- 20 Marks
CR – May 2025 – PROFESSIONAL – Q2 – Business Combinations (IFRS 3), Presentation of Financial Statements (IAS 1), Accounting Policies, Changes in Accounting Estimates, and Errors (IAS 8)
Adjust financial statements of Gombe and Uzor for fair comparison in acquisition, recalculate ratios, evaluate senior accountant's conclusion.
Question
Kankanfo Group Plc, is a well established company that is planning to expand through acquisition of some companies.
The Directors of the company have identified two potential target companies, Gombe Limited and Uzor Limited.
Extracts from the financial statements of the two companies are as follows:
Statement of profit or loss and other comprehensive income for the year ended December 31, 2021.
| Gombe Limited | Uzor Limited | |
|---|---|---|
| N’000 | N’000 | |
| Revenue | 272,000 | 264,000 |
| Cost of sales | (168,000) | (183,800) |
| Gross profit | 104,000 | 80,200 |
| Administrative expenses | (72,000) | (56,000) |
| Profit from operations | 32,000 | 24,200 |
| Finance costs | (12,000) | (16,000) |
| Net profit before tax | 20,000 | 8,200 |
| Income tax expense | (6,000) | (4,000) |
| Profit for the year | 14,000 | 4,200 |
| Other comprehensive income: | ||
| Items that will not be reclassified to P or L | ||
| Surplus on revaluation | — | 24,000 |
| Total comprehensive income | 14,000 | 28,200 |
Statement of financial position as at December 31, 2021
| Gombe Limited | Uzor Limited | |
|---|---|---|
| N’000 | N’000 | |
| Non-current assets: | ||
| Property, plant and equipment | 128,000 | 140,200 |
| Current assets: | ||
| Inventories | 24,000 | 28,000 |
| Receivables | 48,000 | 40,000 |
| Current assets | 72,000 | 68,000 |
| Total assets | 200,000 | 208,200 |
| Equity and liabilities: | ||
| Equity | ||
| Ordinary share capital (N1 each) | 64,000 | 48,000 |
| Revaluation reserves | — | 20,000 |
| Retained earnings | 30,000 | 20,200 |
| 94,000 | 88,200 | |
| Non-current liabilities: | ||
| Loan notes | 64,000 | 72,000 |
| Current Liabilities: | ||
| Trade payables | 20,000 | 20,000 |
| Income tax | 6,000 | 4,000 |
| Borrowings | 16,000 | 24,000 |
| 42,000 | 48,000 | |
| Equity and liabilities | 200,000 | 208,200 |
Statement of changes in equity for year ended December 31, 2021
| Gombe Limited | Uzor Limited | |
|---|---|---|
| N‟000 | N‟000 | |
| Bal. b/f January 1, 2021 | 88,000 | 64,000 |
| Total comprehensive income | 14,000 | 28,200 |
| Dividend paid | (8,000) | (4,000) |
| Bal. December 31, 2021 | 94,000 | 88,200 |
Additional Information:
(i) Uzor Limited revalued its property, plant and equipment (PPE) for the first time on January 1, 2021. The property, plant and equipment of Gombe Ltd are very similar in age and type to that of Uzor Limited. Gombe Limited has a policy of maintaining all its property, plant and equipment at depreciated historical costs, using 20% rate on straight line basis. Both Gombe Limited and Uzor Limited charge depreciation on PPE to cost of sales. Uzor Limited has transferred the excess depreciation on the re-valued assets from revaluation reserve to retained earnings.
(ii) On December 31, 2021 Gombe Limited supplied goods at the normal selling price of N9,600,000 to another Company Mamagold Limited. Gombe Limited‟s normal selling price is at a mark up of 60% on costs. Mamagold Limited paid for the goods in cash on the same day. The terms of the selling agreement were that Gombe Limited repurchase these goods on June 30, 2022 for N10,000,000. Gombe Limited accounted for this transaction as sales for the year ended December 31, 2021.
(iii) It is the practice of Kakanfo Group Plc to appraise potential investment opportunities by making use of the following ratios:
Gearing;
Turnover to capital employed;
Gross profit margin; and
Return on capital employed.
Your Senior Accountant computed the four key ratios for the two target companies from the financial statement extracts provided and the result are as follows:
| Gombe Limited | Uzor Limited | |
|---|---|---|
| N‟000 | N‟000 | |
| Gearing | 46% | 52.1% |
| Turnover to capital employed | 1.6 | 1.4 |
| Gross profit margin | 38.2% | 30.4% |
| Return on capital employed | 18.4% | 13.1% |
(iv) After the computation in (iii) above, the Senior Accountant concluded that performance of Gombe Limited is better than that of Uzor Limited. Therefore, Kankanfo Group Plc should carry out due diligence on Gombe Limited with a view to making a bid to acquire it.
However, as the Chief Accountant of Kankanfo Group Plc., you are not sure whether the conclusion of your Senior Accountant is correct in view of information in notes (i) and (ii) above.
Required:
a. Carry out the necessary adjustments that would be appropriate on the financial statements of Gombe Limited and Uzor Limited to facilitate comparison showing your answers in tabular form, with columns for original figures, adjustments, new figures and justifying reasons for the adjustments.
(10 Marks)
b. Recalculate the four key ratios for Gombe Limited and Uzor Limited using the new figures obtained after the necessary adjustments. (4 Marks)
c. Evaluate your Senior Accountant‟s conclusion in the light of your answer in (a) and (b) above.
(6 Marks)
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