Profitability 1 / 6

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Question 31a

Mowair Co is an international airline which flies to destinations all over the world.

Mowair Co experienced strong initial growth but in recent periods the company has been criticised for under-investing in its non-current assets.

Extracts from Mowair Co’s financial statements are provided below.

Statements of financial position as at 30 June:

20X720X6
$’000$’000
Assets
Non-current assets
Property, plant and equipment 317,000 174,000
Intangible assets (note ii) 20,000 16,000
337,000
190,000
Current assets
Inventories 580 490
Trade and other receivables 6,100 6,300
Cash and cash equivalents 9,300 22,100
Total current assets
15,980
28,890
Total assets 352,980
 218,890
Equity and liabilities
Equity
Equity shares 3,000 3,000
Retained earnings 44,100 41,800
Revaluation surplus 145,000 Nil
Total equity
192,100
44,800
Liabilities
Non-current liabilities
6% loan notes 130,960
 150,400
Current liabilities
Trade and other payables 10,480 4,250
6% loan notes 19,440 19,440
Total current liabilities
29,920
23,690
Total equity and liabilities 352,980
 218,890

Other EXTRACTS from Mowair Co’s financial statements for the years ended 30 June:

20X720X6
$’000$’000
Revenue154,000159,000
Profit from operations12,30018,600
Finance costs(9,200 )(10,200 )
Cash generated from operations18,48024,310

The following information is also relevant:

(i)

Mowair Co had exactly the same flight schedule in 20X7 as in 20X6, with the overall number of flights and
destinations being the same in both years.

(ii)

In April 20X7, Mowair Co had to renegotiate its licences with five major airports, which led to an increase in the prices Mowair Co had to pay for the right to operate flights there. The licences with ten more major airports are due to expire in December 20X7, and Mowair Co is currently in negotiation with these airports.

Required:

(a) Calculate the following ratios for the years ended 30 June 20X6 and 20X7:

(i)

Operating profit margin;

(ii)

Return on capital employed;

(iii)

Net asset turnover;

(iv)

Current ratio;

(v)

Interest cover;

(vi)

Gearing (Debt/Equity).

Note: For calculation purposes, all loan notes should be treated as debt.

(6 marks)

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Question 31b

Funject Co has identified Aspect Co as a possible acquisition within the same industry.

Aspect Co is currently owned by the Gamilton Group and the following are extracts from the financial statements of Aspect Co:

Extract from the statement of profit or loss for the year ended 31 December 20X4

$’000
Revenue54,200
Cost of sales21,500
Gross profit32,700
Operating expenses11,700
Operating profit
21,000

Statement of financial position as at 31 December 20X4

$’000 $’000
Assets
Non-current assets 24,400
Current assets
Inventory 4,900
Receivables 5,700
Cash at bank 2,300
 12,900
Total assets37,300
Equity and liabilities
Equity
Equity shares 1,000
Retained earnings 8,000
9,000
Liabilities
Non-current liabilities
Loan 16,700
Current liabilities
Trade payables 5,400
Current tax payable 6,200
 11,600
Total equity and liabilities37,300

Additional information:

(i)

On 1 April 20X4, Aspect Co decided to focus on its core business and so disposed of a non-core division. The disposal generated a loss of $1·5m which is included within operating expenses. The following extracts show the results of the non-core division for the period prior to disposal which were included in Aspect Co’s results for 20X4:

$’000
Revenue2,100
Cost of sales(1,200)
Gross profit900
Operating expenses(700)
Operating profit
200
(ii)

At present Aspect Co pays a management charge of 1% of revenue to the Gamilton Group which is included in operating expenses. Funject Co imposes a management charge of 10% of gross profit on all of its subsidiaries.

(iii)

Aspect Co’s administration offices are currently located within a building owned by the Gamilton Group. If Aspect Co were acquired, the company would need to seek alternative premises. Aspect Co paid rent of $46,000 in 20X4. Commercial rents for equivalent office space would cost $120,000.

(iv)

The following is a list of comparable industry average key performance indicators (KPIs) for 20X4:

KPI
Gross profit margin45%
Operating profit margin28%
Receivables collection period41 days
Current ratio1·6:1
Acid test (quick) ratio1·4:1
Gearing (debt/ekvity)240%

Required:

(b)

Calculate the 20X4 ratios for Aspect Co equivalent to those shown in note (iv) based on the restated financial
information calculated in part (a).

Note: You should assume that any increase or decrease in profit as a result of your adjustments in part (a) will
also increase or decrease cash. 
(5 marks)

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Question 31c

Funject Co has identified Aspect Co as a possible acquisition within the same industry.

Aspect Co is currently owned by the Gamilton Group and the following are extracts from the financial statements of Aspect Co:

Extract from the statement of profit or loss for the year ended 31 December 20X4

$’000
Revenue54,200
Cost of sales21,500
Gross profit32,700
Operating expenses11,700
Operating profit
21,000

Statement of financial position as at 31 December 20X4

$’000 $’000
Assets
Non-current assets 24,400
Current assets
Inventory 4,900
Receivables 5,700
Cash at bank 2,300
 12,900
Total assets37,300
Equity and liabilities
Equity
Equity shares 1,000
Retained earnings 8,000
9,000
Liabilities
Non-current liabilities
Loan 16,700
Current liabilities
Trade payables 5,400
Current tax payable 6,200
 11,600
Total equity and liabilities37,300

Additional information:

(i)

On 1 April 20X4, Aspect Co decided to focus on its core business and so disposed of a non-core division. The disposal generated a loss of $1·5m which is included within operating expenses. The following extracts show the results of the non-core division for the period prior to disposal which were included in Aspect Co’s results for 20X4:

$’000
Revenue2,100
Cost of sales(1,200)
Gross profit900
Operating expenses(700)
Operating profit
200
(ii)

At present Aspect Co pays a management charge of 1% of revenue to the Gamilton Group which is included in operating expenses. Funject Co imposes a management charge of 10% of gross profit on all of its subsidiaries.

(iii)

Aspect Co’s administration offices are currently located within a building owned by the Gamilton Group. If Aspect Co were acquired, the company would need to seek alternative premises. Aspect Co paid rent of $46,000 in 20X4. Commercial rents for equivalent office space would cost $120,000.

(iv)

The following is a list of comparable industry average key performance indicators (KPIs) for 20X4:

KPI
Gross profit margin45%
Operating profit margin28%
Receivables collection period41 days
Current ratio1·6:1
Acid test (quick) ratio1·4:1
Gearing (debt/ekvity)240%

Required:

(c)

Using the ratios calculated in part (b), comment on Aspect Co’s 20X4 performance and financial position compared to the industry average KPIs provided in note (iv).

(10 marks)

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Question 32abc

ACCA FR (F7) Past Papers Specimen exam question September 2016 Q32

At 1 October 20X4, the Tangier group consisted of the parent, Tangier Co, and two wholly-owned subsidiaries which
had been owned for many years.

On 1 January 20X5, Tangier Co purchased a third 100% owned investment in a subsidiary called Raremetal Co. The consideration paid for Raremetal Co was a combination of cash and shares.

The cash payment was partly funded by the issue of 10% loan notes. On 1 January 20X5, Tangier Co also won a tender
for a new contract to supply aircraft engines which Tangier Co manufactures under a recently acquired long-term
licence.

Raremetal Co was purchased with a view to securing the supply of specialised materials used in the manufacture of these engines.

The bidding process had been very competitive and Tangier Co had to increase its manufacturing capacity to fulfil the contract.

Required:

(a)   Comment on how the new contract and the purchase of Raremetal Co may have affected the comparability
       of the consolidated financial statements of Tangier Co for the years ended 30 September 20X4 and 20X5.

(b)   Calculate appropriate ratios and comment on Tangier Co’s profitability and gearing. Your analysis should
        identify instances where the new contract and the purchase of Raremetal Co have limited the usefulness of
        the ratios and your analysis.

Note: Your ratios should be based on the consolidated financial statements provided and you should not
        attempt to adjust for the effects of the new contract or the consolidation. Working capital and liquidity ratios
        are not required.

(c) Explain what further information you might require to make your analysis more meaningful.

The following mark allocation is provided as guidance for this question:
(a)     5 marks
(b)     12 marks (up to 5 marks for the ratio calculations)
(c)     3 marks

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MC Question 20

Which of the following current year events would explain a fall in a company’s operating profit margin compared
to the previous year?

A

An increase in gearing leading to higher interest costs

B

A reduction in the allowance for uncollectible receivables

C

A decision to value inventory on the average cost basis from the first in first out (FIFO) basis. Unit prices of inventory had risen during the current year

D

A change from the amortisation of development costs being included in cost of sales to being included in administrative expenses

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