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THE UNIVERSITY OF THE WEST INDIES

EXAMINATION OF DECEMBER. 2008

Code and Name of Course: SBC06110: Financial & Managerial Accounting Paper: MBA PT1FT

Date and Time: Friday, December 19, 2008; 9:00 a.m. -12:00 noon Duration: 3 hours

INSTRUCTIONSTO CANDIDATES: This paper has 13 pages and 7 questions.

Instructions:

This examination consists of seven (7) questions and is divided into two (2)
sections: Sections 1 & 2.

You are required to answer three (3) questions.

You must answer at least one (1) question from each section.

Each question is worth 20 marks.

This examination is'worth 60 marks.

For computational type answers, show all workings.

For essay type responses, fully explain your points but be concise.

Calculators are permitted.

Table of ratios is attached.

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SECTION 1

Do at least one(l) question.

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QUESTION 1 (do both parts) ."

Part (A)

"The biggest culprit [with respect to the recent financial crisis in the US] is the change in our
accounting rules that the Accounting Standards Board and the SEC put into place over the past
15 Years: Fair Value Accounting. Fair Value Accounting dictates that financial institutions
holding financial instruments available for sale (such as mortgage-backed securities) must mark
those assets to market" - William Isaac, The Wall Street Journal, September 19th,2008.

Required:

(i) Do you or don't you agree with the above statement? Why or why not? Carefully explain
your position on this issue. [3 marks]

(ii) Explain the accounting treatment for available for sale securities as recommended by IAS
39 /IFRS 7 (US SAFI15). With respect to:

(a) valuation on the balance sheet

(b) treatment of realized and unrealized losses/ gains
(c) treatment of dividends/ interest received.
(d) disclosure in the financial statements. [4 marks]

(iii) How does accounting for available for sale securities differ from accounting for traded
securities? [3 marks]

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Part (B)

Blooming Things Company is in the business of growing and selling Christmas trees, a
seasonal business. By January 2, after the heavy selling.season, the company has cash on hand
that will not be needed for several months. It has minimal expenses from January to October and
heavy expenses during the harvest and shipping months of November and December. The
company's management follows the practice of investing the idle cash in marketable securities,
which can be sold as funds are needed for operations. The company's financial year ends on
June 30.

On January 10 of the year 2008, the company has cash 0($8,405,000. It keeps $200,000 on hand
for operating purposes and invests the rest ~s follows:

$1,000,000 3 month T-bills $ 910,000

100,000 shares($30per share) BNS $3,000,000
25,000 shares ($50 per share) First Life $1,250,000
21,000 shares($145per share) Grace $3,045,000
Total short-term investments $8,205,000

On February 10 and May 10, Blooming Things receives quarterly dividends from each company
in which it has invested: BNS - $0.50 per share; First Life - $0.05 per share; and Grace - $0.25
per share. The Treasury bills are redeemed at face value on April 10. On June 1, management
sells 5,000 First Life shares at $55 per share.

On June 30, the market values (per share) of the investments are as follows:
-
BNS $20; First Life - $46; and Grace - $140.

Blooming Things sells all its remaining shares on November 1 at the followingprices: BNS -
$25; First Life - $44 and Grace - $160 per share.

Required:

(i) Record the investment transactions that occurred on January 10,February 10, April 10,
May 10 and June 1,2008. The T-bills are accounted for as held-to-maturitysecurities,
and the stocks are traded securities. [4 marks]

(ii) Prepare the required adjusting entries on June 30, 2008 and record the investment
transactions on November 1. [2 marks]

(iii) Explain how the short-term investments would be shown on the balance sheet at
June 30, 2008. [2 marks]

(iv) What is your assessment of the company's strategy with respect to cash management?
[2 marks]

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Question 2

Mr. David Jones, the CEO operates Computer Sales which assembles computer equipment from
bought in components and distributes them to various wholesalers and retailers. It has recently
subscribed to an interfirm comparison service. Members submit accounting ratios as specified by
the operator of the service, and in return, members receive the average figures for each of the
specified ratios taken from all of the companies,in the same sector that subscribe to the service.
The specified ratios and the average figures for Computer Sales' sector are shown below. Ratios
of companies reporting a full year's results for periQds ending between I July 2008 and
30 September 2008 Me listed below:

Return on capital employed 22.1%

Asset turnover 1.8 times
Gross profit margin 30%
Net profit (before tax) margin 12.5%
Current ratio 1,6:1
Quick ratio 0.9:1
Debt to equity 40%
Dividend yield 6%
Dividend cover 3 times

Computer Sales' financial statements for the year to 30 September 2008 are set out below:

Income statement
$000
Sales revenue 2,425
Cost of sales (1,870)

Gross profit 555

Other operating expenses (215)
Exceptional item (note (ii)) (120)

Operating profit 220

Interest payable (34)
-
Profit before taxation 186
Income tax (90)
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Profit after taxation 96
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Extracts of changes in equity:

Accumulatedprofits - 1 October 2007 179

Net profit for the period 96
Dividends paid (interim $60,000; final $30,000) (90)
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Accumulated profits - 30 September 2008 185
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Course Code SBC06110 2008/12/19
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Balance Sheet
$000 $000
Non-current assets (note (i)) 540

Current Assets

Inventory 275
Accounts receivable 320
Bank nil 595

Total assets 1,135

Share Capital and Reserves

Ordinary shares (25 cents each) 150

Accumulated profits 185

335
Non-current liabilities

8% loan notes 300

Current liabilities

Bank overdraft 65
Trade accounts payable 350
.Taxation 85 500

Total Equity & Liabilities 1,135

Notes:

(1) The details of the non-current assets are:

. Cost Accumulateddepreciation Net book value
$000 $000 $000
At 30 September2008 3,600 3,060 540

(2) The exceptional item relates to losses on the sale of a non-current asset.

(3) The market price of Computer sales' shares throughoutthe year averaged $6.00 each.

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Required:

(i) Explain the problems that are inherent when ratios are used to assess a company's
financial performance. Your answer should consider any additiomil problems that may
be encountered when using inter-firm comparisons such as those used to compare
Computer Sales. [4 marks]

(ii) Calculate the ratios for Computer Sales, equivalent to those provided by the inter-firm
comparison. [9 marks]

(iii) Write a report to the CEO, Mr. Jones analyzing the financial performance of Computer
Sales based q,n comparison with th~ sector averages: [7 marks]

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Question 3

The statementof cash flows for Appliance Sales and Sen;ices Ltd appears below:

Appliance Sales & Services Limited

Statement of Cash Flows
For the Years Ended December 31,2007 and 2006
2007 2006
(In $ millions)
Cash flows from operating activities:
.
Net income (loss) ~ , $297.9 $ 61.3
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Restricted stock awards 9.6 82.6
Provision for loss on sale of Business segment - 108.2
Depreciation and amortization 90.2 99.0
Deferred income taxes and other items 49.0 (4.0)
Provision for credit losses and bad debts 9.9 12.5
Changes in operating assets and liabilities:
Receivables (38.3) (36.7)
Inventories 52.6 85.6
Other current assets 15.1 17.7
Accounts payable, accrued expenses & income taxes 75.6 Q.lA}
Net cash provided by operating activities 561.6 414.8

Investing activities:
Additions to property, plant and equipment (102.4) ( 131.5)
Proceeds from sale of property, plant and equipment 5.6 6.7
Proceeds from sales of Computer City - 36.5
Investment in North Point Communication (20.0)
Other investing activities (4.2) (4.7)
Net cash used by investing activities (121.0) ( 93.0)

Financing activities:
Purchases of treasury stock (422.2) (337.4)
Proceeds from sale of common stock put options 4.4 0.3
Sale of treasury stock to employee stock plans 39.5 35.4
Proceeds from exercise of stock options 42.0 22.4
Dividends paid (42.5) (44.8)
Changes in short-term borrowings, net (42.3) (44.9)
Additions to long-term borrowings 100.6 45.7
Repayments of long-term borrowings (20.0) (39.9)
(340.5) (363.2)
Net cash used by financing activities .
Increase (decrease) in cash and cash equivalents 100.1 (41.4)
Cash and cash equivalents,beginning of period 105.9

Cash and cash equivalents, end of period $164.6 $ 64.5

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The following additional data comes from Appliance Sales' annual report (in thousands):
2007 2006 2005
( $' 000)

Net sales $4,126.2 $4,787.9 $5,372.2

Total Assets 2,142.0 1,993.6 2,317.5
Stock price at year end $26.25 $26.00 $25.75

Reauired:

For the two years shown for the cash flow statements:

(i) Compute the cash-generating efficiencyratios of: Cash flow yield, Cash flows to sales,
Cash flows to assets and free cash flow. [4 marks]

(ii) Assume that you report to the chairman of the board who has asked you to analyze the
statement of cash flows for 2007 and 2006. Prepare a memorandumthat assesses the
company's cash generating efficiency and evaluates its available free cash flow in light of
its operating, investing and financing activities. [7 marks]

(iii) Are there any special operating circumstancesthat should be taken into consideration?
Refer to your computations and to the Statementof Cash Flows and additional
information provided in the question. [6 marks]

(iv) . From your analysis of the informationgiven, what business strategies can you discern
that management is attempting? Clearlyidentify three (3) such strategies.
(Note: althoughyour identificationshould bejustifiable a discussion on each is not
required.) [3 marks]

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SECTION 2

Do at least one (1) question from this section.

QUESTION 4 (do both parts)

(Part A)

(i) Why are conv.entional product costing systems mor~ likely to systematically distort
product costs in highly automated plants? How do (ABC) activity-based costing systems
deal with such a situation? [4 marks]

(ii) What major steps must be performed to determinethe activity cost driverrates in a
traditional ABC cost system? [2 marks]

(Part B)

MTM Manufacturing Company produces two types of pre-fabricatedexterior walls:

deluxe and standard. The assignmentbasis for support costs (Overheads)has been direct
labor hours. For 2007, MTM compiled the following data for the two products:

Deluxe Standard
Sales units 5,000 40,000

Sales price per unit $6,500.00 $4,750.00

Direct material and direct labor costs per unit $1,800.00 $1,300.00
Manufacturing support costs per unit $ 900.00 $1,200.00

Last year, MTM purchased an expensive robotics system to allow for more complex
products in the deluxe line. The CFO suggestedthat an ABC analysis could be valuable
to help evaluate a product mix and promotion strategy for the next sales campaign.
She obtained the following ABC information for 2007:

Cost driver levels

Activity Cost driver Cost Total Deluxe Standard
Setup # setups $650,000 500 400 100
Machine-related # of machine hours $30,600,000 600,000 300,000 300,000
Packaging # Shipments $5,250,000 250,000 50,000 200,000

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Reuuired:

(i) Using the current cost system, what is the estimated profit per unit for each type of wall?
.. [2 marks]
(ii) Using the current cost system, estimated manufacturing support costs per unit are less for
the deluxe wall ($900 per unit) than the standard wall ($1,200 per unit). What is a likely
explanation for this? [2 marks]

(iii) Review the machine-relatedcosts above. What is a likely explanationfor machine-related

costs being so high? What might explain'why total machininghours for the deluxe walls
(300,000hours) are the same as for the standard walls
. . (300,000hours)? [3 marks]
(iv) Using the activity-based costing data presented above: ..

(a) compute the cost driver rate for each support activity. [3 marks]

(b) compute the revised total cost to manufacture one unit of the deluxe wall.
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(v) Is the deluxe wall as profitable as the original data estimated? Why or why not?
[2 marks]

QUESTION 5 (do both parts)

(PartA)
(i) . Clearly distinguish between the supply chain and the value chain. [2 marks]

(ii) Explain how an understanding of the supply chain can assist managers in maintaining a
JIT system. [3 marks]

(iii) Explain how value chain analysis can assist managers in making outsourcing decisions.
[3 marks]

(Part B)

Diamond Bicycle Company manufactures and sells bicycles nation-wide through specialty
bicycle shops. Diamond's average selling price to its distributors is $185 per bicycle. These
stores then sell retail to their customers for $349.

After several years of high sales, Diamond's sales over the last three years have slumped to
160,000 bicycles per year which is only 64% of its manufacturing capacity. Diamond expects the
demand for its product to remain the same over the next few 'years.

Premier Stores, a nation-wide chain of discount retail stores, has recently approached Diamond
to manufacture bicycles for Premier to sell. Premier has offered to purchase 40,000 bicycles
annually at $125 per bicycle. It is not willing to pay a higher price because it is planning to retail
the bicycles for only $200. Diamond had not previously sold bicycles through any marketing
channel other than specialty stores.

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Mike Diamond is the chief executive officer of Diamond Bicycle. Although Premier's offer is
well below Diamond's normal price, Mike is interested in the offer because Diamond has
significant excess capacity.He has asked for and has received the followingper unit product cost
information relating to the manufacture of bicycles:

Direct material $50

Direct labour $30
Variable manufacturing overheads $25
:
Fixed manufacturingoverheads $30
Total cost per unit $135

Diamond pays its staff a 10% commission but will not have to pay commissionto any
salesperson if this special offer is accepted as this opportunitycame about as a result of a chance
meeting last year between Mike and Joe (the CEO of Premier) at a trade show in which Diamond
had to pay $20,000to exhibit.

Premier's offer requires that Diamond emboss Premier's private label on each bicycle. This
requirement will cost $2.50 per bicycle to cover materials. It will also require the purchase of a
custom-made embossing machine to do the embossment costing $50,000.This machine can/will
only be used on the bicycles sold to Premier and will be discardedthereafter.

Premier's offer also requires Diamond to deliver the bicycles to Premier's regional warehouse in
batches of 5,000 bicycles so that Premier can have ready access to an inventoryof bicycles to
meet fluctuating market demands. To meet this requirement,Diamond will have to contract with
a trucking company to do the delivery who will charge Diamond $25,000per shipment.

Required:

(i) Produce a statement which clearly shows whether or not Diamond should
accept or reject the offer from Premier. [9 marks]

(ii) What non-financial factors should management consider in making this decision?
[3 marks]

QUESTION 6 (do both parts)

(Part A)
,

(i) Explain how a balanced scorecard approach is helpful in identifyingcritical processes

and evaluatingthese processes. [4 marks]

(ii) "All of a balanced scorecard's measures for processes should be fully controllable by
persons who perform the work in these the processes". Do you agree with this statement?
Explain. [4 marks]

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(Part B)

Syverson Manufacturingis a producer of plastic bottles for bottled water companies. In July of
this year, the plant manager switched to a new supplier of raw material. The materialhas a lower
cost, and because of its chemical composition, more bottles can be made per hour.

Below are the production data for the bottles for the two months before and after the switch of
suppliers.

May dome d.ily Au9JSt

G>od Bad Good Bad <?doc{ Bad G>od Bad
Machine 1 21,014 1,116 20,560 . 1,182 22,584 1,564 23,651 1,622
Machine 2 19,876 1,220 19,614 1,202 22,108 1,605 23,615 1,638
Machine 3 19,912 1,204 20,811 951 22,916 1,477 23,918 1,714

Required:

1. Carefully evaluate the success of the decision to switch suppliers.To what extent has it
achieved the objective stated by the plant manager? Are there any draw backs?
[10 marks]
11. What does the plant manager need to consider in determiningwhether or not to continue
buying raw material from the new supplier? [2 marks]

QUESTION 7

The Blue Mountain Restaurant's financial informationfor the months of July- September, 2008,
is as follows:

Budeeted sales

July $60,000
August 65,000
September 70,000

In the past, cash and credit sales have been 40% and 60%, respectively, of the total sales. Actual
sales for May and June 2008 totaled $58,000 and $62,000,respectively.

Collections on credit sales average 25% in the month followihgthe sale and 75% in the second
month after the sale.

Food costs average 35% of total sales. Thirty percent of the food cost is paid in the month of sale
with Food Suppliers giving a 10% discount on all payments made within the month of sale. The
remaining 70% of the food cost is paid in the following month.

Payroll costs are paid at the end of each month and average 20% of total sales.

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Other budgeted expenses incurred in each month are as follows:

July August September

Depreciation 500 500 500
Property taxes 1,000 1,000 1,000
Insurance 400 400 400
Licenses 13,000 - -
Other expenses 2,000 2,000
, 2,000

Property tax totaling $12,000 for the year is paid in two eq~al installments in July and December.

The annual insurance of $4,800 was paid in January.

Other expenses are paid each month as the expense is incurred.

During August, a new cash register is to be purchased for $18,000 from Cash Register Ltd. The
old register will be traded in to Cash Register Ltd in the same month at an expectedLoss of
$600; its net book value at the time of sale will be $1,000. The proceeds from the old cash
register will be set off against the purchase price of the new cash register.

The bank balance on June 30, 2008, was -$10,000 (bank overdraft).

All borrowings take place at the beginning of a month. Repaymentsof loans take place at the end
of a month if there is excess cash available to do so. The interestrate is 24% per annum.
Interest is calculated to the nearest dollar and is paid only when some repaymentof the loan is
made.

Required:

(i) Prepare the Blue Mountain Restaurant's cash~3J9,get for each of the months July-
September 2008 and for the quarter ending~with the assumption that the company
wants to maintain a cash balance at the end of each month of at least $40,000.
Round to the nearest dollar where necessary. [16 marks]

(ii) Explain how a cash budget can assist management in a seasonal cyclical business in
managing its cashflows. [4 marks]

END OF EXAMINATION PAPER

RATIO FORMULA SHEET ATTACHED.

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RATIO FORMULA SHEET

PROFITABILITY RATIOS

Net Profit margin Profit after tax

Sales

Gross Profit Margin Gross Profit

Sales

Net Profit Before Tax margin Net Profit before TaX

. Sales
OperatingProfit margin Operating Profit
Sales

Return on Capital Employed = OperatingProfit or OperatingProfit

Capital Employed Equity + Non-currentLiabilities

Return on total Assets Profit after Tax

Average Total Assets

SHAREHOLDER'S FUNDS / MARKET VALUE RATIOS

Dividend Yield Dividend per Share

Market Price per Share

Earnings per share Profit after Tax - Pref.Div.

# of Ord. shares in issue

Dividend Cover Profit after Tax - Pref. Div.

Ordinary Dividend

Price Earnings Ratio Market price per share

Earnings per share

Market to Book Market price per share

Value Ratio Book value per share

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ASSET MANAGEMENT/ ACTIVITYRATIOS

Debtor Turnover Credit Sales

Average Debtors

Days Sales Outstanding! Average Debtors x 360

Collection Period Credit Sales
(days)

Creditor Turnover Credit Purchases

Average (;~editors

Payment Period (days) Average Creditors x 360

Credit Purchases

Stock Turnover Cost of Sales

Average Stock

Stock Period (days) Average Stock x 360

Cost of Sales

Asset Turnover Sales

Average total assets

DEBT RATIOS

Times-Interest-Earned! Operating Profit

Interest Cover Interest Expense

Net Cash Flow :trom Operating

Cash Flow Interest Activities + Interest Paid + taxes Paid
Interest Paid

Gearing Ratio Long-Term Debt

Capital Employed

Debt Ratio Total Debt

Total Assets

Debt to Equity Total Debt

Common Equity

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LIQUIDITY RATIOS

Current Ratio CUITentAssets.

CUITentLiabilities

Quick Ratio Current Assets - Stock

Current Liabilities

Cash flow Ratios

Cash Flow Adequacy Ratios:

Cash flow yield Net Cash Flows from

Operating Activities
Net Income

Cash flows to sales = Net Cash Flows from

Operating Activities
Net Sales

Cash flows to assets Net Cash Flows from

Operating Activities
Average Total Assets

Free cash flow Net Cash Flows from Operating

Activities - Dividends-
Net Capital Expenditures

Operating Cash Flow to = Net Cash Flow form Operating Activities

CUITentLiabilities Average Current Liabilities

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