Question

You are the Group Chief Accountant of Kofi Limited and Olamide Limited. Kofi Limited is a holding company while Olamide Limited is a subsidiary company registered in Nigeria. Kofi Limited is a medium-sized retailer of imported and retailer of hand sanitizers in Ghana. Due to numerous requests from the customers in Nigeria for the company’s product, Kofi Limited decided to expand its operations to Nigeria to increase sales and make more profits for the shareholders. In 2016 the business registered a new company in Nigeria and named it Olamide Limited. The sole purpose of incorporating Olamide Limited in Nigeria was to boost the company’s market share and make more profits for the shareholders. But the financial performance of Olamide Limited has not been encouraging to the management of the business, and shareholders have complained about the decision to expand into the Nigerian Market. Shareholders have noted with dismay that Olamide Limited has reported continuous losses for the business for the past two years. The financial statements show that the Nigeria expansion strategy was extremely bad and management is blamed for the bad decision to expand into the Nigerian market. Management explained the past performance at the Annual General Meeting and provide forecast to the future performance of the business. At the meeting, the management assured the shareholders that measures taken in 2019 is going to put an end to the loss making of Olamide Limited. The Managing Director explained that the losses recorded were temporal and that the future financial performance will be better. Contrary to the promise made to the shareholders, 2019 financial performance was also not encouraging, because Olamide Limited has recorded a net loss of GH GHȼ100,000 for the year ended 31st December, 2019. The Managing Director argued that unless something drastic is done to the figures in the 2019 financial reports for the period under review, the going concern assumption for Olamide Limited has to be revoked. This net loss recorded for 2019 was due to high expenditure on advertisement incurred for that period, while sales fell below the expected target. The Managing Director is concerned about Olamide Limited continuous reporting of losses to the group and called for an emergency meeting to be held to decide on the figures to be included in the 2019 financial statements. At the Board meeting to discuss the figure to be included in the financial statements, the following key managers made some statements for the consideration of the Managing Director. Notable among them were reprinted for the consideration of the board. The Group General Manager argued and was quoted here that: “Figures to be included in the financial statement are always grey and that there are very little absolute figures in the financial statement. A smart manager is able to save the reputation of the business in times of financial difficulties by simply changing accounting policies to boost performance of the business. Just a change of the company’s depreciation policy from straight line method to reducing balance method is enough to change the company’s net loss to net profit for the business”. The Group Operational Manager sided with the comment made to change net loss to net profit using the company’s policy and defended his position that “Managers are engaged to maximize profits for the shareholders, therefore, any financial performance that does not show profit, simply means that management has failed. Therefore, there is the need to adjust the company’s policy on depreciation in order to maximize profit for shareholders”.
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The Group Marketing Director contributed to the discussion and said that “He knows of companies that have manipulated their financial statements and the reputations of the managers involved were enhanced due to better performance recorded by the business. Therefore, to boost the financial performance of Olamide Limited, there is the need to double the company’s sales figures and reduce the operating expenses by half to boost net profit of the business”. He commented further that the stakeholders will not know that the figures in the financial statements were manipulated unless they are informed about it”.   As the Group Chief Accountant and a young professional accountant in the making, you tried to object to some of the comments made by your colleagues at the meeting. You reiterated the concerns of International Financial Reporting Standards (IFRS) regarding the issues of qualitative characteristics of financial statement at the meeting. Your concerns were due to several seminars you attended on IFRS on the conceptual and regulatory framework used to prepare financial statements by businesses. IFRS requires that the financial statements prepared should comply with accounting concepts, assumptions that are commonly referred to as qualitative characteristics. Despite your worries, the Managing Director deliberately refused to take your advice into consideration and prepared the final accounts of Olamide Limited against the ethical and moral considerations that show the net profit for the business as shown below:

Statement of Financial Position as at 31st December, 2019   Olamide Limited Kofi Limited GH¢000 GH¢000 GH¢000 GH¢000 Assets     Noncurrent assets (Note 1) 9,400 7,500 Current assets     Inventory 2,000 2,400 Trade receivables 2,400 3,700 Bank 600 1,200    5,000 7,300 Total Assets 14,400 14,800 Equity and liabilities     Equity     Stated capital (GH¢1 each) 2,000 2,000 Retained Earnings 3,500 800    5,500 2,800 Noncurrent liability     7% Debenture 4,800 6,300 Current liabilities     Bank overdraft 400 1,700 Trade payables 3,100 3,800 Taxation 600 200    4,100 5,700 Total equity and liabilities 14,400 14,800
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Statement of Comprehensive Incomes for the year ended 31st December, 2019 Olamide Limited Kofi Limited GH¢000 GH¢000 Revenue 12,000 20,500 Cost of sales 10,500 17,000 Gross profit 1,500 3,500 Operating expenses 240 500 Operating profit 1,260 3,000 Finance cost 210 600 Profit before tax 1,050 2,400 Tax expense 150 400 Profit after tax 900 2,000 Dividend paid for the year 250 700 Note 1: There were no disposals of plant during the year by either company.

Question 1 As a professional accountant who is concerned about the qualitative characteristics of preparing financial statements. (a) You are required to: (i) Explain five (5) qualitative characteristics of IFRS that is used to prepare financial statements to your colleagues at the meeting.                                                   (ii) Explain the difference between profit and profitability.                                                                                    (iii) Explain the concept of going concern and the implication of revocation of going concern assumption when financial statements are prepared.                                                                                                                                                 (Total marks 20)                                                                        

Question 2 (a) With reference to the case study above. You are required to calculate for Kofi and Olamide Limited, two ratios of significance to: (i) Management.                                                                                                       (ii) Creditors.                                                                                                             (iii) Shareholders.                                                                                                       (iv) Comment on the profitability ratios, liquidity ratios and efficiency ratios calculated between Kofi Limited and Olamide Limited for the period under review.             (v) Explain three (3) advantages for using ratio analysis.           (vi) Explain two (2) disadvantages associated with the use ratio analysis.                                                                                                                         (Total marks 20)

Answer 1

Answer 1 (1 ) :-

Qualitative characteristics of IFRS that is used to prepare financial statements :-

1. Understandability :- An essential quality of the information provided in financial statements is that it is readily understandable by users. For this purpose, users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. However, information about complex matters that should be included in the financial statements because of its relevance to the economic decision-making needs of users should not be excluded merely on the grounds that it may be too difficult for certain users to understand.

2. Relevance :-To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

The predictive and confirmatory roles of information are interrelated. For example, information about the current level and structure of asset holdings has value to users when they endeavour to predict the ability of the entity to take advantage of opportunities and its ability to react to adverse situation

3. Materiality :- The relevance of information is affected by its nature and materiality. In some cases, the nature of information alone is sufficient to determine its relevance. For example, the reporting of a new segment may affect the assessment of the risks and opportunities facing the entity irrespective of the materiality of the results achieved by the new segment in the reporting period.

Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.

4. Reliability :- To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.

Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading. For example, if the validity and amount of a claim for damages under a legal action are disputed, it may be inappropriate for the entity to recognize the full amount of the claim in the balance sheet, although it may be appropriate to disclose the amount and circumstances of the claim.

5. Comparability :- An important implication of the qualitative characteristic of comparability is that users be informed of the accounting policies employed in the preparation of the financial statements, any changes in those policies and the effects of such changes. Users need to be able to identify differences between the accounting policies for like transactions and other events used by the same entity from period to period and by different entities. Compliance with International Accounting Standards, including the disclosure of the accounting policies used by the entity, helps to achieve comparability.

Answer 1 (II ) :- the difference between profit and profitability are :-

Particular	profit	Profitability
Defination	Profit is the net income made after covering expenses	Profitability is the extent to which profit is made.
Interpretation	Profit is an absolute amount.	Profitability is expressed as a percentage
Comparision	Profit cannot be successfully compared since it is not relative	Profitability can be successfully compared through the use of ratios

Answer 1 (III ) :-  

The Concept of going concern implies that the business entity will continue its operations in the future and will not liquidate or be forced to discontinue operations due to any reason. A company is a going concern if no evidence is available to believe that it will or will have to cease its operations in foreseeable future.

The going concern concept is applicable to the company’s business as a whole. If, for example, a company closes a small business segment or discontinues one of its product and continues with others, it does not mean that the company is no longer a going concern because the going concern concept is applicable to the entity as a whole not to the particular segment of business or product.

The going concern concept of accounting is of great importance for accountants because if a company is a going concern, it must prepare its financial statements in accordance with applicable financial reporting framework such as generally accepted accounting principals applicable in United States of America (US-GAAP) and international financial reporting standards (IFRS).

Answer 2 (a)(1) :-

The  two ratios of significance to following are as follows :-

Management 1. inventory Turnover Ratio = Cost of Goods Sold / Inventories

= 1,050,017,000 / 2,000 2,400

= 0.016

2. Fixed Assets Turnover Ratio = Total Annual Sales / Total Fixed Assets

= 1,200,020,500 / 9,400 7,500

= 12.76

Creditors :-

1. Debt Ratio :- Total Debt / Total Assets

= 4,800 6,300 + 400 1,700 / 1,440,014,800

=52,008,000 / 1,440,014,800

= 0.036

2. Current Ratio = Current Assets / Current Liabilities

= 5,000 7,300 / 4,100 5,700

= 1.21

Shareholders :-

1. Divident payout ratio = Cash Dividends / Net Income

= 250700 / 9002,000

= 0.027

2. Return on Equity = Dividend / total Equity  

= 250700 / 2,000 2,000

= 0.012  

Answer 2 (V) :-

Advantages for using ratio analysis :-

1. Ratio analysis will help validate or disprove the financing, investment and operating decisions of the firm. They summarize the financial statement into comparative figures, thus helping the management to compare and evaluate the financial position of the firm and the results of their decisions.

2. It simplifies complex accounting statements and financial data into simple ratios of operating efficiency, financial efficiency, solvency, long-term positions etc.

3. Ratio analysis help identify problem areas and bring the attention of the management to such areas. Some of the information is lost in the complex accounting statements, and ratios will help pinpoint such problems.

4. Allows the company to conduct comparisons with other firms, industry standards, intra-firm comparisons etc. This will help the organization better understand its fiscal position in the economy.

Answer 2 (VI) :-

The disadvantages of using ratio analysis :-

1. The firm can make some year-end changes to their financial statements, to improve their ratios. Then the ratios end up being nothing but window dressing.

2. Ratios ignore the price level changes due to inflation. Many ratios are calculated using historical costs, and they overlook the changes in price level between the periods. This does not reflect the correct financial situation.

3. Accounting ratios completely ignore the qualitative aspects of the firm. They only take into consideration the monetary aspects (quantitative)

4. There are no standard definitions of the ratios. So firms may be using different formulas for the ratios. One such example is Current Ratio, where some firms take into consideration all current liabilities but others ignore bank overdrafts from current liabilities while calculating current ratio , And finally, accounting ratios do not resolve any financial problems of the company. They are a means to the end, not the actual solution.