​ASSIGNMENT

Q1. ‘Happy and Healthy’ is a traditional independent health food business

that has been run as a family company for 40 years by Ken and Steffi
Potter. As a couple they have always been passionate campaigners for
healthy foods and are more concerned about the quality of the foods they
sell than the financial detail of their business. Since the company started in
1970, it has been audited by Watson Shreeves, a local audit firm. Mr
Shreeves has overseen the Potters’ audit for all of the 40 year history
(rotating the engagement partner) and has always taken the opportunity to
meet with Ken and Steffi informally at the end of each audit to sign off the
financial statements and to offer a briefing and some free financial advice in
his role as what he calls, ‘auditor and friend’. In these briefings, Mr
Shreeves, who has become a close family friend of the Potters over the
years, always points out that the business is profitable (which the Potters
already knew without knowing the actual figures) and how they might
increase their margins. But the Potters have never been too concerned
about financial performance as long as they can provide a good service to
their customers, make enough to keep the business going and provide
continued employment for themselves and their son, Ivan. Whilst Ken and
Steffi still retain a majority shareholding in ‘Happy and healthy’ they have
gradually increased Ivan’s proportion over the years. They currently own
60% to Ivan’s 40%. Ivan was appointed a director, alongside Ken and
Steffi, in 2008. Ivan grew up in the business and has helped his parents out
since he was a young boy. As he grew up, Ken and Steffi gave him more
and more responsibility in the hope that he would one day take the
business over. By the end of 2009, Ken made sure that Ivan drew more
salary than Ken and Steffi combined as they sought to ensure that Ivan
was happy to continue in the business after they retired. During the audit
for the year ended 31 March 2010, a member of Watson Shreeves was
performing the audit as usual when he noticed a dramatic drop in the
profitability of the business as a whole. He noticed that whilst food sales
continued to be profitable, a large amount of inventory had been sold below
cost to Barong Company with no further explanation and it was this that
had caused the reduction in the company’s operating margin. Each
transaction with Barong Company had, the invoices showed, been
authorised by Ivan. Mr Shreeves was certain Ken and Steffi would not
know anything about this and he prepared to tell them about it as a part of
his annual end of audit meeting. Before the meeting, however, he carried
out some checks on Barong Company and found that it was a separate
business owned by Ivan and his wife. Mr Shreeves’s conclusion was that
Ivan was effectively stealing from ‘Happy and healthy’ to provide inventory
for Barong Company at a highly discounted cost price. Although Mr
Shreeves now​ ​had to recommend certain disclosures to the financial
statements in this meeting, his main fear was that Ken and Steffi would be
devastated if they found out that Ivan was stealing and that it would have
long-term implications for their family relationships and the future of ‘Happy
and healthy’.

Discuss the professional and ethical dilemma facing Mr

Shreeves in deciding whether or not to tell Ken and Steffi
about Ivan’s activity. Advise Mr Shreeves of the most
appropriate course of action (7M)

Q2.Ambion is the third largest industrial country in the world. It is densely

populated with a high standard of living. Joe Swift Transport (known as
Swift) is the largest logistics company in Ambion, owning 1500 trucks. It is
a private limited company with all shares held by the Swift family. It has
significant haulage and storage contracts with retail and supermarket
chains in Ambion. The logistics market-place is mature and extremely
competitive and Swift has become market leader through a combination of
economies of scale, cost efficiencies, innovative IT solutions and clever
branding. However, the profitability of the sector is under increased
pressure from a recently elected government that is committed to heavily
taxing fuel and reducing expenditure on roads in favour of alternative forms
of transport. It has also announced a number of taxes on vehicles which
have high carbon emission levels as well as reducing the maximum
working hours and increasing the national minimum wage for employees.
The company is perceived as a good performer in its sector. The 20X9
financial results reported a Return on Capital Employed of 18%, a gross
profit margin of 17% and a net profit margin of 9.15%. The accounts also
showed a current liquidity ratio of 1.55 and an acid test ratio of 1.15. The
gearing ratio is currently 60% with an interest cover ratio of 8. 10 years ago
the northern political bloc split up and nine new independent states were
formed. One of these states was Ecuria. The people of Ecuria (known as
Ecurians) traditionally have a strong work ethic and a passion for precision
and promptness. Since the formation of the state, their hard work has been
rewarded by strong economic growth, a higher standard of living and an
increased demand for goods which were once perceived as unobtainable
luxuries. Since the formation of the state, the government of Ecuria has
TECHNICAL PRACTICE QUESTIONS : SECTION 1 KAPLAN
PUBLISHING 33 pursued a policy of privatisation. It has also invested
heavily in infrastructure, particularly the road transport system, required to
support the increased economic activity in the country. The state haulage
operator (EVM) was sold off to two Ecurian investors who raised the
finance to buy it from a foreign bank. The capital markets in Ecuria are still
immature and the government has not wished to interfere with or bolster
them. EVM now has 700 modern trucks and holds all the major logistics
contracts in the country. It is praised for its prompt delivery of goods.
Problems in raising finance have made it difficult for significant competitors
to emerge. Most are family firms, each of which operates about 20 trucks
making local deliveries within one of Ecuria’s 20 regions. These two
investors now wish to realise their investment in EVM and have announced
that it is for sale. In principle, Swift are keen to buy the company and are
currently evaluating its possible acquisition. Swift’s management perceive
that their capabilities in logistics will greatly enhance the profitability of
EVM. The financial results for EVM are shown in Figure 1. Swift has
acquired a number of smaller Ambion companies in the last decade, but
has no experience of acquiring foreign companies, or indeed, working in
Ecuria. Joe Swift is also contemplating a more radical change. He is
becoming progressively disillusioned with Ambion. In a recent interview he
said that ‘trading here is becoming impossible. The government is more
interested in over regulating enterprise than stimulating growth’. He is
considering moving large parts of his logistics operation to another country
and Ecuria is one of the possibilities he is considering.

Extract from financial results: EVM 20X9

Extract from the statement of financial position
Assets $million
Non-current assets
Intangible assets 2,000
Property, plant, equipment ​ ​ ​6,100
​ 8100

Current assets $million

Inventories 100
Trade receivables 900
Cash and cash equivalents 200
1,200
Total assets 9,300
Equity and liabilities $million
Equity
Share capital 5,700
Retained earnings ​ 50
Total equity 5,750
Non-current liabilities
​Long-term borrowings 2,500
Current liabilities
Trade payables 1,000
Current tax payable 50
1,050
 ​ otal liabilities
T 3,550
Total equity and liabilities 9,300

Extract from statement of profit or loss $million

Revenue 20,000
Cost of sales (16,000)
Gross profit 4,000
Administrative expenses (2,500)
Finance cost (300)
Profit before tax 1,200
Income tax expense (50)
Profit for the year 1,150

Assess, using both financial and non-financial measures,

the attractiveness, from Swift’s perspective, of EVM as an
acquisition target. (8M)