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Copyright ICAEW 2014. All rights reserved.





This paper consists of THREE questions (100 marks).

1. Ensure your candidate details are on the front of your answer booklet.

2. Answer each question in black ball point pen only.

3. Answers to each question must begin on a new page and must be clearly numbered.
Use both sides of the paper in your answer booklet.

4. The examiner will take account of the way in which material is presented.

The questions in this paper have been prepared on the assumption that candidates do
not have a detailed knowledge of the types of organisations to which they relate. No
additional credit will be given to candidates displaying such knowledge.

Interest tables are provided with this examination paper.


Question papers contain confidential
information and must NOT be removed
from the examination hall.


You MUST enter your candidate number in this box

ICAEW\BCJ14 Page 2 of 15

Zangle plc is a listed company which operates in the soft drinks and bottling industry.
You are a senior working for Fenn and Fuller LLP (FF) a firm of ICAEW Chartered
Accountants and business advisers. Zangle is a client of FF, but FF does not carry out the
audit of Zangle.
You receive the following email message from the engagement partner, Scott Olsen:
To: A. Senior
From: Scott Olsen
Date: 22 July 2014

Welcome to the team. I know you are new to this client, so I have provided you with some
background information (Exhibit 1).

The Zangle board is considering making an acquisition of one of its suppliers, Bottle Top
Sealings Ltd (BTS). I have provided you with some financial and operating data for BTS
(Exhibit 2). I have also attached an email from Chloe Minks, the finance director of Zangle
(Exhibit 3). BTS has provided some working assumptions (Exhibit 4) as a basis for
discussion and Chloe has asked us to use these for our initial analysis.

I have a meeting with Chloe on Friday and I need you to prepare some notes which:

Evaluate the quarterly and the annual performance of BTS in the year ended 30 June
2014 and its financial position at that date. Include an assessment of the extent to
which BTS is dependent on sales to Zangle.
Determine a valuation for the entire ordinary share capital of BTS at
30 September 2014, using the working assumptions for your calculations (Exhibit 4).
Give reasoned advice as to whether this would be a good acquisition for Zangle at this
price, having regard to all relevant factors.
For each of the three proposals concerning the form of consideration for acquiring
BTS (Exhibit 3), calculate the goodwill to be recognised in the consolidated financial
statements of Zangle for the year ending 30 June 2015. For this purpose use your
valuation of BTSs share capital and explain your calculations.
Explain the tax implications of development and patent costs for BTS for the year
ending 30 June 2015. Indicate any claims, reliefs and elections that are available.
(BTS will cease to be treated as an SME following the acquisition by Zangle).


Respond to the instructions of the engagement partner.
(42 marks)

ICAEW\BCJ14 Page 3 of 15
Exhibit 1 Zangle: Background information

Zangle was incorporated many years ago and obtained a listing in 1990. It produces fizzy
(ie carbonated) non-alcoholic drinks, which it bottles at its own factory. Its products are sold

Zangle produced 300 million bottled drinks in the year ended 30 June 2014 and production
volume per month is reasonably constant. Every bottle requires a bottle top. It is essential
that the bottle top provides a good-quality, tight seal in order to maintain the pressure in the
bottle and sustain the useful shelf life of the product.

Zangle had been experiencing some performance issues with its bottle tops prior to 1 July
2013 when it changed to BTS as the sole supplier of all its bottle tops, which are branded the
Flip-Top. Zangle has been very pleased with the performance of the BTS Flip-Top.

Exhibit 2 Financial and operating data for BTS

BTS was incorporated on 1 July 2012 as a start-up company by Alfie Jardine, who is its chief
executive and sole shareholder. Alfie is an engineer who develops innovative commercial

In its first year, BTS focused on research and development for the Flip-Top. The Flip-Top is
an innovative bottle top which has a distinctive design and provides a more efficient seal than
other bottle tops currently available. In early 2013, BTS successfully completed development
of the Flip-Top and obtained a patent to protect its intellectual property rights.

BTS began commercial production and sales of the Flip-Top on 1 July 2013, initially with
Zangle as its only customer. The Zangle contract increased BTSs credibility with other large
potential customers.

Alfies strategic plan is to demonstrate the Flip-Tops commercial success and then sell
BTS, along with all rights to the Flip-Top, to a larger company.

ICAEW\BCJ14 Page 4 of 15
Financial data for BTS

Quarterly management accounts of BTS for the year ended 30 June 2014

3 months to
30 September
3 months to
31 December

3 months to
31 March
3 months to
30 June

Revenue 15,000 16,000 17,000 18,000 66,000
Operating costs:
Fixed costs (10,000) (10,000) (10,000) (10,000) (40,000)
(3,750) (4,000) (4,250) (4,500) (16,500)





Operating profit 250 1,000 1,750 2,500 5,500
Tax 22% (55) (220) (385) (550) (1,210)
Profit after tax 195 780 1,365 1,950 4,290

Operating data for BTS for the year ended 30 June 2014

3 months
30 September
3 months
31 December
3 months
31 March
3 months
30 June


Volume of bottle
tops produced and
sold (in millions)





Number of
1 6 8 9 9

Summary statement of financial position of BTS at 30 June 2014
Non-current assets
Patent 450
Development costs 3,800
Net current assets 340

Share capital - 1 shares 500
Retained earnings 4,090

The carrying amount of the patent comprises the costs incurred in establishing and
registering the patent less amortisation.

ICAEW\BCJ14 Page 5 of 15
Development costs relate to costs capitalised in respect of the development of the Flip-Top

Amortisation costs are included in fixed operating costs.

All property, plant and equipment is held under operating leases.

Most customers of BTS are rivals to Zangle. Unlike Zangle, most drinks companies only use
BTS for a small proportion of their output. For some, this is because they are being cautious
about a new product and wish to retain multiple suppliers, but for others it is because they
are tied into long-term contracts with existing suppliers.

Exhibit 3 Email from Chloe Minks, finance director of Zangle, to Scott Olsen

The Zangle board would like to give urgent consideration to the possibility of acquiring the
entire ordinary share capital of BTS, which is one of Zangles suppliers. I had a meeting with
the chief executive of BTS, Alfie Jardine, who is keen to sell all his BTS shares and has set a
target date of 30 September 2014 for completion of the deal. He has told me, however, that
at least two of Zangles competitors are also interested in making the acquisition and that he
will sell to the highest bidder.

Alfie is very optimistic about the future of BTS and he expects his forecasts of future growth
in the working assumptions (Exhibit 4) to be fully reflected in determining the acquisition price
for BTS. He did, however, state that he would be flexible as to the form and timing of the
consideration, provided the overall price is acceptable, based upon an agreed valuation.

Whilst the amount of the consideration is yet to be determined, three proposals for the form
of the consideration are:

Proposal 1
A fixed amount in cash, based on the valuation of BTS, payable on
30 September 2014.

Proposal 2
(i) A fixed amount in cash, payable on 30 September 2014; and
(ii) A cash amount equal to 80% of BTSs operating profit for the year ending
30 June 2015, payable on 30 September 2015.

Proposal 3
(i) A fixed amount in cash, payable on 30 September 2014; and
(ii) A cash amount of 9 million (payable on 30 September 2015), but only if BTS
earns an operating profit of at least 17.5 million in the year ending 30 June

ICAEW\BCJ14 Page 6 of 15
The overall consideration is assumed to be the same in all three cases (based upon
forecasts of operating profit), being equal to the agreed valuation. Clearly, the fixed amount in
cash, payable immediately on acquisition, would be greater for Proposal 1 than the fixed
amount in cash for the other proposals, as this would be the only element of the
consideration in Proposal 1.

Exhibit 4 Working assumptions: prepared by Alfie Jardine

Alfie has set out the following working assumptions and he expects these to form the basis of
determining the valuation for his shares.

The acquisition

The acquisition would take place on 30 September 2014.
All the ordinary shares in BTS would be acquired by Zangle, including all rights to the
intangible assets, which would be transferred on acquisition.
The fair value of the Flip-Top patent is approximately 80 million if it were to be sold
separately from the company.

Operating and financing

Volumes sold will continue to grow at 5 million bottle tops per quarter up to and
including the quarter ending 30 September 2015. They will then remain constant per
quarter at this level.
The selling price will remain constant at 200 per 1,000 bottle tops for the foreseeable
future and will apply for all customers.
Fixed costs per quarter and variable cost per bottle top are expected to remain
constant for the foreseeable future.
Profit after tax equals operating cash flows after tax.
Operating cash flows arise at the end of the quarter to which they relate.
The effective rate of tax is 22%.
The annual interest rate for discounting is 10% (this equates to a quarterly interest rate
of 2.411%).

ICAEW\BCJ14 Page 7 of 15


ICAEW\BCJ14 Page 8 of 15

Toru plc is a UK resident company which sells home furnishings and bespoke home design
services from stores in the UK. Toru has a 30 September year end.

You are Chris Olaf, an ICAEW Chartered Accountant and you have recently joined Toru plc
as the finance director. Your role at Toru includes advising the Toru board of directors on the
tax implications of acquisitions. You previously worked for Torus auditors Menton & Blass
(MB) as an audit manager. Your wife, who is also an ICAEW Chartered Accountant, still
works for MB as an audit manager, but has no involvement with the Toru audit assignment.

The Toru brand is very strong in the UK and the companys reputation is based on its use of
sustainably-sourced materials. As a result of a media story about the use of illegally-sourced
raw materials by one of its supplier companies, the Toru board has decided to take more
active control over its supply chain. The medium-term strategy of the board is to identify and
acquire businesses which comply with Toru business ethics.

The Toru CEO, Felix Smith, gives you the following briefing on the potential acquisition of the
business of RMM Ltd:

RMM Ltd is a UK tax resident company which manufactures and sells its own brand of
wallpaper and fabrics, CulorMe, to major department stores in the UK.

RMM produces wallpaper and fabrics at its factory in Italy. The management and control of
the Italian operations are in the UK. The acquisition of RMM is a good opportunity for Toru to
secure a supply of sustainably-sourced wallpaper and fabrics.

Ozz plc owns 90% of the RMM shares and is keen to divest itself of the RMM investment as
Ozz is withdrawing from the home furnishing market in the UK. The remaining 10% of the
shares are owned by Hansi Ford, who works as a consultant in Torus design department. He
has offered to help with the negotiations.

The Toru board has decided to sell its brand name, PaperOvr, on 1 October 2014 to help
fund the acquisition of RMM (Exhibit 1).

The proposed date of the acquisition is 1 October 2014. The Ozz board has provided some
information on the forecast net assets of RMM at that date (Exhibit 2).

Although we need to carry out some due diligence work on RMM, this can be minimised
because Hansi is on the RMM board and he has said he will be able to provide Toru with
reliable information about RMMs order book. Also, as MB are the auditors of RMM, you
should, with your connections, be able to find out if there is anything we need to know about
RMMs finances. I will make sure that you are rewarded with a bonus this year for your
assistance in this matter.

ICAEW\BCJ14 Page 9 of 15

Please prepare a report for me in which you:

Explain the tax implications of the sale of Torus brand name PaperOvr (Exhibit 1).

Evaluate the tax implications of both of the following alternatives:
o Purchasing RMMs trade and assets; and
o Acquiring 100% of RMMs shares.

Hansi has asked that we provide him with information to help him in the negotiations,
so please make your evaluation from the perspectives of both Toru, (the acquirer) and
the vendor. Hansi has taken separate advice concerning his position.

Compare the key potential tax risks arising from: purchasing RMMs trade and assets;
and acquiring 100% of RMMs shares. Explain the due diligence procedures that we
should perform in respect of these risks.


a) Prepare the report requested by Felix Smith.

b) In a separate document, explain any ethical concerns, implications for you and actions
you should take, arising from Felix Smiths briefing.

(30 marks)

NOTE: Assume RPI at 1 October 2014 is 257.8

Exhibit 1 Sale of brand PaperOvr for 15 million on 1 October 2014

On 1 October 2012 Toru bought the brand name PaperOvr for 10 million and commenced
production of wallpaper under the brand name PaperOvr on that date. Toru is amortising
this brand over 10 years in its financial statements and for tax purposes.

The Toru board believes that the RMM brand CulorMe is much stronger and that the
business cannot support two competing product ranges. The Toru board has therefore
decided to sell the PaperOvr brand on 1 October 2014 for 15 million to help finance the
acquisition of RMM.

Following the acquisition of RMM, Toru will cease to produce wallpaper and will sell only the
CulorMe range in its stores. RMM will expand its production capacity. It will continue to sell
to its existing customer base, but it will also expand its product range to accommodate the
specific tastes of Torus customers.

ICAEW\BCJ14 Page 10 of 15
Exhibit 2 Information concerning the net assets of RMM as at 1 October 2014
prepared by the Ozz board.

Notes Fair value
CulorMe brand (i) 18.0
Factory in Italy (ii) 6.0
Office building in Manchester (iii) 19.5
Plant and machinery 3.0
Net current assets 1.0
Long-term loan (iv) (5.0)


(i) The fair value of the brand name CulorMe will be equal to its carrying amount and to
its tax written down value at 1 October 2014. This brand name was bought by RMM
in October 2011 for 24 million and is being amortised over 12 years.

(ii) The factory in Italy was purpose-built for RMM in 2001 at a cost of 9 million. Due to
a decline in commercial property prices, the fair value of the property will be
6 million at 1 October 2014.

(iii) The office building was transferred to RMM by Ozz on a no gain/no loss basis in
February 2012 for 7 million (cost plus indexation allowance). The market value at
the time of the transfer was 13 million. The original cost to Ozz was 5 million in
January 2001.

(iv) If Toru buys RMMs trade and assets, the Ozz board proposes that the consideration
will be 55 million for the assets, including net current assets, but excluding the long
term loan. If Toru buys the RMM shares the consideration should be adjusted to
50 million to take into account the 5 million long-term loan.

RMM is projected to have cumulative trading losses of 12 million and a capital loss of
2 million at 1 October 2014. RMM has a 30 September year end.

ICAEW\BCJ14 Page 11 of 15


ICAEW\BCJ14 Page 12 of 15

Liebitz & Luber plc (LL) is a global company, manufacturing and selling chemical-based
products worldwide. The companys products include: cleaning products, paints, adhesives,
and fertilizers. LL is listed on the London Stock Exchange and its head office and board are
located in the UK.

You are Zara Harris, and you work in the business advisory and assurance section of ICAEW
Chartered Accountants, Raul & Roberts LLP (RR). RR does not audit LL. One of the
managers in your department, Andrew Andover, asked you to accompany him to a meeting
with the LL chairman, Martyn James.

A meeting with the LL chairman

Martyn opened the meeting: Thanks for coming to see me. I would like RR to help us review
our risk management procedures at all levels. These have not been adequate in the past and
we have suffered losses recently from not managing our risks appropriately.

The LL board has already carried out an initial review of risk management from the top
down, including a reappraisal of our corporate governance structures and risk reporting
procedures. As a consequence, we have decided to set up a risk committee as a separate
committee of the board to ensure there is high-level responsibility for all risk management.
The risk committee will comprise myself, as chairman, a non-executive director and two
executive directors. Responsibility for strategic and operating risk management currently
belongs to the audit committee, but this has not been satisfactory.

I realise that you have no previous experience of LL, so I have provided some background
information about the company (Exhibit 1) and our current risk management procedures
(Exhibit 2).

We need RR to help us identify and manage high-level risks, but I also have concerns about
managing some specific financial risks (Exhibit 3) and health and safety risks from ammonia
spillages (Exhibit 4).

A number of our major institutional shareholders have not been happy with the way the LL
board has dealt with some key risks. Once we have completed redesigning our risk
management procedures and internal controls, I would like RR to consider accepting a risk
assurance assignment attesting to their effectiveness. I would hope that your report and
conclusions could be published in our annual report and accounts.

As a preliminary step, the LL board has asked for the following from RR:

An explanation of the financial risks associated with the issues set out in Exhibit 3 and an
evaluation of the methods by which these risks may be managed.

An explanation of the financial reporting treatment of the planned purchase of ammonia in
Exhibit 3 and for possible hedging arrangements. I do not require detailed calculations,
but I do require comprehensive and clear explanations of how the relevant planned
transactions should be treated in LLs financial statements.

ICAEW\BCJ14 Page 13 of 15
A briefing note which, using the information in Exhibit 4, provides advice to the LL board,
on whether LL should insure against spillage risks or accept these risks. Prepare
supporting calculations.

An explanation and justification of the level of assurance that RR could provide in
attesting to the effectiveness of LLs risk management procedures. Also, explain the
benefits arising to LL from this risk assurance assignment. I do not need a list of
assurance procedures.

Immediately after the meeting Andrew asked you to draft a response to these requests from
the LL board.


Draft the response requested by Andrew.
(28 marks)

Exhibit 1 Background information about LL

LL has three factories in the UK, one factory in China and one factory in Japan. All of these
are approximately equal in size, but they manufacture different types of products. Some of
the factory output is in the form of partially finished products, which are transferred to one of
the other LL factories for completion.

Total external sales amounted to 900 million for the year ended 31 December 2013. There
were a further 200 million of internal sales in the year. External sales for the year ended
31 December 2013 were geographically distributed as follows:

UK 40%
US 15%
Europe (eurozone) 25%
Asia 10%
Australia 10%

Operating profit for the year ended 31 December 2013 was 62 million.

Raw materials are one of the largest operating costs. Many of the raw material chemicals that
LL uses are hazardous to individuals and there is also a significant risk of major fires and
explosions. LL relies on a small number of key suppliers in order to obtain quantity discounts
from bulk transport by ship or train, which is sometimes over long distances.

Some adverse events have affected profitability in recent years. Our factory in Japan was
damaged by a tsunami and, as a result, we could not supply our Japanese customers for two
months thereafter. We just did not have the appropriate business continuity procedures in

We have also suffered from exchange rate movements and commodity price movements, but
in other periods we have benefited from such price movements. The global economic
downturn has also caused us major problems.

LL has long-term gearing of approximately 40%, with debt comprising mainly variable interest
rate loans.

LL has a 31 December accounting year end.

ICAEW\BCJ14 Page 14 of 15
Exhibit 2 LLs current risk management procedures

Financial risk management

The companys activities expose it to a variety of financial risks, including those arising from:
foreign currency exchange rates, interest rates and commodity prices. The treasury
department seeks to manage the potential adverse effects of these risks on the financial
performance of the company. The treasury department reports on financial risk management
to the board.

Strategic and operating risk management

The audit committee is currently responsible for strategic and operating risk management. It
examines key risk events that have occurred and, in light of these, reviews risk procedures
and policies. Every year it reviews the key risks of the business and reports to the board.

Exhibit 3 Specific financial risks

One of the raw material chemicals that we use in our products is ammonia. This is a basic
commodity, in other words it is the same, no matter where we buy it. It is traded on global
commodity markets, therefore derivatives and other financial instruments are available based
on its market price.

There are three issues for LL. First, ammonia is a dangerous substance therefore we would
not want to hold too much of it in inventory; second, the price of ammonia as a commodity is
volatile; and third, trading ammonia as a commodity is denominated in US$, whereas the
functional currency of LL is sterling.

As a specific example, LL has a firm plan that it will require, in five months (ie on, or around,
22 December 2014) the purchase of 2,000 tonnes of ammonia at the spot price on that date.
The current spot price is US$500 per tonne, but LL does not want to make the purchase now,
because of the costs and risks of storing ammonia for such a long period. Nevertheless, the
LL head of treasury is concerned that there may be financial risks from fluctuations in the
ammonia commodity price and in the /$ exchange rate.

He therefore plans to hedge these risks, but is unsure how best to do this. He is also
concerned about the impact on the financial statements of hedging arrangements for
commodity price changes and currency fluctuations.

A futures contract for ammonia for delivery on 22 December 2014 is currently US$520 per

The /US$ exchange rates are:

Current spot: 1 = US$1.55
5-month forward rate: 1 = US$1.60

ICAEW\BCJ14 Page 15 of 15
Exhibit 4 Health and safety risks chemical spillages

Concern has been raised by some directors about the risks that arise as a consequence of a
possible spillage of chemicals, causing health and safety problems with associated costs.
Some board members are also concerned, however, that the cost of insuring such risks has
become excessive.

Management has collected the following data to support the boards decision making on this

Number of spillages to occur in any one year 0 1 2 3
Probability 90% 5% 3% 2%

The probability of more than three spillages occurring in any one year is insignificant.

There are two types of spillage: major and minor. The costs per spillage and the probabilities
(of any one spillage being major or minor) are as follows:

Probability Cost
Major 7% 150m
Minor 93% 10m

The annual insurance premium to cover the identifiable costs of all spillages in a year is
4 million. However, the maximum payout for any one spillage is limited to 100 million.