Wednesday 25 July 2012

(4 hours)

CASE STUDY
CANDIDATE NUMBER

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ICAEW USE ONLY

Copyright © ICAEW 2012. All rights reserved. 159470

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 List of exhibits

The following exhibits were included in the material provided as Advance Information:

1 About you (Ashley Franklin), your employer (Baron Young) and your client
(Luvlox Ltd)

2 The UK hairdressing industry: Background

3 Hairdressing: The business model

4 Luvlox Ltd: History and overview

5 Luvlox Ltd: The business

6 Email dated 19 July 2011 from Liz Newby (Accountant) to all Luvlox Ltd directors

7 Luvlox Ltd: Management accounts for the year ended 30 June 2011

8 Luvlox Ltd: Price list

9 Luvlox Ltd: Extracts from insurance policies

10 Luvlox Ltd: New incentive scheme (July 2011)

11 Press articles

The following items are newly provided:

12 Email dated 25 July 2012 from Sarah Chandler to you

13 Email dated 19 July 2012 from Amanda Richards to salon managers, together
with her follow-up note dated 20 July 2012 to Liz Newby

14 LL’s management accounts for the year ended 30 June 2012

15 Email dated 20 July 2012 from Irina Yu (Manager, Newcastle salon) to Amanda
Richards

16 Email dated 24 July 2012 from Liz Newby to Sarah Chandler, together with press
release dated 23 July 2012

17 Email dated 20 July 2012 from Amanda Richards to Sarah Chandler

18 Press article

ICAEW/CS/J12 1 of 17
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ICAEW/CS/J12 2 of 17
 LUVLOX LTD: CASE STUDY REQUIREMENT

You are Ashley Franklin, a final-year trainee Chartered Accountant working for Baron
Young, a firm of Chartered Accountants and Business Advisors with its headquarters in
Newcastle-Upon-Tyne in the north-east of England. You report to one of the partners,
Sarah Chandler, among whose business advisory clients is Luvlox Ltd (LL), which
operates a chain of three hairdressing salons.

Requirement

You are required to prepare a draft report for the LL board, as set out in the email dated
25 July 2012 from Sarah Chandler to you (Exhibit 12). Your report should comprise the
following four elements:

• An executive summary
• Your responses to the three detailed requirements set out in Exhibit 12, including
financial appendices (as required).

State clearly any assumptions that you make. All workings should be attached to your
answer. Your report should be balanced across the three detailed requirements, and the
following time allocation is suggested:

Reading and planning 1 hour

Performing calculations and financial analysis 1 hour
Drafting report 2 hours

Marks allocation

All of the marks in the Case Study are awarded for the demonstration of professional skills,
allocated broadly as follows:

Applied to the four elements of your report (as described above)

• Assimilating and using information 20%
• Structuring problems and solutions 25%
• Applying judgement 25%
• Drawing conclusions and making recommendations 20%
90%
Applied to your report as a whole
• Demonstrating integrative and multidisciplinary skills 5%
• Presenting appropriate appendices 5%
100%

Of the total marks available, 15% are awarded for the executive summary and approximately
10% for the relevant discussion of ethical issues within your answer to the requirements.

In planning your report, you should be aware that not attempting one of the requirements
will have a significantly detrimental effect on your chances of success, as will not
submitting an executive summary. In addition, as indicated above, all four skills areas will
be assessed under each of the four elements of your report. Accordingly, not
demonstrating your judgement and failing to include appropriate conclusions and/or
recommendations in each element of your report will affect your chances of success.

ICAEW/CS/J12 3 of 17
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ICAEW/CS/J12 4 of 17
 EXHIBIT 12

EMAIL
From: Sarah Chandler
To: Ashley Franklin
Date: 25 July 2012
Subject: Luvlox (LL)

As you know, for the year to 30 June 2012, LL introduced a staff incentive scheme. This
has given rise to some ill-feeling at the Newcastle salon, on which LL requires our
advice. LL also needs our help in considering the impact of last weekend’s fire at the
Wallsend salon and in assessing a new business opportunity that has arisen.

I attach the following relevant documents:

• An email from Amanda Richards to salon managers, together with her later note to
Liz Newby (Accountant) (Exhibit 13)
• LL’s management accounts for the year ended 30 June 2012 (Exhibit 14)
• An email from Irina Yu (Manager, Newcastle salon) to Amanda Richards (Exhibit 15)
• An email from Liz Newby to me, together with a press release (Exhibits 16(i)-(ii))
• An email from Amanda Richards to me (Exhibit 17)
• A recent press article (Exhibit 18).

Please prepare a draft report to the LL board, in which you should:

1. Compare the performance of the three salons for the year ended 30 June 2012.

Your comparison should comprise a commentary on revenue and gross profit, as

presented in Exhibit 14, by reference to the previous year and to the key
performance data. You should also advise LL on how to respond to the issues raised
in Irina Yu’s email to Amanda Richards (Exhibit 15).

2. Evaluate the proposal (Exhibit 16(i)) to offer an additional 25% loyalty discount to all
existing clients of the Wallsend salon during the period to 31 December 2012.

Your evaluation should include calculations to show LL’s expected loss of gross
profit arising from the shortfall in revenue for the five months to 31 December 2012,
in accordance with Liz Newby’s instructions. Please also advise on the staffing and
other issues identified by Liz. You should state any assumptions that you make.

3. Assess the opportunity set out in Exhibit 17.

Your assessment should cover the strategic, operational and ethical aspects of the
proposed new salon opening and related product supply arrangement.

I look forward to reading your draft report.

ICAEW/CS/J12 5 of 17
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ICAEW/CS/J12 6 of 17
 EXHIBIT 13
EMAIL
From: Amanda Richards
To: Salon managers
Date: 19 July 2012
Subject: Incentive scheme

Please find attached (Exhibit 14) the management accounts for the year ended 30 June 2012.

I hope you will all agree that it has been a good year. This is reinforced by the latest feedback
findings, which show that 92% of clients are ‘delighted’ with the service they receive from LL,
93% would recommend LL and 85% rate LL ‘excellent’ or ‘very good’ value for money.
Gateshead continues to achieve the highest scores and Newcastle the lowest. In addition, our
current estimates of recurring client numbers (Newcastle: 4,500; Gateshead: 6,100; Wallsend:
6,200) reveal an overall rise from June 2011.

I am now very pleased to announce that under the incentive scheme announced last July,
Gateshead staff will receive a bonus for the year and, in addition, Renata Taylor will receive the
£10,000 manager bonus. Gateshead is the only salon to have achieved a 10% increase in the ratio
of gross profit to staff numbers.

Gateshead staff will receive a separate email advising how and when these payments will be
made. Congratulations to all those involved!

Details of the 2013 scheme are due to be announced next week.

Note from Amanda Richards to Liz Newby, 20 July 2012

I have received a very forthright response from Irina Yu (Exhibit 15) to the
above email. In the light of this, I propose to ask Sarah Chandler to compare
the performance of the three salons and to advise us on how to respond to
the issues that Irina has raised.

ICAEW/CS/J12 7 of 17
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ICAEW/CS/J12 8 of 17
 EXHIBIT 14
Luvlox Ltd: Management accounts for the year ended 30 June 2012

INCOME STATEMENT Notes Newcastle Gateshead Wallsend TOTAL

£000 £000 £000 £000
Revenue – services 1,282 1,907 1,679 4,868
Revenue – products 233 417 260 910
Revenue 1 1,515 2,324 1,939 5,778
Cost of sales 2 (634) (923) (820) (2,377)
Gross profit 881 1,401 1,119 3,401
Administrative expenses 3 (697) (1,044) (1,049) (2,790)
Operating profit 184 357 70 611

STATEMENT OF FINANCIAL POSITION £000

ASSETS
Non-current assets
Property, plant and equipment 1,037

Current assets
Inventories 99
Receivables 300
Cash 621

1,020

Total assets 2,057

EQUITY & LIABILITIES

Equity
Ordinary share capital 180
Retained earnings 1,093

Total equity 1,273

Current liabilities 784

Total equity & liabilities 2,057

CASH FLOW STATEMENT (summary) £000

Net cash from operating activities 717

Net cash used in investing activities (215)

Net increase in cash and cash equivalents 502

Cash and cash equivalents at beginning of year 61

Cash and cash equivalents at end of year 563

ICAEW/CS/J12 9 of 17
 NOTES TO THE MANAGEMENT ACCOUNTS

1 Key performance data

Newcastle Gateshead Wallsend TOTAL
Number of appointments (000) 32.3 44.9 42.2 119.4
Number of products sold (000) 13.5 20.5 18.4 52.4

2 Cost of sales
Newcastle Gateshead Wallsend TOTAL
£000 £000 £000 £000
Staff salaries 474 676 632 1,782
Product costs 115 194 138 447
Miscellaneous 45 53 50 148
634 923 820 2,377

3 Administrative expenses
Newcastle Gateshead Wallsend TOTAL
£000 £000 £000 £000
Rent, rates, utilities & postage 237 403 349 989
Directors' remuneration 119 193 188 500
Head office salaries – other 45 72 70 187
Insurance & security 29 39 35 103
Depreciation 53 86 84 223
Professional fees 33 52 59 144
Marketing & advertising 113 114 122 349
Other 68 85 142 295
697 1,044 1,049 2,790

4 Employee numbers

The average number of salon employees, excluding assistants, during the year was as follows:

Newcastle Gateshead Wallsend TOTAL

Managers, senior stylists and stylists 21 34 33 88

There were also 10 Head Office staff, including 5 directors.

ICAEW/CS/J12 10 of 17
 EXHIBIT 15

EMAIL

From: Irina Yu (Manager, Newcastle salon)

To: Amanda Richards
Date: 20 July 2012
Subject: Newcastle salon

I was disappointed to receive your email of 19 July (Exhibit 13). I believe that my staff are
entitled to the 10% bonus (Exhibit 10) and that I am also entitled to the £10,000 manager bonus.
I calculate that Newcastle salon has clearly met the scheme target, taking account of the
following:

1. I have been very dedicated to LL since its earliest days, and especially since 1 January 2012,
when two stylists have been on long-term sick leave (at full pay) because of stress. It was
Head Office’s decision not to replace them, on the grounds that the salon should be able to
meet client demand using the remaining stylists. These staff should not be included as full-
time equivalents. In addition, I have had to take on much of the extra hairdressing myself –
meaning that I have had to work late to keep up with my normal day-to-day management
duties.

2. The prices that I have to charge on the twice-weekly visits by one of my stylists to the old
people’s home nearby are much lower than in the salon. These prices were imposed solely on
Newcastle as part of an experiment. If the appointments had been charged at our regular
salon prices (as was the case in the previous year), gross profit would have been £25,000
higher.

3. At the year-end inventory check, we found that we were carrying excessive amounts of
colouring, much of which is now past its ‘use by’ date. You instructed us to write off
£20,000 against cost of sales for these items. I do not accept that this is a cost to the salon as
the inventory in question was ordered at the request of Head Office over a period of three
months in order to receive an incentive payment from the supplier. To date, we have not
received credit for this incentive – which would have been worth £8,000 to us – in our salon
accounts.

I eagerly await your response.

ICAEW/CS/J12 11 of 17
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ICAEW/CS/J12 12 of 17
 EXHIBIT 16(i)
EMAIL
From: Liz Newby (Accountant)
To: Sarah Chandler, Baron Young
Date: 24 July 2012
Subject: Wallsend fire insurance claim: Proposed discount scheme; staffing and other issues

This is an update on developments since yesterday’s press release (Exhibit 16(ii)) and a request
for assistance.

The Wallsend salon will now undergo refurbishment – paid for by the insurance company –
earlier than previously planned, and will reopen on Wednesday 2 January 2013 after the New
Year holiday. (The other two salons will not now be refurbished.) In the meantime, we are
preparing an insurance claim for the expected loss of gross profit, as a consequence of the fire,
initially to cover the period in which the salon will be closed. A key requirement of the insurance
policy (Exhibit 9(ii)) is to take whatever steps we can to ‘mitigate’ the loss.

Proposed discount scheme

Naturally, we are keen that our Wallsend clients remain with LL during the period of disruption.
With this in mind, we propose to offer an additional 25% loyalty discount to existing Wallsend
clients on the cost of one appointment (excluding product purchases) at either Newcastle or
Gateshead from 1 August to 31 December 2012. The insurance company will permit this as a
means to mitigate the loss as it considers that the discount scheme will not be ‘used to promote
the business excessively’.

From a phone survey conducted since the weekend on a sample of existing Wallsend clients, we
estimate that:

• 5,000 Wallsend clients would take up the discount offer for a first appointment in the period.
• 80% of these 5,000 clients would then also use Newcastle or Gateshead for all their other
appointments up to 31 December 2012. On average, they would have two such appointments.
• 50% of all clients attending appointments would purchase one or more products at their
appointments. They would spend an average of £20 on products at their first appointment and
£12 at each of their other appointments.

Using this information, please prepare calculations to show LL’s expected loss of gross profit
arising from the ‘shortfall in revenue’, as defined in clause (a) of the policy, for the five months
from 1 August to 31 December 2012. We do not need you at this stage to calculate the loss of
gross profit in connection with clause (b), ‘increase in cost of sales’.

Staffing and other issues

We are aware that the proposed scheme, together with the general transfer of work following the
fire, will have implications for our existing Wallsend staff, as well as for the level of activity,
staffing and quality of service at Newcastle and Gateshead.

Please also advise us how to manage these issues as effectively as possible.

ICAEW/CS/J12 13 of 17
 EXHIBIT 16(ii)

Press release (23 July 2012)

Luvlox’s Wallsend salon was the subject of a serious fire in the early hours of Sunday
morning. The structure of the salon and all fittings were severely damaged: it is unlikely
that any of them can be salvaged. The contents of the tills (all of Saturday’s takings and
petty cash) have been saved, as have computer records, appointment books and work slips.

The salon will be closed for around five months while it is restored as closely as possible to
its previous form. Luvlox would like to assure all its clients that it will do everything it can
to minimise the inconvenience caused by these unfortunate events and will shortly be
announcing details of special arrangements for the period of closure.

ICAEW/CS/J12 14 of 17
 EXHIBIT 17
EMAIL
From: Amanda Richards
To: Sarah Chandler
Date: 20 July 2012
Subject: Potential new salon – York

A new shopping mall is opening in York in July 2013. This is a kilometre away from Marie
Duval’s premises where I received my training. In addition, Renata Taylor’s husband’s job is
being relocated to York in January 2013, and she has already told me that they are looking to buy
a house close by, so the potential opportunity to manage a new salon could be an exciting, fresh
challenge for her.

One unit (on the second floor) has been designated as a salon, and the mall’s developers have
approached LL to ask if we would like to occupy it. It is likely to be able to accommodate
around 25 chairs. Their preference would be that it also includes a beauty area (including
sunbeds for tanning), which they say would be very popular among the clientele they are hoping
to attract to the mall. From their experience of other malls around the country, beauty and
tanning would also significantly increase revenue from the main hairdressing services.

Indigo Products

Since receiving the approach, we have been in discussions with Indigo Products (Indigo), well-
known Canadian supplier of hair products to salons and supermarkets (but not currently to LL).
If LL accepted the developers’ invitation, Indigo would pay in full to fit out the York salon. In
return, LL would give Indigo exclusivity on its products at the salon with effect from 1 July 2013
for an initial period of 12 months. The fitting-out would also include an IT upgrade (enhanced
online booking system plus e-commerce facility for selling Indigo products).

At this stage, we do not know what the Indigo product range would include. It is therefore hard
to say to what extent the sales prices and volumes for Indigo products would differ from those
typically achieved for products sold at the existing LL salons. However, our initial estimate is
that the average gross profit margin we would earn on the Indigo products would be 5 percentage
points lower than that achieved for products at the existing LL salons.

I believe that we should seriously consider this opportunity to expand the business. I would also
see it as a trial for a new kind of Luvlox salon.

Please advise us on this opportunity, with a recommendation as to whether we should proceed.

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ICAEW/CS/J12 16 of 17
 EXHIBIT 18

Property for Tomorrow, July 2012

The new shopping mall due to open next July in York is now claiming 75% occupancy, with
several leading department stores, restaurants and designer clothing outlets having signed up
in recent weeks. There will also be a four-screen cinema and other leisure facilities.
Promoting itself as ‘the destination for the image-conscious shopper’, the mall is expecting
to attract over 100,000 visitors each week, with the enticement of free car parking and easy
transport links. The mall’s developers estimate that 50% of these shoppers will be ‘affluent’,
60% will be in the 18-35 age-range and 75% will be female.

However, it is proving hard to find occupants for some units. In particular, the one
designated for hairdressing has already been rejected by a large chain of salons, which is
reportedly worried that a Sullivan supermarket that is opening on the ground floor will
incorporate a salon of its own – something that the developers are refusing to confirm or
deny.

ICAEW/CS/J12 17 of 17