Kat-suit-Ko Ltd is a new company that specialises in the design and manufacture of luxury cat homes and travel systems. They have sky-rocketed quickly up the ladder of fame and fortune using social media, generating a vast global clientele of key influencers. Kat-suit-Ko Ltd has produced a range of high-end, uniquely ergonomical products for domestic feline pets and trade on their environmentally responsible company ethos.
Kat-suit-Ko Ltd commenced life on 1st January in Year 1. Year 1 has just been completed. In January, it issued 100,000 ordinary shares with a nominal value of £1 each at a premium of £0.50 each. It also obtained a 5-year bank loan of £150,000 at an annual interest rate of 8% when it started business. During Year 1, the following occurred:
1. In January Year 1, £26,250 was spent on rent of buildings for the first eighteen months.
2. At the start of Year 1, machinery and equipment was purchased for £100,000, to be used for 5 years. Non-current assets are depreciated using the reducing balance approach (also known as the declining balance approach).
3. Inventories totalling £120,000 were purchased on credit during the year and at the end of the year, closing inventories amounted to £31,000. £40,000 was still owed to trade payables at the end of the year.
4. Inventories were sold on credit and generated total revenue of £550,000, but during the year a debtor owing £20,000 went bankrupt and the debt was written off as a bad debt. At the end of the year, the business was still owed £80,000 by credit customers. It was decided to create a provision for doubtful debts of 5% of the year end receivables.
5. Various operating expenses amounted to £2,500 each month, paid with one month’s delay.
6. Wages and salaries totalled £190,000 for the year and were all paid in full.
7. At the end of Year 1, the bank loan interest due for Year 1 was paid.
8. Taxation on Year 1’s profit is estimated as being £29,500. Half of this sum had been paid midway during Year 1. The remainder is payable in the next year, Year 2.
9. At the end of Year 1 £125,000 was paid to the bank as a part-repayment of the loan taken out at the beginning of the year.
10. The directors proposed paying no dividends for Year 1.
The directors of Kat-suit-Ko Ltd have been looking to diversify into the home surveillance market with an offering called Kat-Stealth that includes the software development of an online App that can monitor pet daily activity and health, whilst owners are out of the home. With no competitors currently offering similar kit of this specification, Kat-suit-Ko Ltd could take advantage of a gap in the market.
R&D costs attributed to the new project, already paid, are £25,000. The purchase of new IT equipment necessary to develop the kit requires an initial outlay of £50,000. The Kat-suitKo depreciation policy allows for 20% straight-line depreciation on all IT equipment.
The initial social media marketing campaign outlay will be £10,000 and Kat-Stealth projected sales are 1,000 units in year 1 with expected growth of 20% year on year until year 3. As part of the marketing strategy, Kat-suit-Ko has secured product endorsement by Kooky-Kat, an influencer with 2 million followers worldwide, who has agreed to be part of a global campaign for a fee of £250,000 but is not available until Year 3. She will be paid in the third year of the 5-year project and with Kooky-Kat’s endorsement, projected sales are expected to rise to 3,000 units in year 3 with growth of 20% year on year thereafter. The Kat-Stealth package sells for £120 per unit with variable costs per unit of £45 and fixed costs of £110,000 per annum (including depreciation). The business has a cost of capital of 10%. Implications of taxation are to be ignored.
DISCOUNT FACTOR TABLE
Imputed rate of interest (i)
Time in years (t) 0% 2% 4% 6% 8% 10% 12%
0 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
1 1.0000 0.9804 0.9615 0.9434 0.9259 0.9091 0.8929
2 1.0000 0.9612 0.9246 0.8900 0.8573 0.8264 0.7972
3 1.0000 0.9423 0.8890 0.8396 0.7938 0.7513 0.7118
4 1.0000 0.9238 0.8548 0.7921 0.7350 0.6830 0.6355
5 1.0000 0.9057 0.8219 0.7473 0.6806 0.6209 0.5674
6 1.0000 0.8880 0.7903 0.7050 0.6302 0.5645 0.5066
7 1.0000 0.8706 0.7599 0.6651 0.5835 0.5132 0.4523
8 1.0000 0.8535 0.7307 0.6274 0.5403 0.4665 0.4039
9 1.0000 0.8368 0.7026 0.5919 0.5002 0.4241 0.3606
10 1.0000 0.8203 0.6756 0.5584 0.4632 0.3855 0.3220
Prepare the following statements for Kat-suit-Ko Ltd for Year 1:
a) Income Statement. [8 Marks]
b) Statement of Changes in Equity. [3 Marks]
c) Statement of Financial Position. [7 Marks]
d) Prepare a statement of incremental cash flows arising from the Kat-Stealth project and calculate the project’s Net Present Value and Payback Period. Advise the Directors of Kat-suit-Ko Ltd whether to proceed with the Kat-Stealth project or not, using your calculations here to support your recommendation.
[TOTAL 30 Marks]
Marking criteria note:
Within the allocated marks for Q1 parts (a, b, c & d), marks are awarded for correct figures only. No method marks will be awarded.
QUESTION 2 [25 MARKS]
You have been asked to prepare the statement of cash flows in a form suitable for publication for Solfeggio Ltd for the year ended 31 March 2020.
The most recent income statement and statement of financial position (with comparatives for the previous year) of Solfeggio Ltd are set out below.
Solfeggio Ltd – Income Statement for the year ended 31 March 2020
Income Statement for the year ending 31 March 2020
Cost of sales (408,136)
Gross profit 539,360
Profit on disposal of non-current assets 5,408
Distribution costs (98,872)
Administrative expenses (213,744)
Profit from operations 232,152
Dividends received 50,112
Finance costs (14,720)
Profit before tax 267,544
Profit for the period 214,032
Solfeggio Ltd – Statements of financial position as at 31 March 2019/20
Statement of Financial Position as at 31 March
Non-current assets 2020
Property, plant and equipment 707,520 510,656
Inventories 110,920 75,840
Trade receivables 218,736 98,976
Cash and cash equivalents 0 2784
Total Assets 1,037,176 688,256
EQUITY AND LIABILITIES
Share capital 280,000 224,000
Share premium 107,200 101,600
Retained ear nings 363,408 149,376
Total Equity 750,608 474,976
Bank loans 184,000 156,800
Trade payables 47,576 41,120
Tax liabilities 53,512 15,360
Bank overdraft 1480 0
Total Liabilities 286,568 213,280
Total Equity and Liabilities 1,037,176 688,256
Further information relating to the year ended 31 March 2020:
• The total depreciation charge for the year was £105,130
• Property, plant and equipment with a carrying amount of £6,288 was sold in the year.
• All sales and purchases were on credit. Other expenses were paid for in cash.
a) Using the above information generate the cash flow statement for publication using the ‘indirect method’ for year ended 31 March 2020.Note you must show all relevant workings and itemised parts individually. If your answer is not in this format and does not use the ‘indirect method’, you will be awarded ZERO marks for this question. [11 Marks]
b) Comment briefly on the significance of the information provided by the company’s Cash Flow Statement and in doing so identify 3 potential limitations of the Statement of Cash Flows.
c) “The size of an entity’s profit is an unreliable indicator of its cash situation.”
Discuss the above statement by outlining four circumstances whereby a company might report a healthy profit in its financial statements and yet suffer severe cash flow problems.
Marking criteria note:
Within the mark allocation to this question, there is a sub-allocation of 5 marks reflecting academic judgement applied by the marker/assessor, based on the marker/assessor’s perception of logic, rationale, thrust, and communication. The composition of the 5 marks is based upon the assessment criteria for a level 7 module in relation to Knowledge and Understanding as well as Intellectual Skills.