Case study july 2012 exam paper ICAEW

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

Wednesday 25 July 2012

(4 hours)

CASE STUDY

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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

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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:

Performing calculations and financial analysis 1 hour

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)

• Drawing conclusions and making recommendations 20%

90%

Applied to your report as a whole

• Demonstrating integrative and multidisciplinary skills 5%

100%

Of the total marks available, 15% are awarded for the executive summary and approximately

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

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EXHIBIT 12 EMAIL

To: Ashley Franklin

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

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EXHIBIT 13 EMAIL

To: Salon managers

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

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EXHIBIT 14 Luvlox Ltd: Management accounts for the year ended 30 June 2012

Revenue – services 1,282 1,907 1,679 4,868

Revenue – products 233 417 260 910

Administrative expenses 3 (697) (1,044) (1,049) (2,790)

ASSETS

Non-current assets

Current assets

1,020

EQUITY & LIABILITIES

Equity

Net cash used in investing activities (215)

Net increase in cash and cash equivalents 502

Cash and cash equivalents at beginning of year 61

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NOTES TO THE MANAGEMENT ACCOUNTS

1 Key performance data

Newcastle Gateshead Wallsend TOTAL

2 Cost of sales

Newcastle Gateshead Wallsend TOTAL

3 Administrative expenses

Newcastle Gateshead Wallsend TOTAL

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

Newcastle Gateshead Wallsend TOTAL

There were also 10 Head Office staff, including 5 directors

EXHIBIT 15 EMAIL

From: Irina Yu (Manager, Newcastle salon)

To: Amanda Richards

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

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EXHIBIT 16(i) EMAIL

From: Liz Newby (Accountant)

To: Sarah Chandler, Baron Young

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

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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

EXHIBIT 17 EMAIL

To: Sarah Chandler

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