Financial Statements (A Level) (Cambridge International A-Level Business): Exam Questions

Define the term ‘published accounts’.

[case-study] Hannah’s Handbags (HH)

Hannah started HH six years ago. HH operates in a niche market providing unique bags. The bags are made using job production. As demand grew for the bags, Hannah took on a partner, her brother Kwom. They both agreed to keep the name ‘Hannah’s Handbags’ as it is an established, reputable and widely recognised brand.

HH operates from a small workshop and showroom. Customers are encouraged to visit the showroom to discuss design and materials with either Hannah or Kwom.

HH employs four highly skilled specialist production staff. Table 2.1 shows an extract from the latest income statement.

Table 2.1: Extract of financial data for HH (year ended 30 October 2019)

	$000
Revenue	980
Cost of sales	588
Expenses	245

A new product

Hannah and Kwom would like to expand the business by producing a limited number of batch produced bags to sell online. Hannah has noticed other bag producers do this successfully. The new market has many more competitors, with 15 large businesses and many small ones. The bags would have to be priced competitively. Kwom estimates that this new venture would require additional finance of $350 000. HH would also require a specialist IT provider to set up a website and a marketing agency to run a viral marketing campaign.

Define the term ‘income statement’.

Explain one reason why a public limited company must publish its financial statements.

Define the term 'statement of financial position'.

Define the term 'non-current asset'.

Explain how the statement of profit or loss is linked to the statement of financial position.

Define the term 'net realisable value'.

Explain one difficulty a business may face when valuing its inventory.

Explain one way in which a supplier could use a business's statement of financial position.

Explain one reason why a business charges depreciation in its accounts.

[case-study] George’s Gym (GG)

George identified a potential niche market for a new gym in his local area. He set up GG as a sole trader business three years ago. GG is a modern gym with the latest equipment.

George has recently gained planning permission to build a new swimming pool. George wants to open the swimming pool because a national competitor is planning to open a new gym close by and he wants GG to remain competitive. The swimming pool will cost $400 000 and George has yet to decide on the best source of fi nance. He has $50 000 in savings that he could use and he does not have any mortgage or loans. George is thinking about seeking a private investor but is unsure of the risks involved.

The local population is wealthy. Last year (2012), GG had 300 members who each paid a membership fee of $60 per month. George is thinking about new ways of increasing revenue such as offering additional ‘keep fit’ classes. He also plans to increase the monthly fee he charges members to $66. His accountant has told him he needs to think about the price elasticity of demand before making a pricing decision.

Table 3 – Annual revenue and profit for the year for the previous 3 years ($000)

	2010	2011	2012
Annual revenue	120	160	X
Profit for the year	20	50	80

George hopes that the information in Table 3 will help show any potential lender how attractive the gym is as an investment.

GG has a problem of a high labour turnover of personal trainers. Three of them have left in the last six months. He has just employed a new personal trainer, Sally. George needs to issue her contract of employment. George thinks that the reasons for the high labour turnover include:

• George is always busy and so he can never offer an effective induction training programme for his employees
• GG salaries are below average for the industry.

Calculate the value of X in Table 3.

Extract:

Pop Cool (PC)

PC is a public limited company. Its head office is in Europe and it operates with centralised decision making. The company owns the Pop Cool brand name, logo and the distinctive bottle shape that is still used in some markets. PC operates its own bottling and canning factories in some countries. However, it also has joint venture agreements with packaging businesses in other countries. Much of the fruit and sugar used in producing the soft drinks is imported from African and Asian countries. 75% of PC’s sales and 90% of its profits are earned in the USA and Europe. The directors of PC are keen to develop other markets and other products so that the company becomes less dependent on a few key markets and products. Economic changes The economies of the USA and Europe have experienced very slow economic growth since 2008 – and some have even been hit by recession. Interest rates are very low as the monetary policy of these countries is aiming to boost demand. However, this has contributed to exchange rate depreciations of the US dollar and the European euro. Consumer spending has fallen due to declining real incomes. There are ageing populations in most of the countries where PC sells its products. A loss of competitiveness in many industrial sectors has resulted in rising unemployment. Statement of financial position valuations Since 2008 PC’s share price has fallen. This has been the trend for many public limited companies. PC’s Finance Director has been considering three changes that will affect PC’s accounts. He could make all three changes or just one or two of them. • When calculating depreciation of new production equipment bought last year for $25m, use an estimated life of 8 years not 5 years. The equipment would still have an estimated residual value of $3m. • Sell $10m of property assets and lease them back at an annual leasing cost of $1.5m. • Revalue the company’s intangible assets by 50%. He used an extract of PC’s most recent accounts to calculate what the impact of these changes might be on profit and gearing (see Appendix 1). Entering new markets – Africa and Asia Paul, PC’s Chief Executive Officer (CEO), has been discussing with the Marketing Director, Suzy, alternative marketing strategies the company could use to enter the rapidly expanding markets of Asia and Africa. They have different views. Paul stated that: ‘I think we should take over an existing soft drinks manufacturer in, for example, India or China. We would then have all of the production facilities and distribution channels through large supermarkets that we will need. The existing brand names could then be replaced with the Pop Cool brand which we would advertise very heavily for a short period. Consumers will be attracted to this because it is so popular elsewhere in the world.’ Suzy replied: ‘There could be local opposition to this globalised approach – although the marketing economies of scale will be substantial. I think we should develop a range of soft drinks to suit local tastes with brand names that reflect local language and culture. We could distribute these new drinks through small retail stores and street markets. This way we will slowly but steadily build up consumer awareness and loyalty.’

Workforce planning in country X Country X is one of PC’s biggest markets. The company fully owns all of the production facilities in this country and it has a large sales and marketing team too. PC employs 468 people in country X and labour costs are the company’s biggest expense in this country. The Human Resources department is under pressure from PC’s Head Office to reduce labour costs in country X by 15%. The Human Resources manager in country X, Bill, thinks that cutting labour costs might be risky. He told other senior managers: ‘We must maintain consistent and adequate production levels so that consumers can always buy the quantity they want. Production workers are sometimes reluctant to learn new skills and they are resistant to job flexibility. Should we cut back on sales and marketing staff? Perhaps we should employ more production workers on flexible contracts. Another option is to introduce even more automation at our main packaging plant.’ The other managers agreed with him that meeting this new company objective of reducing labour costs was going to need careful workforce planning. Special order in country X PC’s marketing team in country X has just received an enquiry from the country’s largest supermarket group – Superfood. The supermarket is asking PC to produce one large batch of soft drinks as a trial product to be sold under Superfood’s own brand name. The drinks would be similar to an existing Pop Cool product. PC’s Marketing manager in country X is not prepared to take this decision without the approval of Head Office. He consulted with the Operations manager in country X. They compiled data to present to PC’s senior management team in country X before asking Head Office for a final decision (see Appendix 2). Future options for PC’s growth PC’s Board of Directors has been criticised by the newspapers and by major shareholders for the company’s slow rate of growth in sales and profits since 2008. Apart from expansion into markets in Asia and Africa, the directors are investigating two other strategic options for growth and increasing long term profitability. Option A: Develop new flavours and distinctive names for a wider range of PC products. These could include: Pop Cool Energy aimed at the sports people market segment and Pop Cool Vital aimed at young people wanting to buy healthy drinks. The Marketing Director believes that much clearer market segmentation is the best strategy for achieving market penetration and higher profits. He said at a recent Board meeting: ‘This is a low risk strategy that could be implemented within two years’. Option B: Extend the Pop Cool brand name and image by organising a joint venture with a clothing designer. The plan would be to launch a range of modern clothes aimed at young consumers. With careful and extensive promotion, the CEO thinks that these consumers would quickly link the clothing range with Pop Cool’s positive image. He believes that the best way to expand profitably in the longer term is for PC to diversify into markets and products that could lead to higher profit margins than those achieved with soft drinks.

Appendix 1: Extract from Pop Cool’s latest published accounts (before any changes proposed by Finance Director) Statement of financial position extract as at 31 October 2013 $m Non-current assets: Land Buildings Production equipment Vehicles Intangible assets Total non-current assets 78 112 78 10 80 358 Net current assets 86 Non-current liabilities 156 Shareholders’ equity 288 Income statement extract for year ending 31 October 2013 Revenue 750 Profit after depreciation and interest 87 Appendix 2: Superfood’s special order – data produced by Marketing manager and Operations manager PC’s annual production capacity in country X 50m cans PC’s actual production level (2012) in country X 45m cans Superfood order 4m cans Unit material cost per can of drink $0.10 Unit direct labour cost per can of drink $0.15 Cost of new design of can for Superfood and product testing $0.5m Transport costs for Superfood order $0.1m PC factory overhead cost per can of drink (2012) $0.25 Price per can offered by Superfood to PC $0.50

Read the following extract (lines 17–27 and Appendix 1) before answering

Calculate the change in the annual depreciation of the new production equipment.

Extract:

Normax Hotels (NH)

NH is a public limited company that owns 32 hotels in country X. Jolin is the Chief Executive. NH has a centralised organisational structure. NH has three types of hotel: • Luxury hotels offer high quality accommodation at premium prices in city centres and exclusive beach resorts. They attract guests from all over the world as well as high‑income earners in country X. • Family hotels offer family rooms, children’s play areas, babysitting services and activities for children in rural and seaside locations. • Basic hotels offer clean, simple accommodation with basic food and facilities. The guests are low‑income travellers and students. They are located in city retail parks. Each hotel manager has limited authority to make decisions because they are told what to do by NH’s Head Office. NH is organised into the following functional departments: administration, operations, finance, marketing, human resources, IT and strategic planning. International expansion? Country Q is a low‑income country. It has a small but growing number of locally owned hotels. Jolin has held two meetings with the Minister for Tourism in country Q to discuss the possibility of opening three NH hotels in her country. These would be located in areas of outstanding natural beauty. Jolin told her that the three hotels would employ several hundred people and generate significant profits. However, the Minister expressed concern that country Q could lose more than it gained from such an investment from a large foreign company. She would have to consider the proposal in more detail. Operations issues Jolin is concerned that profits have recently decreased. He monitors key statistics and is considering introducing lean production principles. Table 1 shows some relevant information. NH holds high levels of inventory of supplies needed for the rooms. Each hotel can supply enough sheets, towels, soaps and cosmetics to every room every day, whether needed or not. The kitchens are expected to have enough food inventory for three days. A small but increasing number of employees have been dismissed for taking home food from the kitchen stores.

Table 1: NH capacity utilisation (room occupancy) and price data, 2019 Hotel type Total number of rooms Budgeted average number of rooms occupied per night Average number of rooms actually occupied per night Price per room per night Luxury 1600 1400 1300 $150 Family 1400 1100 1000 $110 Basic 2000 1800 1600 $40 Customer service Hotel managers claim that they follow company policy and insist that employees do the same. However, many customers complain about the difficulty of communicating with employees and managers who often claim that they are ‘too busy’. Another common complaint is that the hotels need modernising. Head Office has received some letters from employees with ideas for improvements but these have not been considered. Table 2 shows information about NH customers’ experience. Table 2: NH customers’ experience Hotel type Customer complaints 2019 Percentage change of customer complaints from 2018 Average customer satisfaction rating out of 10 Luxury 8560 +8 8.3 Family 6800 +7 7.1 Basic 9040 +9 8.1 Human resource issues Hotel employees are recruited by each hotel manager. Many employees have part time, flexible and temporary contracts. None of them are on zero hour contracts. All employees are trained to perform only one role in the hotel. The hotel managers are given strict labour cost budgets. Each manager has assistant managers who decide the allocation of tasks. Employees have worksheets that detail each task and how long it should take. No time is allowed to discuss these details. The Human Resource Director has just returned from a conference about Management by Objectives (MBO) and is now considering the information in Table 3.

Table 3: NH employee information 2018 2019 Employment costs as a percentage of total costs 68% 74% Employees average hourly wage rate $8 $8 Trade union membership as a percentage of employees 14% 18% Percentage of employees involved in disciplinary proceedings 3% 6% Labour turnover: non‑management employees 14% 26% Labour turnover: assistant managers 4% 15% Average job satisfaction rating out of 10: non‑management employees 6 5 Average job satisfaction rating out of 10: assistant managers 9 8 Marketing NH hotels Jolin is worried about room occupancy rates being below budget. Katie, the Marketing Director, told Jolin that: • the balance between the advertising media used (magazines, television and direct marketing) needed to be reviewed • economic and market conditions have not been favourable • room prices are fixed at the start of each year. Jolin insisted that Katie should revise the marketing plan to achieve the objectives of increased occupancy rates and increased revenue. A possible takeover Pitro, the Finance Director, has prepared the latest financial statements. See Table 4 and Table 5. Jolin recently told him: ‘I have been approached by the owners of EatBest, a restaurant chain, who want to sell the business. If NH takes over EatBest it could be completed in 2021. It would involve making a cash payment of $20m plus 0.5m NH shares. EatBest’s restaurants are valued at $40m.’ Jolin has forecast that this takeover would result in the following changes to NH’s accounts for the year ending 31 October 2021: • revenue would increase to $170m, cost of sales would increase to $46m and expenses would increase to $109m • additional borrowing of $50m at 5% interest per year • current assets and current liabilities increase by 10%

Table 4: NH income statement year ended 31 October 2020 $m Revenue 140 Cost of sales 36 Gross profit 104 Expenses 84 Operating profit 20 Interest 4 Profit before tax 16 Profit after tax 8 Dividends 5 Retained earnings 3 Table 5: Extract from NH statement of financial position at 31 October 2020 $m Non‑current assets 80 Current assets 35 Total assets 115 Non‑current liabilities (60) Current liabilities (20) Total liabilities (80) Net assets 35 Directors’ meeting Jolin has just had a meeting with the directors. He started by reminding them that NH is recognised as having three core competencies which must provide the framework for any strategic decisions made. These are: • outstanding customer service • professional standards that focus on efficiency • clear leadership based on understanding the industry.

The directors discussed whether the organisational structure of NH should be changed. Jolin told the directors: ‘I am convinced that we need to change the organisational structure of NH. When the company started with just one hotel it was obvious that functional organisation was best. Now I think this is a barrier to success. Perhaps we should consider management theory including Chandler’s assertion that strategy and structure are linked. Maybe we also need to consider delayering NH’s organisational structure.’ Jolin finished the meeting by telling directors: ‘We also need a new strategy to avoid decline. We have to review our objectives and structure as part of producing a detailed strategic plan for success.’

Read the following extract (lines 82-92 and Table 4 and Table 5) before answering

Assume NH takes over EatBest in 2021 and no other factors change. Calculate the forecast profit before tax for the year ended 31 October 2021

[case-study] Ormesby

Ormesby manufactures workwear for construction and healthcare businesses in country K.

Two years ago Ormesby moved to a cheaper fabric supplier and raised its prices by 6%. It also opened a showroom and increased its sales team from 4 people to 11.

Table 1.1 shows extracts from Ormesby's statement of profit or loss.

Table 1.1 Ormesby statement of profit or loss extracts ($000)

	2024	2026
Revenue	4 200	4 750
Cost of sales	2 940	3 087
Gross profit	1 260	1 663
Expenses	890	1 430
Profit from operations	370	233

Analyse two aspects of Ormesby's performance shown by its statement of profit or loss.

[case-study] Wexford Signs

Wexford Signs designs and installs illuminated shop signs in country H.

Wexford has agreed to buy the workshop it currently rents. The purchase removes annual rent of $84 000, but Wexford will take a loan of $700 000 at 7% interest a year, and the building will be depreciated at $28 000 a year using the straight-line method.

The directors expect no change to revenue or cost of sales.

Table 1.1 shows Wexford's most recent statement of profit or loss.

Table 1.1 Wexford Signs statement of profit or loss, year ended 2026 ($)

Revenue	1 640 000
Cost of sales	902 000
Gross profit	738 000
Expenses	601 000
Profit from operations	137 000
Interest	19 000
Profit for the year	118 000

Analyse the impact of buying the workshop on Wexford Signs' statement of profit or loss.

‘The published accounts of a public limited company are only useful to internal stakeholders.’

Discuss the extent to which you agree with this view.

[case-study] Talgarth Scaffolding

Talgarth Scaffolding hires out scaffolding to builders in country V. It has asked its bank for a loan of $600 000 to buy new equipment.

Talgarth's directors have given the bank its statement of profit or loss, pointing out that profit for the year has risen from $210 000 to $340 000.

Three further facts are not obvious from the statement:

• $180 000 of the 2026 profit came from selling a depot that Talgarth no longer needed
• Talgarth changed its depreciation policy in 2026, extending the assumed useful life of its scaffolding from five years to eight, which reduced the annual depreciation charge by $70 000
• Two large customers now take 90 days to pay rather than 30

Anya, the bank's lending manager, must decide whether the statement of profit or loss gives her enough information.

Evaluate the usefulness of Talgarth Scaffolding's statement of profit or loss to the bank in deciding whether to lend.

[case-study] Ellersby

Ellersby manufactures office furniture in country G. It currently makes its own metal frames and is considering buying them from an outside supplier instead.

Table 1.1 shows Ellersby's statement of profit or loss for 2026 and the directors' forecast for 2027 if frames are bought in.

Table 1.1 Ellersby statement of profit or loss ($000)

	2026 actual	2027 forecast
Revenue	9 400	9 400
Cost of sales	6 110	5 640
Gross profit	3 290	3 760
Expenses	2 820	3 015
Profit from operations	470	745

The 2027 forecast includes redundancy payments of $390 000 to the 14 employees who make frames. Without those payments, expenses would fall to $2 625 000.

The supplier is the only business in country G able to make the frames to Ellersby's specification. It quotes a seven-week lead time; Ellersby currently offers its corporate customers four weeks, which is its main selling point.

Evaluate whether Ellersby should buy in its metal frames rather than making them.