Masters in Accounting Summer Exam 2020 : Version 2.

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SEMESTER EXAMINATIONS - sample paper

MTBUS001 MASTER OF ACCOUNTING

INTEGRATIVE ANALYSIS IN ACCOUNTING

Time Allowed: 2 Hours

Instructions for Candidates

Please address the case study.

State clearly any assumptions you make. All workings will be taken into consideration in marking your script.

This examination paper has a total of 8 pages including the coversheet .

Instructions for Invigilators

This is an open book examination.

Candidates are allowed to consult any material they wish except for electronic or other communication
devices.

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ActiveWear Limited (Revised for use in class) Suggested Time (120 minutes)

You are Jack Duggan. It is a dreary monday morning in February 2020. You qualified as a Chartered
Accountant 2 years ago and have recently transferred to the Financial Advisory Services department of a
large accountancy practice. Previously you worked in the audit department however you were keen to get
some broader experience as a platform to getting a job in industry in the future. You are determined to
create a good impression with Kate Smith, the partner who heads up the Financial Advisory Services
department.

Kate asks you to attend a meeting with Conor Hughes, Managing Director of ActiveWear Limited, a
successful Irish company which is engaged in the design and manufacture of high quality outdoor clothing.

Kate briefs you in advance of the meeting. "ActiveWear has been an audit client of the firm since it was set
up six years ago and it has been a real success story. It is 100% owned by Conor Hughes. I have never met
him but the audit partner, Ger Breen, told me that he is a very dynamic character. In fact as you probably
know Conor Hughes recently won a prestigious national competition as Entrepreneur of the Year in 2019.
Here is a copy of the article that appeared in the national press in December". (see extract from the
article replicated in APPENDIX 1).

Kate continues "Conor Hughes asked Ger to introduce him to the financial consultants in our firm.
Apparently 2019 was a difficult year for ActiveWear and Conor would like a 'fresh pair of eyes' to give him
some new insights on business improvement opportunities. So, no pressure! I am sure he will fill us in
when we meet which incidentally is tomorrow. The 2019 audit is due to start next week so the audit team
will be in Galway from next Monday. Apparently Conor wants us in and out before then so pack an
overnight bag, we may need to get started immediately".

After an early morning drive to Galway you arrive at ActiveWear's head office at 10am. Conor meets you
and Kate at reception. "Welcome to Galway! Thanks for coming down to see me." After a tour of the
factory you get down to business over a coffee in the canteen which looks out over Galway Bay.

Conor highlighted his concerns.

 After years of double digit growth and increasing profitability 2019 results were a bit of a
disappointment to me even though ActiveWear is still profitable. (He hands you the draft
financial statements for 2019 - see APPENDIX 2)

 After such a brilliant year in 2018 I am not 100% sure why profits have declined from €4million to
about €0.6m in 2019 and I would be interested in your views on this.

 We opened a factory in Hanoi, Vietnam during 2019 so that we could double our production
capacity to 20 million units per annum to provide a platform for growth over the medium to long
term. Manufacturing costs are so much lower in Vietnam than Ireland even though it costs more
to ship goods to our main markets in europe and North America. (He hands you a schedule that
one of his finance team prepared - see APPENDIX 3). The factory went into production mid way
through 2019 in July. We incurred €200k on upfront costs on staff training which we included in
admin expenses in the draft financial statements for 2019 and €300k in interest costs prior to
opening which are included in finance costs.

 It was a substantial investment costing €15m and it was principally funded by a €12m term loan
(which we drew down in January 2019), but Conor is happy how it has worked out. It is a state of
the art facility and we now have over 100 people working in Vietnam. The project consultants
engaged to oversee the installation did a good job and although I hate to say it they were worth
the €1m we paid them (included in admin expenses in the draft financial statements for 2019). It
cost €5m more than the €10m we paid for our first factory here in Galway in 2010. However, we
received a capital grant of 40% for the Galway factory from Enterprise Ireland without which we
could never have got started.

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 Sales volumes of 9.8m garments in 2019 were 6.5% higher than 2018 although our customers
sought price reductions in response to increasing competition in the outdoor wear segment. This
trend is likely to continue. I visited all our major customers over the past month, and they are
optimistic about 2020. They love our products! I expect sales growth to recover and
conservatively forecast sales volumes to increase to 12 million units this year. However, they are
insisting on further price reductions. I expect average unit sales price to decline to €5.30 from
€5.70 in 2019. Ultimately, I would like to launch an ActiveWear own brand range of specialised
outdoor wear, as we could earn a considerably higher gross margin but that might be something
to look at in the future.

 At current production schedules and run rates for 2020 we are planning to manufacture 75% of
production in Galway and 25% in Hanoi. However, given pricing pressure we are considering
ramping up production in Hanoi to about 50% of forecast sales volumes. Obviously, this would
mean scaling back on production in Galway. I think we could manage much of this through
reduced overtime but I would probably also need to 'let go' about 40 people. The redundancy
cost would be about €10,000 per person. I wouldn't like to do this, but it might be 'the lesser of
two evils'. I would be interested in your views on this strategy (impact on profitability and other
factors to consider).

 I am a big believer in research and development. There are incredible developments taking place
in synthetic fabrics, making them lighter, more "breathable" and water proof than natural fabrics.
We target an annual investment on R&D of about 2% of revenues to keep ActiveWear at the
forefront of developments. We have a small R&D/design department of 10 people here in Galway
of which I am very proud.

 We have tried to keep a firm handle on operating costs over the years, but they have increased as
the scale of our business has increased. We source most of our raw materials in the far east at
very competitive prices, so I don't think there is any scope there for cost reduction there. In
addition, our wage levels are competitive and with a bit of management we should be able to
keep them fixed for 2020. However, I think there are some areas where we can tighten up
administration and sales & marketing costs. I think we can reduce costs by 10% in 2020 by having
an improved cost management focus.

 Some of the members of the local Chamber of Commerce have previously expressed an interest
in investing in ActiveWear, but I declined because I wanted to retain full control of the business.
Maybe now is the time to revisit this. Perhaps you could also look at this and appraise me of LT
funding options

So, to summarise initially I would like you to prepare a briefing note for me on the following and get
back to me early next week.

 The key reasons why profitability declined in 2019 compared to 2018

 Views on the impact and implications of increasing production in Hanoi to 50% of forecast
sales volumes

 Some initial thoughts on LT funding options worth considering

"I appreciate your help on this. Kate, if you send me a draft letter of engagement later today, I will
review and get it signed. See you next week and if you need anything let me know" [ Note: You are
not required to prepare a draft letter of engagement and you can assume that there are no
engagement acceptance issues].

After Conor leaves the table Kate turns to you." This is a brilliant opportunity for the firm and for you.
Conor is very dynamic and if we do a good job for him, I have no doubt there will be other
opportunities. I need to get back to Dublin today so could you stay on for a few days and prepare a
first draft briefing paper? It's lucky that you brought an overnight bag! Call me on the mobile if you
want to run through some ideas with me." And with that Kate was gone.

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 As you leave the meeting you run into Sean McBride, the financial accountant of ActiveWear. Sean
was in your B.Comm class in college and you used to go kite surfing with him during summer holidays
in the West of Ireland.

"Hi Jack. How's it goin' mate? Fancy meeting you here. I hear on the grapevine that Conor has brought
in financial consultants to help him with a few things. News travels fast around here! The audit team
are in next week and I am finalising the draft financials. I wonder if you could help me with something.
I was looking at the accounting treatment of the new factory in Hanoi and I am not sure if it is correct.
You were always a whizz on technical accounting! Could you have a look at it for me and let me know
if any adjustments are required. I believe Conor gave you the draft financials but if you need any
further information let me know. And if you have a free weekend soon you should come down again
to the West and we could go kite surfing like the good old days! Cheers mate, I have to run."

You needed this like a hole in the head given the amount of work you needed to get done. However,
you were sure you had the data you needed from your meeting with Conor so you resolved to have a
quick look at it and send him an email over the next couple of days.

"It was going to be a busy few days", you think to yourself, " so I may as well get started with (a) the
draft briefing note for Conor Hughes and (b) the email to Sean McBride.

APPENDIX 1: Extract from National Newspaper Article - December 2019

Galway man, Conor Hughes of ActiveWear wins Entrepreneur of the Year 2019

Conor Hughes, MD of ActiveWear, picked up the 11th Entrepreneur of the Year award at a ceremony
in The Four Seasons Hotel last night.

ActiveWear is that rare thing in Ireland these days, a local export driven success story! It was
founded in 2007 by Conor Hughes, who owns 100% of the company. ActiveWear designs and
manufactures stylish, high quality outdoor wear such as fleeces, jackets, base layers, tee shirts,
trousers using the latest synthetic fabics. Although you may not have heard of the company you have
almost certainly seen its products as ActiveWear designs and manufactures product for leading
brands such as The South Face; K2; Over Armour.

ActiveWear was set up in Galway by local man Conor Hughes six years ago. "from day 1 we were
focussed on designing lightweight, comfortable and stylish products for the outdoor enthusiast,
which we saw as a rapidly growing segment. We had the best laboratory weather conditions on our
doorstep given the changeable weather conditions in the West", he joked.

ActiveWear has grown rapidly in recent years. Revenues exceeded €55m in 2019 on sales of nearly
10 million garments. It now employs over 400 staff at its factories in Galway and Hanoi, Vietnam.
"Galway is where we design all product and where most manufacturing takes place. We opened a
new factory in Hanoi in 2019 to provide additional capacity and to develop a foothold in the Asian
market" said Hughes at the ceremony.

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APPENDIX 2: ActiveWear Draft Financial Statements

Income statement

2019 (€'000) 2018(€'000)

Draft Final

Sales (units '000s) 9,800 9,200

Average sales price pu € €5.70 €6.00

Revenue 55,860 55,200

Cost of sales

Direct costs 38,220 38,640

Factory depreciation 2,500 1,000

Grant amortisation (400) (400)

Shipping costs 2,352 1,840

Sub total 42,672 41,080

Gross Profit 13,188 14,120

Admin expenses 6,325 5,140

Sales & marketing costs 4,200 3,500

Research & development expenditure 1,100 1,050

Finance costs 950 340

Sub total 12,575 10,030

Profit before tax 613 4,090

Taxation 80 510

Profit after tax 533 3,580

Opening retained earnings 6,700 3,120

Closing retained earnings 7,233 6,700

APPENDIX 2 contd: ActiveWear Draft Financial Statements

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Statement of Financial Position

2019 (€'000) 2018 (€'000)

Draft Final

Non current assets

Plant, Property & Equipment , net 18,450 5,400

Current assets

Inventories 1,640 1,300

Accounts receivable 7,800 6,900

Cash and cash equivalents 0 1,900

Sub total 9,440 10,100

Current liabilities

Accounts payable 2,927 1,950

Bank overdraft 450 0

Tax payable 80 500

Sub total 3,457 2,450

Net working capital 6,013 7,650

Non current liabilities

Bank loans 15,500 4,250

Deferred government grants 1,600 2,000

Net assets 7,333 6,800

Shareholders funds

Retained earnings 7,233 6,700

Ordinary Share capital 100 100

7,333 6,800

Extracts from the notes to the financial statements

Accounting Policies - Property Plant and Equipment

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Property Plant & Equipment is reported at cost less accumulated depreciation. Cost includes expenditure that is directly
attributable to the acquisition of the asset. Depreciation is calculated on a straight line basis on cost less estimated residual
value to write PPE off over their estimated useful lives using the following annual rates:
Plant and equipment - 10%
Computer equipment - 25%
Depreciation is provided on additions with effect from the first day of the month following commission and on disposals up
to the end of the month of retirement.
Staff Numbers and costs
The average number of permanent full time persons employed during the year was 425 (2018: 352) and is analysed as
follows:

Staff numbers 2019 2018

Number Number

Manufacturing 352 291

Sales and Marketing 28 22

General and Administration 35 30

Research and development 10 9

Total 425 352

Staff costs 2019 €'000 2018 €'000

Wages and salaries 15,910 15,170

Social insurance costs 1,880 1,980

Pension costs 2,150 2,030

Total 19,940 19,180

Government Grants

In 2014 the Company entered into a grant agreement with an Irish Government Agency. Under the terms of the agreement
Grants of €4m were received in respect of capital expenditure on the factory in Galway. 50% of the grants received are
repayable in certain circumstances principally if average permanent headcount in Ireland falls below 300 employees for a
period exceeding 12 months during the 10 year term of the agreement.

Grants income is recognised income statement in line with the depreciation of the assets to which they relate. At 31
December 2019 unamortised grants amounted to €1.6m (2018 - €2.0m). Grant income recognised in the income statement
for 2019 amounted to €400,000 (€2018 - €400,000).

APPENDIX 3: Factory output and cost data

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 Galway Hanoi Total

Production capacity (units '000) 10,000 10,000 20,000

Production 2019 (units '000) 8,000 2,000 10,000

Production 2018 (units '000) 9,000 - 9,000

Average cost per unit € €

Direct materials 1.60 1.60

Direct Labour 1.80 0.60

Direct overhead 0.80 0.50

Total 4.20 2.70

Average shipping cost per unit 0.20 0.40

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