Pontoon plc

Pontoon plc manufactures precision equipment, and the directors have decided that finance of approximately 4 million is required to modernise its production facilities. They estimate that, at current sales levels, this investment will have the effect of reducing cost of sales by 2 million. The industry in which Pontoon is engaged is subject to wide-ranging fluctuations in sales and profits. The directors are uncertain about which method of finance would be most appropriate and are currently considering the following three options: 1. issue of additional shares probably by way of a rights issue. 2. issue of debenture stock at an interest rate of 12% per annum and redeemable in 20 years time 3. obtaining a bank overdraft.

Some information concerning ratios for similar firms in the same industry for 20X2: Net profit before tax and interest to capital employed Net profit before tax and interest to sales Asset turnover Gross profit to sale Current (working capital) ratio Quick (acid test) ratio Average age of debtors Average age of stock Interest cover Gearing ratio (long-term loan capital/shareholders funds) Price/earnings ratio 15% 10% 1.5 times 35% 2.2:1 1.1:1 73 days 206 days 3 times 1:1 7 times

The directors are anxious to complete the current years accounts, the drafts of which are on the next page. The auditor has come up with the following points, which may require adjustment to the figures for 20X2. 1. The final few days sales amounting to 500k were not processed due to a computer problem on the last day of the year, and were overlooked once the system was restarted in the new year. 2. The final transaction at the bank has been omitted. This means that the draft accounts only show a half years interest on the debenture loan. 3. The auditors review of the useful life of the manufacturing equipment reveals the need for a further 750k depreciation. 4. A major customer has finally gone into liquidation after the year end leaving an amount outstanding in debtors of 200k. 5. The company has taken as an administration expense the whole cost, amounting to 40k, of an advertising campaign to appear in the media next year. 6. The administration accrued costs (telephone, electricity, stationery etc.) have been listed on a schedule which shows a total of 450K. transposition clerical error! Audit check reveals that this should be 540k an understandable

7. 8.

Taxation requires to be adjusted for these changes at the ruling effective tax rate.. No final dividend has been provided for an interim dividend only has been paid half way through the year. The directors intend to recommend a final dividend of 550k

Part 1 a) List the adjustments to the draft 20X2 financial statements required to correct the auditors findings, indicating which headings in the balance sheet and profit and loss accounts will be affected and how. You should also identify the accounting principle which guides the suggested adjustment b) Part II Using the revised balance sheet and profit and loss account prepared above you are required to advice the company on which is the best financing option for the modernization program. HINTS a) Prepare a report for the directors analysing Pontoons financial performance over the past year, identifying areas of improvement or deterioration and comparing that performance with the industry peer group. You should indicate any matters of concern about the strengths and weaknesses of the company. In making your diagnosis and seeking to explain any significant issues you have identified, you may make whatever sensible assumptions you need. Having carried out your analysis and reached your conclusions about the performance and position of Pontoon, you should then make preliminary recommendations about he most appropriate route to take in raising the required finance for the modernisation programme. Prepare an amended balance sheet and profit and loss account to incorporate the adjustments you have identified.

b)

DRAFT PROFIT AND LOSS ACCOUNTS 20X2 ,000 Sales all on credit Cost of sales Gross profit Distribution and selling costs Administration costs Operating profit Interest payable Profit before taxation Taxation Profit after taxation Dividends paid and proposed Retained profit for the year 46,500 31,250 15,250 4,000 5,750 9,750 5,500 300 5,200 2,800 2,400 500 1,900 3,800 5,200 9,000 4,000 600 3,400 2,040 1,360 560 800 20X1 ,000 41,000 28,000 13,000

,000

,000

DRAFT BALANCE SHEETS 20X2 ,000 Tangible fixed assets no additions in 20X2 Current assets Stock Debtors Prepayments Cash at bank 20X1 ,000

,000 15,380

,000 17,100

10,200 5,500 160 1,500 17,360 Creditors amounts falling due within one year Trade creditors Proposed dividend Taxation 3,960 3,000 6,960

6,400 3,800 200 1,180 11,580

2,200 560 2,040 4,800 6,780 23,880

10,400 Total assets less current liabilities 25,780 Creditors amounts falling due after more than one year 10% debenture stock (2021-2029) NET ASSETS Capital and reserves Called up share capital ordinary shares of 1 authorised and fully paid Profit and loss account 6,000 19,780

6,000 17,880

6,000 13,780 17,880

6,000 11,880 19,780

The stock valuation and debtors valuations at March 31, 20X0 were 5 million and 3.4 million respectively. The effective tax rate is 50%.