did not actually contribute a great deal to profit margins This may be due to the high costs incurred as a result of the incorrect weather forecast and increased wastage due to unable to sell a lot of the hot food 2.4 HLSF The result of HLSF is disappointing as revenue decreased considerably by 46% of 2012’s level and 9% of 2011’s level Cost of sales on the other hand has increased drastically by 69% of 2012’s level and 169% of 2011’s level © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 Revenue per visitor is £4.9 in 2013, while it was £4.6 in 2012 and £4.2 in 2011 This price increase is expected as the food price inflation is high at almost 5% until April 2013 Therefore, the significant drop in revenue is volume driven, due to the significant decrease in visitor number as a result of the local council’s decision to double the admission fee The revenue is lower than average expected £300k to £350k Gross margin is down considerably from 2012’s 28.9% and 2011’s 24.4% to 8.8% in 2013 This is disappointing as the average margin for the event is at 25% This margin squeeze is due to the increased cost of sales for more staff, kitchen equipment hire, and increased wastage as a result if incorrect weather forecast 2.5 Conclusions Unadjusted accounts showed an overall revenue growth of 2.05%, an increase in cost of sales of 1.2% and 7.9% in gross profit Therefore Palate is performing well TN is also doing great with revenue and GP both increased significantly However, when stripping out HLSF, the results are much worse Revenue for TN is down and GP down even more due to lack of cost control HLSF has a bad year, results are affected significantly by the incorrect weather forecast and rising costs 2.6 Recommendations TN needs to develop more new business and establish more longer-term, recurring and non-seasonal business contracts TN needs to focus on cost control TN needs to perform sufficient research on weather and visitor numbers beforehand to avoid wastage Discuss with local council in regards to the decision of doubling admission fee Ensure it returns to normal next year VIS contract Minimum revenue is expected to be £128,250 in year 1, £352,688 in year 2, £634.838 in year Gross profit is expected to be £6,413 in year 1, £35,269 in year and £95,126 in year Assumptions Food costs will remain relatively stable in the next years However, food price inflation is high in the UK at the moment with 4.7% in 12 months to April 2013 It is expected to increase further If 2008’s level of 8% is reached, this would eat up all of the GP in year 1, which renders this contract unprofitable at the beginning © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 Staff and student numbers are estimates, which may prove inaccurate, leading to loss or increase of revenue in future Staff costs are assumed to be in line with normal school clients However, this may differ due to staff sickness or an unexpected change in staff mix The meal take-up rates are pure estimates With the competition of local well-known fast food outlets and the school’s liberal ethos, the steady increase of take-up rate to 90% may prove to be difficult The calculation ignores the potential hospitality and conference catering work at the school, which is likely to be an increasing portion of the revenue and GP for the VIS contract Total revenue for years could be significantly higher than £1.1m as a result Practical Considerations Tendering for VIS contract is a strategic fit for Palate’s brand image of high-quality, upper end This matches with VIS’s vision and ethos of innovative, high-quality, and nutritious food and value for money Therefore increases Palate’s chance of winning However, competitor Ravenous has already announced its intention to tender for this contract and Ravenous is established nationwide and recently recruited the business development manager from Palate This may serve as a disadvantage to Palate as they are better-informed with the competition if the business manager reveals the trade secrets to Ravenous The contract is very attractive in the long term, with revenue of up to £650k p.a and GP of up to £95k p.a based on assumption However assumptions may prove to be inaccurate And also the drastic increase in student numbers and staff numbers will pose significant logistic challenge as new canteen space will be found to cater for the increased headcount, new kitchens may be required More staff needed, and more food needs to be sourced Need significant investments The potential conferences and other external events will bring more opportunity to Palate, as they tend to be higher margins However, if these are not going ahead, Palate’s cross-selling opportunity may be limited The system created by Jordi to allow menu selection by the same day helps towards cutting wastage This is in line with Project Greenbuy, where wastage is expected to be cut to 3% However, the system is owned by Jordi, who may prevent Palate from using or buying it Fast food and packed lunches contribute to the competition and may result in a lower take-up rate Revenue from the contract should be recognised correctly according to the time period the service occurred © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 Conclusions VIS contract is very attractive in the first years, contributing to a total revenue of £1.1 million according to estimates Total gross profit for years is estimated to be £136,808 reaching up to £95k in year This independent school contract is a strategic fit to Palate and is in line with the board’s strategic review to expand in the sector However, estimates such as take-up rates and food inflation may prove inaccurate, which may reduce profit Recommendations: Palate should tender for VIS contract as it offers great opportunity to expand in the education sector and is a strategic fit to Palate Palate should investigate who else is tendering and act quickly to secure the contract Palate should emphasize on its quality and positive financial results especially healthy working capital cycle in the tendering process Discuss with Jordi in regards to purchasing the menu selection scheme GW’s email Ethical issues Rising wastage of 10% is significantly higher than the Project Greenbuy target of 3% If Palate is put under pressure to use products passed its “use by date”, it contributes to a serious issue, as it may lead to customers becoming ill FSA has authority to close the business operation immediately if this happens The use of own staff as ‘mystery diners’ may be unfair Staff may be biased as they want to present their own company in a better light Therefore, the contradictory findings to Ogilvie is questionable Ogilvie was believed to have been put under pressure by HH’s directors to write a negative report as they want to renegotiate the contract on more favourable terms This is an ethical issue as the independent review is not objective and free from bias and the reliability of findings is questionable This gives HH an unfair advantage in negotiation of contract terms However, if the report is found to be indeed free from bias George Watson may be liable of wrongly accusing independent reviewer and this may lead to damage of relationship with HH and litigation Food labelling, if incorrect, will result in inability to meet dietary requirements Deceit of customers and may cause allergy / illness / offence © The Institute of Chartered Accountants in England and Wales 2013 Page of 12 This is a very serious issue because it causes health risk and has religious significance, violates food labelling regulation, indicates poor controls and causes reputational damage and litigation Palate may lose current and future contracts as a result Oldham Farms beef being replaced by lower-grade imported meat is an ethical issue Recent horse meat scandal identified that even large companies are at risk of loss of customer confidence if they are unable to demonstrate/monitor traceability through supply chain This risks damaging reputation, loss of current and future contracts and potentially breach of Health and Safety regulation Sustainability targets not achieved is a breach of contract with HH The contract requires Palate to achieve 10% reduction in electricity consumption and 25% reduction in total number of deliveries If they are not achieved, breach of contract will result in damages being awarded and potential loss of ability to continue or renew the HH contract HH’s ongoing cost-cutting will put pressure on Palate to deliver better quality at a lower price The provision of catering to customer restaurants is an opportunity to increase revenue 200 job losses at head office with effect from 1/11/2012 will adversely impact on HH revenue in both 2012 and 2013 Project Greenbuy Conclusions Food labelling is a key ethical issue, will lead to health damage Failure to meet sustainability targets is a breach of contract Reduced quality of food risks relation with HH and may lead to loss of contract Maintain relation with HH is important as HH is the biggest client and offers high margin Recommendations Palate should increase food labelling controls, apologise and improve staff training Improve inventory management controls to ensure FIFO Consider donating food passed ‘best before’ to charity Ensure operational manager builds in regular review of sustainability targets Ensure relationship with HH is not damaged by open conversation and engaging independent auditors to review © The Institute of Chartered Accountants in England and Wales 2013 Page 10 of 12 Appendix Unadjusted: Revenue - overall - XX - TN - LA 2013 21,081 9,464 6,633 4,948 2012 20,658 9,594 6,337 4,727 £’000 423 (130) 296 257 % 2.05% (1.4%) 4.7% 5.4% COS - overall - XX - TN - LA 18,330 8,253 5,515 4,562 18,109 8,450 5,259 4,400 221 (197) 256 162 1.2% (2.3%) 4.9% 3.7% GP - overall - XX - TN - LA 2,751 1,211 1,118 422 2,549 1,144 1,078 327 202 67 40 95 7.9% 5.9% 3.7% 2.9% Revenue - overall - TN 20,267 5,819 20,658 6,337 (391) (518) (1.9%) (8.2%) COS - overall - TN 17,694 4,879 18,109 5,259 (415) (380) (2.3%) (7.2%) GP - overall - TN 2,573 940 2,549 1,078 24 (138) 0.94% (12.8%) GPM% - HLSF 2013 8.8% 2012 28.9% 2011 24.4% Adjusted: © The Institute of Chartered Accountants in England and Wales 2013 Page 11 of 12 Appendix 9/13-9/14 9/14-9/15 9/15-9/16 Rev per meal 2.50 2.75 2.75 No of meals (450x60%x190) 51,300 (900x75%x190) 128,250 (130x90%x190) 330,850 Total rev (£) 128,250 352,688 634,838 GP% 5% 10% 15% GP 6,413 35,269 95,226 Total 1,115,775 136,908 Assumption: Food costs remain relatively stable No large inflation increases or shortage Menus with not alter significantly Ratio of catering staff to meal served and hourly rate stay in line with normal school clients © The Institute of Chartered Accountants in England and Wales 2013 Page 12 of 12 ... 18,330 8 ,25 3 5,515 4,5 62 18,109 8,450 5 ,25 9 4,400 22 1 (197) 25 6 1 62 1 .2% (2. 3%) 4.9% 3.7% GP - overall - XX - TN - LA 2, 751 1 ,21 1 1,118 422 2, 549 1,144 1,078 327 20 2 67 40 95 7.9% 5.9% 3.7% 2. 9%... England and Wales 20 13 Page 10 of 12 Appendix Unadjusted: Revenue - overall - XX - TN - LA 20 13 21 ,081 9,464 6,633 4,948 20 12 20,658 9,594 6,337 4, 727 £’000 423 (130) 29 6 25 7 % 2. 05% (1.4%) 4.7%... HLSF 20 13 8.8% 20 12 28.9% 20 11 24 .4% Adjusted: © The Institute of Chartered Accountants in England and Wales 20 13 Page 11 of 12 Appendix 9/13-9/14 9/14-9/15 9/15-9/16 Rev per meal 2. 50 2. 75 2. 75