Question

Youtus Enterprise is an Australian sole proprietorship business which is managed and controlled by The Laba family. With a good background in accounting and finance, Mr. Laba maintains the firm’s books of accounts in addition to the management of the day-to-day operations of the firm. The two sons of Mr. Laba provide additional assistance in their capacity as the sales and product development managers of Youtus. As a family business with a sole proprietorship status, Mr Laba has resigned himself to the constitution of a board of directors of five (5) members with only one independent director. Board meetings are held twice yearly where decisions are made based on majority rule. Youtus Enterprise produces sport gear for elite sport athletes with a focus on the delivery of high-quality running shoes, soccer boots among others. The production process being outsourced to firms in China and Bangladesh, Youtus takes care of the product development process to ensure that high-quality designs are created to produce items of great quality. The firm currently has ten (10) warehouses and three (3) retail centres across Australia. In 2014, Youtus started its online sales to help widen its market base internationally. Although the online sales figures have been growing steadily, Mr. Laba and his sons intend to invest more in online sales technology to boost online sales in the coming years. Furthermore, management of Youtus is considering an expansion of its product line with the introduction of two new soccer boots; Youtus Light and Youtus Flex. In its ten (10) years of operation, Youtus Enterprise has experienced an annual growth in sales of over 20% with a return on equity of 12.5%. The continual good performance of Youtus Enterprise is attributable to its production of high-quality products and great customer care. Over the past four (4) years, Youtus’ brand loyalty and recognition has soared among its customers and seem to rival that of other well-established brands within its industry. Premised on these positive market indicators, proposals have been put forward to revamp operation and undertake massive expansion for further growth in the future. In consultation with the investment advisers of the firm, the management of Youtus came up with two options which could be exploited for attaining its business expansion. Since capital is the most critical resource for the business expansion, the management of Youtus has been advised to consider either an equity funding option or debt funding process. Under the equity funding option, Youtus must change from sole proprietorship business to a company limited by shares and further sell 40% of its share to the public in an Initial Public Offer (IPO). Additionally, Youtus has been advised to constitute a more diverse and independent board for an effective corporate governance. Furthermore, Youtus must revamp its information system particularly accounting information system for better corporate reporting. Additionally, it has also been mentioned that a chief financial officer must be employed to manage financial and reporting issues of the firm. On the other hand, under the debt financing option, Youtus can maintain its original business status and secure a bank loan for its expansion strategy. However, management has been notified that cost of funding is likely to be very high even though interest expense would be deductible for tax purposes. Although Youtus must streamline its information system for better reporting, securing the services of chief financial officer is not deemed to be very crucial. The investment advisers also indicated that there is possibility for some changes to be made in regulation relating to foreign subcontracting by Australian firms. With the Australian government seeking to protect its local manufacturing industry, Australian firms with foreign subcontractors are likely to be adversely affected if the new policy is approved by the parliament. As a part of the growth strategy for Youtus Enterprise, management is considering the acquisition of specialised design making machinery for its customised design making process. The item of machinery is intended to help streamline the five-stage customised design making process into a three-stage process with minimal resource wastage. In line with this vision, management of Youtus has negotiated a 5-year lease contract with Souyos Limited to acquire an item of machinery which has been specially altered to suit the unique needs of Youtus Enterprise. The lease contract requires an advance payment of $45,000 and subsequent annual payments of $85,000 at the end of each financial year. Youtus Enterprise has the option to buy the item of machinery at price below its market value at the end of the lease term. The machinery is expected to have an economic useful life of 6-years. With reference to the case study above, provide critical response to the following questions in a report format: Required: 1) Discuss the three possible reasons why Youtus Enterprise require a better accounting information system, an effective corporate governance and a change in business status under the equity financing option in the context of positive accounting theory perspective. 2) Why is the cost of funding under the debt option expected to be higher than the cost of funding under the equity method of financing. 3) (a) Youtus Enterprise has decided to find a means to influence the outcome of the proposed regulation in its favour. Provide a theoretical justification for the firm’s action in relation to the possible regulatory changes. (b) Cite and illustrate a practice example/s of corporate intervention in public policy formulation. 4) (a) With reference to the agency theory, and assuming the lease liability increases the debt-to equity ratio of Youtus Enterprise, present an argument on whether equity shareholders are better off or adversely affected. (b) On what basis is Youtus Enterprise likely not to capitalise this lease agreement.

Answer 1