CMA DECEMBER, 2020 EXAMINATION STRATEGIC LEVEL
SUBJECT: P3. PERFORMANCE STRATEGY
Model Solution
SECTION – B Solution of the Q. No.2
(a)
A derivative is a financial instrument whose value depends on the price of some other financial assets or some underlying factors. The underlying variables may be commodities such as oil and gold, stocks, interest rates, currencies or some abstract conditions such as the weather.
Derivatives are useful instruments that can be used to manage or reduce risk. There are four basic types of derivatives: forward contracts, futures contract, options contract and swaps.
A forward contract is a legally binding agreement between two parties to buy or sell a specified asset at a specified future date and at a specified price agreed today.
A futures contract is a contract relating to currencies, interest rates, commodities or shares that oblige the buyer (seller) to purchase (sell) the specified quantity of the item represented in the contract at a predetermined price at the expiration of the contract.
A swap is an agreement between two parties to exchange one series of cashflow for another at specified future times. For example, in an interest-rate swap, one party agrees to pay a fixed interest rate on a notional amount to the other party and receive from the other party a floating interest rate on the same amount, based on a reference rate, say the London Inter-Bank Offer Rate (LIBOR).
In forward and futures contracts both the buyer and the seller have the obligation to honour their side of the contract. An option is the right of an option holder to buy or sell a specific asset on predetermined terms on, or before, a future date.
(b)
Fixed versus floating rates:
Fixed-rate finance may be preferred because interest payment commitments are known. This type of finance will be especially useful if interest rates are expected to rise. Floating-rate finance would be preferred if interest rates are expected to fall, or if the company has floating assets which will provide a better match, for example debtors.
Eurobonds: A Eurobond is a bearer bond, issued in a euro currency, usually Eurodollars, which are US dollars deposited with, or borrowed from, a bank outside the United States.
A key advantage of the Eurobond market is that it allows for a greater range of potential investors.
From the investor’s point of view, the bearer bond format may be attractive, although this raises considerations for the safe keeping of the documents. Other benefits from the company’s point of view are as follows:
● they are usually cheaper than equivalent domestic bonds
● the market is more flexible, allowing tailor-made financial instruments
● they may provide a hedge against interest rate or currency movements
● the cost of the issue may be lower than with the US corporate bond market.
The one main disadvantage for the use of Eurobonds is that the market is restricted to large bond issues for internationally recognised companies, although this would not be a problem for GH plc.
(c)
Capital investment techniques
Despite the usefulness of capital investment techniques, the assumption has been that future cash flows can be predicted with some accuracy. Despite the apparent sophistication of techniques (particularly DCF), capital investment decisions are often made subjectively and then justified after
the event by the application of financial techniques to subjectively ‘guessed’ cash flows which can be easily manipulated through sensitivity analysis in order to meet hurdle rates for ROI, payback or internal rate of return.
Budget
One of the most common dysfunctional consequences of budgeting is the creation of ‘slack’ resources. Budget expectations perceived to be unfair or exploitative, are not internalised by employees and can lead to lower motivation and performance. Similarly, the manipulation of data or its presentation to show performance in the best possible light is another common behaviour, particularly where performance is linked to rewards bonus scheme. Dysfunctional behaviours include smoothing performance between periods; selective bias and focusing on particular aspects of performance at the expense of others; gaming, or producing the desired behaviour although this is detrimental to the organisation; filtering out undesirable aspects of performance and ‘illegal’ acts to bypass organisational accounting rules.
Non-financial performance
In non-financial performance measurement, there are similar dysfunctional consequences where targets are perceived to be too stretching. Tunnel vision emphasises quantified results over qualitative performance. Sub-optimisation involves a focus on narrow local objectives rather than organisation-wide ones. Myopia is a focus on short-term performance rather than long-term consequences. Measure fixation emphasises measures rather than the underlying objective.
Misrepresentation involves the deliberate manipulation of data with the aim to mislead.
Misinterpretation is providing an inaccurate explanation about reported performance. Ossification inhibits innovation and leads to paralysis of action.
(d)
(1) Indebtedness of the assistant to the junior staff member
This situation might call into question the independence and objectivity of the assistant in carrying out his work within the finance function. It could also threaten my own position, if it were generally known that a member of my staff is receiving financial assistance from a junior colleague.
The position of the assistant is difficult, because he is presumably unable to repay the debt immediately, and he might be unaware of the fact that he has put the internal audit section into an embarrassing position.
I should discuss the position with him, and explain the problem that it has caused. He should be reminded of CIMA’s ethical guidelines about the need to maintain objectivity and independence. I should find out how quickly he plans to repay the debt. If this will not happen quickly, I should ask whether he might be able to obtain a loan to repay the debt. (The company might possibly be willing to provide a loan for such a purpose.)
If the assistant is unable to agree to my suggestion, I should have to consider recommending that he should be moved to another position where his independence and objectivity would not be compromised.
(2) CEO’s accounting adjustments
It is my responsibility to provide the CEO with financial information that is competently and accurately prepared. The CEO presumably shares the financial information with his board colleagues and the board of the parent company. I need to consider whether any adjustments made by the CEO to financial statements that I prepare will bring my integrity into question.
I should resist attempts by the CEO to amend financial results to make them seem better than they actually are. It would be particularly worrying if figures have been altered in order to improve the financial rewards for the CEO. On the other hand, some prudent adjustments to the figures might be justifiable.
I should discuss the situation with the finance director and the CEO, and establish whether the CEO intends to continue altering financial statements in the future, and his reasons for doing so. If the situation cannot be resolved, I should have to consider my position within the company. I should not remain in a position where I know that my integrity is being compromised.
(3) Errors in the sales tax returns
CMA members have an ethical duty to carry out their work with professional competence.
Technical competence means that the staff in my department should understand the necessary rules in relation to the tax work they do. Ignorance is no excuse for mistakes, and a repetition of the errors – and the fine – must be avoided.
I need to ensure that the staff who carry out specialist tasks are competent to carry them out.
Training should be provided if required. Suitable instructions and guidance should also be available for reference.
(e) Req. (i)
Roberto & Sons follows a product differentiation strategy. Roberto’s designs are ―trendsetting, its T-shirts are distinctive, and it aims to make its T-shirts a ―must have‖ for each and every teenager. These are all clear signs of a product differentiation strategy, and, to succeed, Roberto must continue to innovate and be able to charge a premium price for its product.
Req. (ii)
Possible key elements of Roberto’s balance scorecard, given its product differentiation strategy:
Financial Perspective (1) Increase in operating income from charging higher margins, (2) price premium earned on products. These measures will indicate whether Roberto has been able to charge premium prices and achieve operating income increases through product differentiation.
Customer Perspective (1) Market share in distinctive, name-brand T-shirts, (2) customer satisfaction, (3) new customers, (4) number of mentions of Roberto’s T-shirts in the leading fashion magazines Roberto’s strategy should result in improvements in these customer measures that help evaluate whether Roberto’s product differentiation strategy is succeeding with its customers. These measures are, in turn, leading indicators of superior financial performance.
Internal Business Process Perspective (1) Quality of silk-screening (number of colors, use of glitter, durability of the design), (2) frequency of new designs, (3) time between concept and delivery of design Improvements in these measures are expected to result in more distinctive and trendsetting designs delivered to its customers and in turn, superior financial performance.
Learning and Growth Perspective (1) Ability to attract and retain talented designers (2) improvements in silk-screening processes, (3) continuous education and skill levels of marketing and sales staff, (4) employee satisfaction. Improvements in these measures are expected to improve Roberto’s capabilities to produce distinctive designs that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial
SECTION – C Solution of the Q. No. 3
Req-(i) Popular Ltd.
Threats:
Self-interest threat: The firm may be reluctant to modify its audit opinion for fear of losing the client/fees.
Intimidation threat: Hans appears to be aggressive and to be exerting pressure what may have influenced other areas of the audit work.
Steps:
The firm should undertake an engagement quality control review and consider whether intimidation has affected work in other areas of the audit. More senior members of the firm should be included in the audit team and if the intimidation threat is too great the firm should consider resigning.
If the firm is removed it should use tis its legal rights to circulate a written representation to the minority shareholders and to attend/speak at the general meeting where it would have been reappointed.
Meghna Ltd.
Self-review threat: The outcome of the work defending the claim may impact on future financial statements. The claim is 4.9% of gross assets and 122% of profit before tax and is therefore material to the financial statements. The audit team may place too much reliance on the work performed by the firm’s tax experts or be reluctant to criticize the work if any deficiencies are found during the audit.
Management threat: The tax experts may be expected to make decisions on the best course of action and their views may become too closely aligned with management.
Advocacy threat: The firm may be perceived to be supporting a position held by management if it defends the company against a NBR Ethical Standard S5 prohibits the provisions of such tax services where the firm acts as an advocate before an appeals tribunal.
Self-interest threat: The firm may be reluctant to agree with NBR’s position if it indicates that there are misstatements in prior year financial statements that have been audited by the firm. This may impact adversely on the firm through adverse publicity arising form disciplinary action, fines/penalties and/or damages as result of negligence.
Steps:
Explain to management that the firm cannot act as an advocate at the tribunal but that it may be able to respond to management’s specific request for information in relation to the appeal. The firm must not make management decisions and should document the existence of informed management.
If the advocacy threat is too great it must decline the tax engagement. However, if services of tax experts are provided, these should be performed by employees not involved in the audit and an independent partner review should be performed on the audit team’s conclusions on the accounting treatment of the amounts relating to the NBR claim.
Standard Ltd.
Self-interest threat:
Ethical Standard S5 fee threshold apply to fees earned from both an audited entity and its subsidiaries. The regular fee income from Standard Ltd. will represent 7% of the firm’s total annual fee income which exceeds the 5% threshold for listed companies but does not exceed the 10%
threshold. The firm may be reluctant to modify its opinion or challenge management for fear of losing the fees from its largest client.
Steps:
The firm needs to consider the significant of the self-interest threat and whether safeguards are
independent internal quality control review as part of the audit. The firm should regularly monitor the percentage of fees earned from Standard Ltd. to ensure there is no risk of breaching the 10%
threshold.
Req-(ii) Popular Ltd.
The audit opinion should be modified. Related party transactions are material by nature and the failure to disclose such transactions results in a material misstatement. The misstatement is not pervasive as it is isolated to one aspects of the financial statements therefore a qualified/excepts for opinion should be issued. A basis for qualified opinion paragraph should be include the reasons and amounts to the qualification.
Meghna Ltd.
An unmodified opinion should be issued. The claim is 4% of total assets and 122% of profit before tax and represents a significant uncertainty. The auditor agrees with management’s treatment and there is no limitation on scope. As a successful claim would turn Meghna’s profit into a loss the existence of the claim is fundamental to the user’s understanding of the financial statements.
Therefore, the auditor’s report should be modified using an emphasis of matter paragraph which should draw the user’s attention to the relevant disclosure note. This is included immediately after the basis for opinion paragraph and should indicate that the auditor’s opinion is not modified in respect of this matter.
Standard Ltd.
The audit opinion should be modified. The firm is unable to obtain sufficient appropriate audit evidence over Queen’s financial statements. Queen affects a large number of areas of Standard’s financial statements and therefore appears to be pervasive to the group financial statements. A disclaimer of opinion should be issued stating that the firm does not express an audit opinion. A basis for disclaimer of opinion paragraph should include the reasons for the disclaimer of opinion.
The firm also should report by exception under the Companies Act that it has not received all information and explanations required for the audit.
Solution of the Q. No. 4 Req-(i)
Based on the analysis, it appears that MJS should hedges its bath exposure. The money market hedge appears to be the most appropriate for MJS because it results in the highest dollar value for the net bath inflows. There is only 20% chance that remaining unhedged will result in a higher BDT amount to be received in 90 days.
Calculation of Net Baht paid or received in 90 days:
Forward Hedge:
Money Market Hedge
Amount received after conversion in BDT 3377682.69 BDT accumulated after 90 days 3448614.06
Remain unhedged:
Req-(ii)
Since long term hedging techniques are particularly appropriate for firms that can accurately estimate their foreign currency payables or receivables that will occur in the future, MJS could benefit from long term hedging techniques. For example, it could enter into long term forward contracts, for Thai Bath and/or British pounds, swap currencies with another firm in the future or agree to a parallel loan.
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