Case study november 2011 exam paper ICAEW

November 2011 Case Study: 4DVD Limited List of exhibits The following exhibits were included in the material provided as Advance Information: 1 About you, your employer and the subject

Wednesday 9 November 2011

(4 hours)

CASE STUDY

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November 2011 Case Study: 4DVD Limited List of exhibits

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

1 About you, your employer and the subject company (4DVD Limited [4D])

2 The film industry

3 Film and DVD making

4 4DVD Limited (4D)

5 Email dated 12 January 2011 from James Magnet to you: Financial information

6 4DVD Limited management accounts: Summary for the years ended

30 September 2006-10

7 Loan Agreement dated 1 October 2003 between 4D and NP Bank plc

8 Email dated 12 April 2011 from James Magnet to you: Financial review

9 Revenue: commissioned film projects and income

10 Revenue: sales of DVDs and merchandise

11 Revenue: corporate DVD production

12 Revenue: advertisement production

13 Advertising regulation

14 News and website articles

The following items are newly provided:

15 Email dated 9 November 2011 from James Magnet to you

16 4D Limited: Draft management accounts for the year to 30 September 2011

17 Email dated 7 November 2011 from Don Briggs, partner, Rigour Briggs Chartered Accountants to the 4D Board

18 Email dated 3 November 2011 from Colin Boyd of NP Bank plc to James Magnet and Stephanie Shan together with Stephanie’s email dated 8 November to the 4D Board

19 Email dated 31 October 2011 from John Jones of Foment plc to the 4D Board

20 News articles

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4DVD LIMITED

Case Study requirement

You are Ali Monet, a final-year trainee Chartered Accountant on secondment to 4DVD Limited (4D), a UK-based company engaged in DVD and film production You work within the finance department and report to James Magnet, the Finance Director

Requirement

You are required to prepare a draft report for the 4D Board, as set out in the email dated

9 November 2011 from James Magnet to you (Exhibit 15) Your report should comprise the

following four elements:

 An executive summary

 Your responses to the three detailed requirements set out in Exhibit 15, 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)

 Assimilating and using information 20%

 Structuring problems and solutions 30%

 Drawing conclusions and making recommendations 20%

95%

Applied to your report as a whole

 Demonstrating integrative and multidisciplinary skills 5%

100%

Approximately 15% of the marks are awarded for the executive summary and 10% for the appropriate 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

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EXHIBIT 15 EMAIL

To: Ali Monet

Subject: Financial review

4D is currently passing through a period of uncertainty and change In July, as a result of

under-utilisation and the need to save costs, we closed our second studio and disposed of surplus and technologically obsolete studio equipment In addition, we are obliged to take

note of changes within NP Bank – the provider of our long-term loan – and its assessment of 4D’s financial affairs We have also received a new commercial proposal from one of our

existing corporate clients which may help both our immediate and longer-term business

future For your information I am attaching the following:

 4D’s draft management accounts for the year to 30 September 2011 (Exhibit 16)

 An email from our auditors (Exhibit 17)

 An email from our bank, and responding email from Stephanie Shan (Exhibit 18)

 An email from one of our established clients, Foment plc (Exhibit 19)

 Two recent news articles (Exhibit 20)

Please draft a report for the Board comprising the following:

1 A review of 4D’s results for the year to 30 September 2011, as presented in Exhibit 16,

and of its investment in non-current assets at that date

Your review of 4D’s 2011 results should cover the overall revenue, gross profit and

EBITDA compared with 2010 It should also include an analysis of the trend in each of

4D’s revenue streams You should additionally comment on 4D’s investment in

non-current assets as at 30 September 2011 in the light of the recent studio closure and

equipment disposals

2 A calculation and assessment of the financial impact of the points raised in the email from

the auditors (Exhibit 17)

You should calculate the impact of the proposed adjustments on 4D’s draft management accounts, and you should also assess the resulting adjusted accounts against both the

financial covenant conditions in the Loan Agreement with NP Bank (Exhibit 7) and the

newly-imposed condition (Exhibit 18) Please also suggest how 4D might explain its

current finances in a positive way at the proposed meeting with NP Bank, by providing a review of 4D’s 2011 statement of cash flows and its year-end cash position

3 An evaluation of the email from John Jones of Foment plc (Exhibit 19) requesting us to

create a substantial new advertising campaign for Foment plc, using the Spindles

characters

You should address all the risks and benefits of this request – including any possible

ethical concerns – and the impact for 4D both currently and in the future

I look forward to receiving your draft report

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EXHIBIT 16 4D Limited: Draft management accounts for the year to 30 September 2011

Year ended 30 September 2011

£000s

Overheads/administrative costs 3 (5,252)

As at 30 September 2011

£000s Non-current assets

Property, plant and equipment 4 1,610

1,610

Current assets

3,601

Shareholders' equity

Non-current liabilities

1,100

Current liabilities

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Statement of cash flows

£000s Cash flows from operating activities

Adjustments for:

Losses on disposal of non-current assets 675

1,630

Change in accounts receivable 377 Change in accounts payable (719)

Investing activities

Purchase of non-current assets (586) Proceeds from disposal of non-current assets 41

Financing activities

Repayment of long-term loan (100)

Cash and cash equivalents at start of year (84)

Notes to the accounts

£000s Note 1 Revenue

Fees for corporate DVD production 1,917 Fees for advertisement production 1,889 Hiring out studio and equipment 429

13,928

Note 2 Cost of sales

DVDs, merchandise & materials 2,917 Web, promotional & delivery costs 342 Production personnel & freelance 2,205

Depreciation & loss on disposals 897

8,295

Note 3 Overheads/administrative costs

Motor, travelling & subsistence 404

Depreciation & loss on disposals 352

5,252

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Note 4 Non-current assets

Depreciation

Carrying amount

£000s Note 5 Inventories

964

Note 6 Accounts receivable

Other receivables and prepayments 143

2,218

Note 7 Accounts payable

Other payables and accruals

(including taxation & social security) 304

1,105

EXHIBIT 17 EMAIL

From: Don Briggs, partner, Rigour Briggs Chartered Accountants

To: The 4D Board

Subject: Proposed adjustments to 4D’s management accounts for the year ended

30 September 2011

This email summarises my telephone conversation of 4 November 2011 with James Magnet, following the audit work which has been conducted on the 2011 4D accounts We propose that adjustments be made to the draft management accounts with respect to the following:

Inventories

Our work on 4D’s inventories (gross figure £964k before any provisions) has indicated that provisions should be created in respect of slow-moving, damaged or obsolete items as at

30 September 2011, as follows:

1 DVDs: A sample review of DVDs held in inventories revealed that approximately 20% of

the value of these DVDs related to Spindle safety programmes which have been updated

or superseded by new DVDs produced during the past 12 months We propose that 4D make a full provision for these obsolete items

2 Merchandise goods: From audit work conducted it appears that the packaging

surrounding a quantity of merchandise goods (approximately 15% of items in this

category) was damaged during the relocation of inventories which occurred following the closure of the second studio in July 2011 From discussions with your personnel it is apparent that restoring the packaging will be a costly, time-consuming process In our opinion, because these items cannot be sold in such a condition, a full provision should

be made for them

3 Materials for models: No adjustment is proposed

4 Other: No adjustment is proposed

5 Work-in-progress: From your records it would appear that a sum representing work

done on a project for a client has been included in work-in-progress (at a cost of £20,000) when in fact the related revenue was correctly recognised in September 2011 We

propose that work-in-progress be reduced accordingly

Deferred income

The start of one project relating to one client (Aura Insurance) was delayed due to external circumstances – it has since started in October 2011 However, in September 2011, 4D recognised revenue for the sum of £30,000 in accordance with the contracted completion date and transferred that amount from deferred income into revenue In our opinion this amount should be reinstated as deferred income as at 30 September 2011 because work had not begun on this contract

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EXHIBIT 18

EMAIL

From: Colin Boyd, NP Bank plc

To: James Magnet and Stephanie Shan, 4D Limited

Subject: Review of management accounts for all clients with loans exceeding 10 years

This email is to confirm the conversation with James Magnet this morning As we discussed, a new manager, Clare Vision, has been appointed who will be dealing with the affairs of 4D starting from today – it would be appropriate for a handover meeting to take place as soon as possible – and we agreed that Friday 11 November at 11:00 would suit all parties

As we also discussed, the bank is undertaking a general review of all outstanding corporate loans for clients such as 4D with loans exceeding 10 years As a result of this review, the bank has decided to impose a new covenant condition on all such clients – namely, that their net current assets should be maintained at 150% of the outstanding loan and accrued finance expenses

James informed me this morning that the 4D draft management accounts for 30 September 2011 are already available and, given that they exist, it would seem to be a good opportunity for Clare to use them, both to understand 4D’s current accounts and to review its finances against the existing and new covenant conditions in the Loan Agreement

Clare and I look forward to meeting both of you next Friday

EMAIL

To: The 4D Board

Subject: 4D’s meeting with NP Bank plc to discuss the draft management accounts

The Board is aware that the auditors are proposing that adjustments be made to our draft management accounts before published accounts can be produced (this is normally by mid-December) James was not aware of these proposed adjustments when he spoke with Colin Boyd

I am not sure whether we need to make the adjustments proposed by the auditors ahead of the meeting which James and I are due to have with Colin Boyd and Clare Vision – the

adjustments are almost certainly not favourable to our position A delay in making the proposed adjustments may give us some time to present a stronger case based on events in the run-up to Christmas – traditionally our best trading period of the year

James will ask Ali Monet to calculate the impact of the proposed audit adjustments and to assess the resulting adjusted accounts against the financial covenant conditions – including the additional condition mentioned above That work will clarify our position My concern

is that although 4D has never breached the terms or conditions of the Loan Agreement, and has always met the bank’s entire repayment schedule on the due dates, this meeting will need to be handled very carefully I know that none of the directors wants to provide a personal guarantee for the NP Bank loan

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EXHIBIT 19 EMAIL

From: John Jones, Foment plc

To: The 4D Board

Subject: New advertising campaign

Date: 31 October 2011

As a result of our long-standing working relationship and the excellent standard of the work which you have always produced for Foment plc, both in filming our annual conference and for the numerous training videos you have created, we are writing to ask you to consider a new significant project Foment plc is about to launch a new series of soft drinks and iced products aimed at the young

people’s market, both in the UK and abroad, and we would like you to consider helping us to develop the advertising campaign for these products which would incorporate your “Spindles” characters

We are fully aware that your “Spindles” characters are instantly recognisable by young people and that

we would need to pay a significant premium for their use As a result, we are prepared to offer £6m (subject to negotiation) for the development of a series of 10 short scenario advertisements to be

created and run over the next 24 months Because we are confident that if you agree to such a proposal you would produce an excellent campaign for us, we would be prepared to make an advance payment

of 25% of whatever total fee is finally agreed upon as a gesture of our confidence in your output Obviously we would expect your three creative directors to be heavily involved in this

ground-breaking advertising campaign – we will need all of their formidable skills to maximise the success of the work

Another positive element for our campaign would be that the international aspect could easily be developed by superimposing the appropriate language and voice onto the “Spindles”, thus allowing us

a truly universal dimension to the campaign

If 4D Limited is interested in this proposal, we would welcome the opportunity to meet and discuss the details in the near future, because we would like the advertising campaign to be started in time for Christmas 2011

John Jones

For Foment plc