©the national board of accountants and auditors, …nbaa.go.tz/2019/march/final.pdf(i ) explain why...

©The National Board of Accountants and Auditors, November 2018

Contents

Questions Page

C1 – Corporate Reporting ………………………………………. 1

C2 – Auditing and Assurance …….......……................................. 13

C3 – Business and Corporate Finance ………………………….. 23

C4 – Public Finance and Taxation II ………………………….. 32

Suggested Answers Page

C1 – Corporate Reporting …………………………………… 42

C2 – Auditing and Assurance …….......……............................ 60

C3 – Business and Corporate Finance ……………………… 78

C4 – Public Finance and Taxation II ……………………… 93

Final Level, November 2018 1

EXAMINATION : FINAL LEVEL

SUBJECT : CORPORATE REPORTING

CODE : C1

EXAMINATION DATE : WEDNESDAY, 31ST OCTOBER 2018

TIME ALLOWED : THREE HOURS (9:00 A.M. – 12:00 NOON)

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GENERAL INSTRUCTIONS

1. There are TWO Sections in this paper. Sections A and B which comprise SIXquestions.

2. Answer question ONE in Section A.

3. Answer ANY THREE questions in Section B.

4. In total, answer FOUR questions.

5. Show clearly all your workings in the respective answers where applicable.

6. Calculate your answers to the nearest one decimal point where necessary.

7. This question paper comprises 12 printed pages.

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Final Level, November 20182

------------------------------------------------------------------------------------------------------SECTION A

Compulsory question------------------------------------------------------------------------------------------------------

QUESTION 1

(a) Utata is a private mutual fund registered under the laws of Tanzania for over 20years. Utata obtains funds from a large group of investors and provides thoseinvestors with returns and investment management services. Utata’s mainbusiness line has been to acquire portfolios of undervalued investments fromdiverse range of entities and later resell the investment at lucrative prices. Utatacurrently report all its investments on a ‘fair value through profit or loss’ basis.Early January 2017, Utata purchased 71% of the equity shares of Tanzania JuiceCompany (TJC). Following this acquisition some directors have feelings thatthe investment in TJC constitutes Utata’s controlling power, to direct relevantactivities of TJC, and consequently the latter has to be consolidated inaccordance with International Financial Reporting Standards (IFRSs). Othershave retained the long standing policy of Utata that, TJC will be treated like anyother investments. Utata asserts to comply with IFRSs. Utata’s board ofdirectors have approached you to present to them guidance on the divergentviews of the directors.

REQUIRED:

Prepare briefing notes to assist you in your presentation on how to deal with thematter in accordance with IFRSs. (8 marks)

(b) Three parties A, B and C establish a separate legal entity (entity X) in which thethree parties have different shares of voting rights. Entity X’s activitiesconstitute a business (as defined in IFRS 3: Business Combination). The partiesA, B and C have 50%, 25% and 25% voting rights respectively in entity X. Acontractual arrangement entered into by the three parties specifies that at least75% of votes are required to make decisions about the relevant activities.

REQUIRED:

Assess the appropriate accounting treatment of entity X by each of the threeparties A, B and C with reference to their agreements on matters of voting anddecisions. (6 marks)


(c) You are given the following statements of financial position pertaining toNyangumi, Sato and Kambale entities as at 31st December 2017.

NyangumiTZS. million

SatoTZS.

million

KambaleTZS. million

Non-current assetsProperty, plant and equipment 2,458 1,410 870Investment in Sato 900 - -Investment in Kambale 27 240 -

3,385 1,650 870Current assetsInventories 450 200 260Trade receivables 610 365 139Cash 240 95 116

1,300 660 5154,685 2,310 1,385

EquityOrdinary share capital 500 200 100Share premium 250 120 50Retained earnings 2,805 1,572 850

3,555 1,892 1,000Current liabilitiesTrade payables 1,130 418 385

4,685 2,310 1,385

The following additional information is given:(1) On 1st January 2013 Nyangumi, a public limited company acquired 60% of

Sato, a public limited company. On 31st July 2011 Nyangumi acquired 10%of Kambale, a public limited company, and on the same day Sato acquired80% of Kambale.

(2) During the year 2017, Sato sold goods to Kambale for TZS.260 millionincluding a mark-up of 25%. All these goods remain in inventories at theyear end?

(3) The retained earnings of the three companies at the acquisition dates was(figures in millions of TZS.):

As at 31st July 2011 As at 1st January 2013Nyangumi 1,610 1,860Sato 700 950Kambale 40 100

(4) The book values of the identifiable net assets at the acquisition date areequivalent to their fair values. The fair value of Nyangumi’s 10% holdingin Kambale on 1st January 2013 was TZS.50 million

(5) Nyangumi and Sato hold their investments in subsidiaries at cost in theirseparate financial statements.


(6) It is the group policy to value the non-controlling interests at fair value atacquisition. The directors valued the non-controlling interests in Sato atTZS.536 million and Kambale at TZS.210 million on 1st January 2013.

(7) No impairment losses have been necessary in the consolidated financialstatements to date.

REQUIRED:

Prepare the consolidated statement of financial position of Nyangumi group asat 31st December 2017. (Show all the workings clearly) (26 marks)

(Total : 40 marks)

---------------------------------------------------------------------------------------------------------SECTION B

There are FIVE questions. Answer any THREE questions----------------------------------------------------------------------------------------------------------------------------- ----------------

QUESTION 2

(a) In producing the Conceptual Framework for Financial Reporting and some ofthe current IFRSs, the International Accounting Standards Board (IASB) hashad to address the potential problem that the management of some companiesmay choose to adopt inappropriate accounting policies. These could have theeffect of portraying an entity’s financial position in a favourable manner. Insome countries this is referred to as ‘creative accounting’.

REQUIRED:

(i) Describe in broad terms, common ways in which management canmanipulate financial statements to indulge in ‘creative accounting’ andwhy they would wish to do so. (4 marks)

(ii) Explain with examples how IFRS seek to limit creative accounting ineach of the following areas of accounting:

Group accounting Financing non-current assets Measurement and disclosure of current assets (6 marks)

(b) Alpha, a public listed corporation, is considering how it should raise TZS.10billion of finance which is required for a major and vital non-current assetrenewal scheme that will be undertaken during the current year to 31st

December 2018. Alpha is particularly concerned about how analysts are likelyto react to its financial statements for the year to 31st December 2018. Presentforecasts suggest that Alpha’s earning per share and its financial gearing ratiosmay be worse than market expectations. Mr. Wanyemi, Alpha’s FinanceDirector, is in favour of raising the finance by issuing a convertible loan. Hehas suggested that the coupon (interest) rate on the loan should be 5%; this isbelow the current market rate of 9% for this type of loan. In order to make the


stock attractive to investors the terms of conversion into equity would be veryfavourable to compensate for the low interest rate.

REQUIRED:

(i) Explain why the Finance Director believes the above scheme mayfavourably improve Alpha’s earnings per share and gearing. (3 marks)

(ii) Describe how the requirements of IAS 33: Earnings per share and IAS32: Financial Instruments; presentation are intended to prevent theabove effects. (4 marks)

(c) The IASB Conceptual Framework requires information to reflect the substanceof a transaction for it to be reliable.

The substance of a transaction is its commercial effect. Normally this is thesame as its legal form but for complex transactions, this may not be the case.The general principle that results from the IASB Conceptual Framework is thatwhere the legal form of the transaction does not reflect its substance, the legalform should be set aside in order to reflect substance. This is known assubstance over form accounting.

REQUIRED:

Explain briefly why it is important for transactions to be accounted usingsubstance rather than legal form, and describe how financial statements can beadversely affected if the substance of transactions is not recorded. (3 marks)

(Total : 20 marks)


QUESTION 3

Wise Plan Ltd is a public company that would like to acquire 100% of a suitable privatecompany. It has obtained the following extracts of draft financial statements for twocompanies, Knowledge and Ourplan. They operate in the same industry and theirmanagements have indicated that they would be receptive to a takeover.

STATEMENT OF FINANCIAL POSITION AS AT 30TH SEPTEMBER 2018Knowledge Ourplan

TZS"000,000"

TZS"000,000"

TZS"000,000"

TZS"000,000"

AssetsNon-Current AssetsFreehold factory (note i) 4,400 nil

Owned plant (note ii) 5,000 2,200

Leases plant (note ii) nil 5,300

9,400 7,500Current AssetsInventory 2,000 3,600

Trade receivables 2,400 3,700

Bank 600 5,000 nil 7,300

Total Assets 14,400 14,800Equity and LiabilitiesEquity shares of TZS.1,000 each 2,000 2,000

Property revaluation reserve 900 nil

Retained earnings 2,600 3,500 800 800

5,500 2,800Non-Current LiabilitiesFinance lease obligation (note iii) nil 3,200

7% loan notes 3,000 nil

10% loan notes nil 3,000

Deferred tax 600 100

Government grants 1,200 4,800 nil 6,300Current LiabilitiesBank overdraft nil 1,200

Trade payables 3,100 3,800

Government grants 400 nil

Finance lease obligations (note iii) nil 500

Provisions 600 4,100 200 5,700Total Equity and Liabilities 14,400 14,800


STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED30 SEPTEMBER 2018

Knowledge OurplanTZS

"000,000"TZS

"000,000"Revenue 12,000 20,500Cost of sales (10,500) (18,000)Gross profit 1,500 2,500Operating expenses (240) (500)Finance costs - Loan (210) (300)

- Overdraft nil (10)

- Lease nil (290)

Profit before tax 1,050 1,400Income tax expense (150) (400)Profit for the year 900 1,000Note: dividend paid during the year 250 700

Additional notes(i) Both companies operate from similar premises.(ii) Additional details of the two companies’ plants are:

Knowledge OurplanTZS “000,000” TZS “000,000”

Owned plant – cost 8,000 10,000Leased plant – original fair value Nil 7,500

There were no disposals of plant during the year by either company.

(iii) The interest rate implicit within Ourplan’s finance leases is 7.5% per annum. Forthe purpose of calculating ROCE and gearing, all finance lease obligations aretreated as long-term interest bearing borrowings.

(iv) The following ratios have been calculated for Knowledge and can be taken to becorrect:

Return on year end capital employed (ROCE) 14.8%(capital employed taken as shareholders’ funds pluslong-term interest bearing borrowings – see note (iii) above)

Gross profit margin 12.5%Operating profit margin 10.5%Current ratio 1.2:1Closing inventory holding period 70 daysTrade receivables’ collection period 73 daysTrade payables’ payment period (using cost of sales) 108 daysGearing (see note (iii) above) 35.3%


REQUIRED:

(a) Calculate for Ourplan the ratios equivalent to all those given for Knowledgeabove. (6 marks)

(b) Assess the relative performance and financial position of Knowledge and Ourplanfor the year ended 30th September 2018 to inform the directors of Wise Plan Ltdin their acquisition decision. (8 marks)

(c) Discuss potential problems of using ratios for comparison purposes, and proposeother relevant factors/information that should be considered by Wise Plan Ltd intheir acquisition decision. (6 marks)

(Total: 20 marks)

QUESTION 4

(a) Due to the complexity of International Financial Reporting Standards (IFRSs),judgements used at the time of transition to IFRSs have often resulted in priorperiod adjustments and changes in estimates being disclosed in financialstatements. The selection of accounting policies and estimation techniques areintended to aid comparability and consistency in financial statements.However, IFRSs also place particular emphasis on the need to take into accountqualitative characteristics and the use of professional judgement when preparingfinancial statements. Although IFRSs may appear prescriptive, the achievementof all the objectives for a set of financial statements will rely on the skills of thepreparer. Entities should follow the requirements of IAS 8: AccountingPolicies, Changes in Accounting Estimates and Errors when selecting orchanging accounting policies, changing estimation techniques, and correctingerrors. However, the application of IAS 8 is additionally dependent upon theapplication of materiality analysis to identify issues and guide reporting. Inmany cases, entities have to consider the acceptability of the use of hindsight intheir reporting.

REQUIRED:

(i) Discuss how judgment and materiality play a significant part in theselection of an entity’s accounting policies. (5 marks)

(ii) Explain the circumstances under which an entity may change itsaccounting policies, setting out how a change of accounting policy isapplied and the difficulties faced by entities where a change inaccounting policy is made. (7 marks)

(b) The International Accounting Standards Board (IASB) had publishedamendments to IAS 7 'Statement of Cash Flows' which recently becameeffective (for annual periods that began on or after 1st January 2017). Theamendments were intended to clarify IAS 7 and improve information providedto users of financial statements about an entity's financing activities. These


require companies to disclose additional information that will assist investors inmaking net debt reconciliation.

Mtiririko Limited, a public listed company, has prepared a statement of cashflows for the year ended 31st August 2018. Under financing activities, it hasshown an increase in long-term borrowings to TZS.9,800 million, increase ofshort term borrowings to TZS.767 million and a decrease of lease liability toTZS.500 million.

As at 31st August 2017, Mtiririko Limited had shown in its financial statementslong term borrowings of TZS.4,600 million, short term borrowings of TZS.600millIion and capital element of lease liability of TZS.310 million.

During the year ended 31st August 2018 Mtiririko Limited acquired 90% ofshareholdings of Pambana Ltd for TZS.780 million. Pambana took a short termloan of TZS.47 million and a long term loan of TZS.86.million. Furthermore,during the year, Mtiririko took out a long term loan of TZS.6,114 million fromABCD bank and on 31st August 2018 the company paid TZS.1,400 million(Principal element being TZS.1,000 million and interest being TZS.400 million)to the bank as a liability payment installment. The TZS.400 million interest wasshown under operating activities in the statement of cash flows.

During the year Mtiririko also entered into a finance lease agreement to leaseequipment for TZS.400 million and had paid TZS.210 million in arrear off thecapital element of the lease liabilities. Interest of TZS.70 million on the leasewas also shown under operating activities in the statement of cash flows.

At the beginning of the year there was an American supplier whom Mtiririkoowed US Dollar 132,000, equivalent to TZS.190 million as at 1st September2017, but due to currency fluctuation the amount owing increased to TZS.310million at 31st August 2018. The company also had an overdraft of TZS.400million as at 31st August 2018.

REQUIRED:

Show the note to the statement of cash flows, required under the amended IAS7, which sets out the components of financing activities. (8 marks)

(Total : 20 marks)


QUESTION 5

(a) IAS 16: Property, Plant and Equipment sets out the accounting requirement forinitial recognition and measurement, subsequent measurement andderecognition of items of property, plant and equipment. IAS 16 expands onand applies the definition of an asset in the Conceptual Framework, as well asrecognition criteria set out in that document. On 31st December 2017,Anyosisye plc completed the construction of a new building. Some costsassociated with this were:

TZS. ‘000’Purchase of site 200,000Legal costs and stamp duty on site purchase 16,000Demolition of existing old building on site 18,000Design and planning costs 49,000Redesign costs due to conditions of planning permission 15,000Redesign costs due to errors in the original design 12,000Tendering and procurement costs 5,000Management time spent on the activities above, estimatedapportionment

22,000

Construction contractor’s fee and cost for the structure 754,000Completion, painting and furnishing 113,000Cost of moving in staff, files and equipment 37,000Cancellation costs of operating lease on previous headquartersbuilding

3,000

The new building was brought into use on 1st January 2018. It was estimated tohave a useful economic life of 50 years from that date, and a residual value ofTZS.140,000,000 at the end of its life (excluding the land). All the above costswere debited to a suspense account and credited to cash. No other entries weremade. All items were paid as incurred.

REQUIRED:

(i) Outline how a newly constructed building should be recorded in thefinancial records applying the principles of IAS 16: Property, Plant andEquipment. (3 marks)

(ii) Recommend on how further expenditure on an existing building shouldbe treated under IAS 16: Property, Plant and Equipment. (3 marks)

(iii) Set out journal entries and supporting calculations to show how theprinciples of IAS 16: Property, Plant and Equipment should be applied inaccounting for the transactions described above for the year ended 31st

March 2018. (8 marks)


(b) Kavenuka is a Senior Assistant Accountant at Anyosisye plc in (a) above. Hehas recommended that no depreciation should be charged to the building, sinceit is hardly the case that its value will fall in the near future. He recommendsinstead, that impairment testing be done every year to confirm whether its valueis decreasing or not.

REQUIRED:

Comment on the propositions of Kavenuka with reference to relevantInternational Financial Reporting Standards (IFRSs). (6 marks)

(Total : 20 marks)QUESTION 6

(a) Agriculture is one of the world's largest industry. In some countries it is themainstay of the gross domestic product. Yet until January 2003 when the IASBissued IAS 41 Agriculture, no major accounting standard setting body hadissued a comprehensive pronouncement on this topic. IAS 41 introduced whatsome would say are radical changes in the way agricultural enterprises shouldaccount for biological assets.

REQUIRED:

Define biological assets and explain how IAS 41 requires them to be treated inthe financial statements. (5 marks)

(b) Miti Safi na Nyuki Brothers (MSNB) is a Limited Company that wasincorporated to invest in forest and bee resources in general and to collectforestry and beekeeping revenues. As at 30th June 2018, it had a forestplantation in the Sourthen Highland part of Tanzania in Njombe regionconsisting of 250,000 Eucalyptus trees that were planted 2 years earlier.

Maturity and ideal harvesting age of Eucalyptus trees are dependent on theintended purpose or market. The harvesting age significantly varies from 3 to 4years (construction poles), 8 to 15 years (transmission poles) to as late as 20years for timber production. The company’s weighted average cost of capital is9% per annum.

The accountants of the MSNB were unable to value the 250,000 Eucalyptustrees for inclusion in the company’s statement of financial position as biologicalassets as only mature Eucalyptus trees for timber production had established fairvalues by reference to a quoted price in an active market. The fair value(inclusive of current transport costs) for a mature tree for timber production ofthe same grade as in the plantation is:

As at 1st July 2017: TZS 6,000 As at 30th June 2018: TZS 7,000


REQUIRED:

(i) Determine the amount of the biological asset to be reported as at 1st July2017 and 30th June 2018. (3 marks)

(ii) Determine the total fair value change of the immature trees during theyear ended 30th June 2018. (2 marks)

(iii) Determine the gain or loss due to changes in fair values as a result of theeffects of change in market price, and (5 marks)

(iv) Determine the gain or loss due to changes in fair values as a result of thephysical change (growth) of the trees in the forest plantation. (5 marks)

(Total: 20 marks)

________________ _______________



SUBJECT : AUDITING AND ASSURANCE

CODE : C2

EXAMINATION DATE : TUESDAY, 30TH OCTOBER 2018


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1. There are TWO Sections in this paper. Sections A and B which comprise atotal of SIX questions.



4. In total answer FOUR questions.

5. Marks are shown at the end of each question.

6. Presentation, clarity of expression, logic of arguments and the use of lucidEnglish will be taken into account in the assessment of candidates’performance.


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---------------------------------------------------------------------------------------------------------SECTION A

Compulsory question---------------------------------------------------------------------------------------------------------

QUESTION 1

(a) Your firm has five offices all over Tanzania and it specialises in the provision ofaudit and tax advisory services to clients in the entertainment and mediaindustries. The Finance Director of Nguvu Ltd (Nguvu) has recently requestedyour firm to accept appointment as external auditor for the year ended 30th

September 2018.

Nguvu’s previous auditors have not been reappointed. Nguvu is a music eventscompany that has its head office in Dar es Salaam. It organises and performseven live-music events held in the same seven locations in Tanzania each year.Music events are large-scale events, held outdoors, where a variety of musiciansperform live on an open-air stage. The musicians performance vary betweenlocations from year to year. Each event is held over a weekend (Saturday andSunday) between June and August.

Tickets can be purchased online in advance from Nguvu’s website or on the dayof the event at the entrance gate. Online tickets are available for the followingyear’s event one week after the current year’s events have been completelyperformed. The online Tickets bought are paid for by credit card. Ticketspurchased at the entrance gate can be paid for by credit card or by cash. Cashcollected at the entrance gate is periodically transferred to the on-site cash officeduring the day.

Customers who purchase their tickets online are required to present theirbooking confirmation at the ‘wristband exchange’ where they receive awristband to wear during the event. Wristbands are colour-coded according tothe day of the event for which the ticket has been purchased. Customers whopurchase their tickets on the day of the event receive their wristband at theentrance gate. No customers are permitted to enter the event venue without thecorrect wristband.

Nguvu arranges musicians to perform at the events through the musician’sagent. Fees to well known musicians are usually agreed and paid in advance,either in Tanzanian shillings or in the musician’s local currency. Somemusicians ask for a portion of their fee to be paid in cash (Tanzanian shillings)on the day of their performance. Less well-known musicians are fully paid incash (Tanzania shillings) at the end of their performance. Cash fees arecollected by musicians, or their agents, at the on-site cash office.

Nguvu recruits a number of stewards for the duration of each event whose roleis to provide information and directions to customers. Other temporary staff areemployed to work at the entrance gate or in the wristband exchange. Stewardsand temporary staff are paid in cash at the on-site cash office at the end of eachevent.


Permission to hold each event has to be obtained annually from both the localpolice authority and the local council that is governing the local area where theevent is taking place. The local council determines the maximum number oftickets that may be sold for each day of an event.

The Finance Director of Nguvu has provided you with the followinginformation:(1) At one of the events in August 2018, a customer was seriously injured

after he gained access through the lighting pole and tried to climb it for abetter view of the stage. He fell down and got injured. He was unable towork since the accident event. Nguvu is currently being sued for damagesafter a national newspaper started a campaign on behalf of the injuredcustomer. There were no signs warning customers against climbing thelighting poles and no steward was present near the pole to guide thecustomers.

(2) During 2018, the weaker economic climate and unpredictable coldweather resulted in a decline in ticket sales. This, coupled with increasingcosts from the suppliers, has led to Nguvu’s decision to investigate thepossibility of expansion of its business to overseas. Negotiations areunderway to purchase the right to organize and perform an event in Kitwetown of Zambia. The purchase is to be funded by a bank loan currentlybeing considered by Nguvu’s bankers. As part of the loan negotiation thebank will require a copy of the audited financial statements.

The Finance Director has requested that the audit be completed and audit reportsigned by 3rd April 2019 so that the bank loan could be granted and the purchaseof the rights to perform the event in Kitwe be finalised by 10th April 2019. Inaddition to carrying out the statutory audit, the Finance Director has requestedyour firm to carry out a review of the controls at each event, in particular, thecontrols over cash and the wristband exchange process.

In the forthcoming year, he would like you to undertake a review of controls intwo events. The remaining five events should be reviewed in subsequent years,with two events being reviewed in 2020, other two events in 2021 and the finalevent in 2022. He has requested you to attend the Nguvu board meeting aftereach review so as to discuss your firm’s findings and present yourrecommendations.

REQUIRED:

(i) Explain the matters that you would consider and the procedures that youwould perform in order to decide whether to accept the appointment asexternal auditors of Nguvu. (4 marks)

(ii) Explain the matters that you would consider and the procedure that youwould perform in order to decide whether to accept the additional work oncontrols proposed by the Finance Director. (4 marks)


(iii) Identify, from the information provided in the scenario, the principal auditrisks in respect of the financial statements of Nguvu for the year ended30th September 2018. For each risk, list the factors which lead to itsidentification and outline the procedures that should be included in theaudit plan in order to address it. (12 marks)

(b) During your firm’s external audit of Hanyegwa Company Ltd (Hanyegwa) theaudit manager in charge has informed the firm that Hanyegwa has offered him arole as its new finance director. The audit manager first discussed the role withHanyegwa at the planning meeting for this year’s audit and that he intends toaccept the offer.

REQUIRED:

Outline the ethical issues arising and the safeguards that your firm should adopt.(4 marks)

(c) You are the training officer in a firm of Certified Public Accountants and youhave scheduled an induction course to a group of new audit trainee staff on thearea of fraud and error. On discussing with the trainees prior to the inductionprogramme, a number of them have stated that, they are aware that the issue offraud and error is something they will likely face while performing their duties.They have advised that they are unsure as to what are their responsibilities andthose of the directors in these two areas. Having reflected on this, you havedecided to prepare for them the explanatory notes with regard to audit matterspertaining to fraud and error.

REQUIRED:

Prepare the notes for the audit trainee staff on your induction course which:(i) Differentiate between “the responsibilities of the auditor” and “those of

the directors” with respect to fraud. (6 marks)

(ii) Discuss the steps that auditors should take when fraud is suspected.(6 marks)

(d) You are completing the audit of Kizibo Ltd where the overall materiality levelis TZS.25,000,000 for the year ended 30th June 2018. During the course of theaudit, you have discovered that the directors of Kizibo had not revealed aboutone of the locations where a physical inventory count took place on 30th June2018. The value of inventory held on this premises is included in the draftaccounts at a value of TZS.27,400,000.

REQUIRED:

Outline how the above scenario will impact on the audit report if the auditorcannot carry out alternative audit procedures to determine the existence of theinventory in the unrevealed location. (4 marks)

(Total: 40 marks)


---------------------------------------------------------------------------------------------------------SECTION B

There are FIVE questions. Answer ANY THREE questions---------------------------------------------------------------------------------------------------------

QUESTION 2

(a) Auditors always conduct their audit with a view to determine whether or not thefinancial statements are materially misstated. For this reason, auditors usuallydetermine a materiality level to be used in conduct of the audit and also aperformance materiality level may be set at less than the materiality for thefinancial statements as a whole.

REQUIRED:

(i) Explain why it is necessary for the auditor to determine the materialityfigure at the planning stage of the audit. (4 marks)

(ii) Distinguish between materiality for the financial statements as a whole andperformance materiality. (4 marks)

(b) You are the audit manager for three clients of your audit firm and you arereviewing audit files and draft audit reports submitted by your subordinates onyour request. Extracts of the proposed audit opinions for the three clients are asgiven below:

Tegeta LtdConsistent losses that the company has been incurring for the past four yearsplus its serious liquidity problems do cast doubt on the going concernassumption made by management in the preparation of the company’s financialstatements.

Management has however assured the auditors that the parent company is readyand has given assurance that they will provide financial assistance to Tegeta Ltdto cover its short term working capital. To substantiate this, the parent companyhas issued a letter of comfort to the auditors. You are sure that the companywill continue to trade only if the assistance promised is materialized. Thedirectors have disclosed this fact in the financial statements in their director’sreport. The audit senior has recommended that a qualified opinion should beissued.

Maringo LtdThe year-end of Maringo Ltd is 30th September. Maringo Ltd planned toconduct a physical inventory count on 30th September 2018. However, thewarehouse caught fire which was caused by an electrical fault in the warehouse.The fire destroyed 40% of the inventory together with all the inventory recordsand therefore making it difficult for the company to reliably determine the valueof the remaining stock as there were no record to rely upon. They could


however estimate stock values based on selling prices and profit margins foreach line of inventory.

The audit senior stated that he was unable to obtain any reliable evidence on thevalue of inventory which he considered material to the financial statements.The audit senior has recommended that a qualified audit opinion should beissued with an emphasis of matter paragraph.

Makuti LtdThe year-end of Makuti Ltd is 31st December. In mid-February before thefinalization of the audit, one of the major customers of Makuti Ltd known asMikonge Ltd went into liquidation. At a meeting with all creditors of MikongeLtd, the liquidator announced that all creditors would only get 20% of theamount that Mikonge Ltd owes them.

Makuti Ltd refused to amend the receivables figure arguing that as at the end ofthe period, Mikonge Ltd was in good stand and capable to pay Makuti Ltd theamount outstanding.

The audit senior agreed with the accounting treatment of Makuti Ltd andrecommended that an unmodified audit opinion be issued.

REQUIRED:

Comment on the suitability of each of the recommended audit opinions aboveby clearly stating the arguments for or against the recommendations.(12 marks)

(Total: 20 marks)

QUESTION 3

You are planning the audit of Crash Bang Ltd., whose principal activities aremotorcycle courier services, and the repair and maintenance of commercialmotorcycles. You have been provided with the summaries of financial statements forthe year ended 30th June 2018.

Draft 2018TZS. ‘000’

Actual 2017TZS. ‘000’

Summary statement of Profit or LossRevenue 109,710 115,600Cost of sales (102,030) (104,740)Gro,ss profit 7,680 10,860Administrative expenses (7,820) (7,790)Interest payable and similar charges (2,350) (1,850)Net (loss) profit (2,490) 1,220


Draft 2018TZS. ‘000’

Actual 2017TZS. ‘000’

Summary statement of financial positionNon-current assets 51,780 46,700Current assets

Inventory (parts and consumables) 950 610Receivables 29,750 23,690

30,700 24,300Current liabilities

Bank loan 2,500 -Overdraft 12,450 9,130Trade payables 15,130 12,450Lease obligations 2,070 -Other payables 2,030 1,490

34,180 23,070Long-term liabilities

Bank loan 7,500 10,000Lease obligations 4,730 ____-

12,230 10,000Net assets 36,070 37,930

You have been informed by the Managing Director of crash Bang that the fall inrevenue is due to:

(1) The loss of a longstanding customer who shifted to a competitor, in July, 2018(2) A decline in trade in the repair and maintenance of commercial motorcycles

Due to the reduction in the repairs business, the company has decided to close theworkshop and sell the equipment and spares inventory. No entries resulting from thisdecision are reflected in the draft financial statements.

During the year, the company replaced a number of vehicles, funding them by acombination of leasing and an increased overdraft facility. The facility was to bereviewed in January 2019 when the audited financial statements will be available.

The draft financial statements show a loss for year 2018 but the forecasts indicate areturn to profitability in 2019 as the Managing Director is optimistic about generatingadditional revenue from new contracts.

REQUIRED:

(a) (i) State any five circumstances particular to Crash Bang Ltd. which mayindicate that the company is not a going concern. (5 marks)

(ii) Explain why the circumstances in (i) above give cause for concern.(5 marks)

(b) Describe any five audit procedures to be performed in respect of going concernat Crash Bang. (10 marks)

(Total : 20 marks)


QUESTION 4

(a) You are the Internal Audit Manager of the Internal Audit Department of KiboTextiles Mills Ltd. (KTML). Your Department is auditing the company’sprocurement system. Extracts from your system notes, which are reliablycorrect (contain no errors) are provided as follows:

Details of the Ordering Department(1) There are six members of staff, one purchasing manager and five

purchasing clerks.(2) The department receives about 75 orders per day. Many orders for

duplicate items come from different departments in the organization.(3) Initial evaluation of internal controls is very high.

Procurement systems:

Ordering Department All orders are raised on pre-numbered purchase requisitions and sent to

the Ordering Department. In the Ordering Department, each requisition is signed by the Purchasing

Manager. Then the Purchasing Clerk transfers the order information ontoan order form and identifies the appropriate supplier for the goods.

One copy of the two-copied order form is sent to the supplier and thesecond copy to the Accounts Department. The requisition is thendestroyed.

Goods Received Notes (GRNs) from the Inward Department are separatedfrom Damaged Goods Notes (DGNs). The DGNs are filed while theGRNs forwarded to the Accounts Department.

Goods Inwards Department All goods received are checked for damage. Damaged goods are returned

to the supplier and a Damaged Goods Note (DGNs) is completed. For undamaged items, a two-copied pre-numbered Goods Received Note

(GRN) is filled.

- One copy of GRN is sent to the Ordering Department attached with theDGN.

- Second copy is filed in order of the reference number for goods beingordered (obtained from the supplier’s goods dispatcheddocumentation), in the goods Inwards Department.

Accounts DepartmentThe GRNs are matched with the orders awaiting the receipt of the invoice (s).

REQUIRED:

Using the system notes provided:


(i) Identify and explain the internal control weaknesses and provide arecommendation to overcome each weakness. (8 marks)

(ii) Identify and explain the additional weaknesses that should be raised by avalue for money audit and provide a suitable recommendation toovercome each weakness. (6 marks)

(b) Independence of the external audit function is the critical component requiredfor the establishment of a positive statutory environment for the work of theController and Auditor General (CAG). However, despite the requirement forthe auditors to become independent, various factors such as ineffectivelegislature, bad vices such as corruption, and political, economic, and socialinfluences may affect the impact of audit findings. In these circumstances,complete independence is unrealistic.

REQUIRED:

Describe criteria used to determine whether the Controller and Auditor General(CAG) maintains adequate independence. (6 marks)

(Total : 20 marks)

QUESTION 5

(a) The report to management, which in some respects is a report on the ability andeffectiveness of management, is as useful to shareholders as the financialstatements and should be distributed to the shareholders and not just to themanagement team.

REQUIRED:

Discuss this proposition giving the arguments for or against it. (10 marks)

(b) A waste disposal company has breached tax regulations, environmentalregulations and health safety regulations. The company auditors have beenapproached by the tax authorities, the government body supervising the awardof licences to such companies and a trade union representative. All of them haveasked the auditors to provide them with information about the company. Theauditors have also been approached by the police who are investigating asuspected fraud perpetrated by the managing director of the company and theywish to ask the auditor certain questions about the company.

REQUIRED:

Describe how the auditors should respond to these types of request. (10 marks)(Total: 20 marks)


QUESTION 6

(a) Briefly describe different models in which internal audit services could bedelivered. (2 marks)

(b) MONO is a listed Construction Company based in the north of the country,whose activities encompass housebuilding and development. Its annual revenueis TZS.550 million and profit before tax is TZS.70 million.

You are the audit senior involved with the audit of MONO for the year ended31st December 2017. The following matters have come to your attention duringthe review stage of the audit in April 2018.1. Customer going into liquidation

One of MONO’s major commercial customers has gone into liquidationshortly after the year-end. As at the year-end, the customer owed thecompany TZS7.5 million.

2. Claim for unfair dismissalOne of the company’s construction workers, Mwakaje Njeri, wasdismissed in November 2017 after turning up to work in a drunkcondition. In December 2017, Mr Njeri opened a case against thecompany for unfair dismissal. Lawyers of the company have advisedthat it is very unlikely that he will be successful in his claim.

3. In March 2018, a fire started as a result of vandalism at one of thecompany’s ten storage depots. The fire destroyed TZS.200 millionworth of building materials.

REQUIRED:

For each of the three above mentioned events at MONO:

(i) Describe additional audit procedures you will carry out. (6 marks)

(ii) State whether the accounts will need to be amended and explain yourreasoning. (6 marks)

(iii) Discuss its potential impact on the audit report, fully explaining youranswers. (6 marks)

(Total: 20 marks)

________________ _______________



SUBJECT : BUSINESS AND CORPORATE FINANCE

CODE : C3

EXAMINATION DATE : THURSDAY, 1ST NOVEMBER, 2018


------------------------------------------------------------------------------------------------------


1. There are TWO Sections in this paper. Sections A and B whichcomprise a total of SIX questions.







_________________


------------------------------------------------------------------------------------------------------SECTION A

Compulsory Question------------------------------------------------------------------------------------------------------

QUESTION 1

(a) Fast-Fast Ltd (trading as FF) provided ferry services along the Indian Oceancoast between Dar es Salaam and Bagamoyo. The company has approached yourfirm for assistance in preparing a business plan to obtain finance for a plannedexpansion of its services. FF’s directors have produced a draft business plan andhave requested your help in completing certain sections of it. They have alsoasked for advice in supplementing the plan in order to maximize the possibilityof raising new finance.

Given below are extracts from the draft business plan prepared by Fast-Fastmanagement.

(1) IntroductionFast Fast Ltd (FF) provides commuter ferry services between Dar es Salaamand Bagamoyo. The business was founded in 1999 by two entrepreneurs,Anton Pembe and Adriano Binamungu, who have spent the majority of theirworking life and leisure time on boats. Anton and Adriano are the onlydirectors and managers, and each owns 50% of FF’s equity.

(2) Description of current servicesCurrently, FF’s commuter ferry service runs between Dar es Saaam andBagamoyo a major tourist and residential area, 40 kilometers outside Dar esSalaam every 2 hours at peak times and every 3 hours off-peak, five days aweek. It stops at piers along the coast where the commuter embark anddisembark and connects to all major commuter bus and rail interchanges. FFalso runs daytime leisure services at weekends and on public holidays.

FF’s boats are fast, modern and fuel-efficient, with a capacity of 200passengers. Coastal services do not suffer from the congestion problems andinterruptions faced by the rail and bus networks and, as a result, journeytimes are more predictable and the majority of services run on time.Standing and overcrowding are not permitted under health and safetyregulations, so all passengers travel in airline-style seats. To date, FF has aperfect safety record. An added attraction for commuters is that an extensivewireless network is available along the coast, allowing internet access forcommuters.

FF’s fares are higher than other forms of public transport because commutersare prepared to pay a premium for these benefits. Tickets for journeysoperate in a similar fashion to other forms of public transport, with theoption to purchase single and return tickets. There are concessionary faresfor students and the elderly and discounts are available for those regular


passengers who purchase season tickets (which allow unlimited travel, at anytime during the period for which the season ticket is valid).

In order to utilize the boats outside the core commuter hours, FF offers acheaper “Ruvu-Saddani” ticket which allows leisure passengers to visit someof Dar es Salam and Bagamoyo tourist and cultural attractions. This ticket isvalid on any off-peak service. FF operates additional services for a varietyof exhibitions and media events held at a wharf-side conference andexhibition centre. It has also recently approached a hotel chain which ownsa wharf-side hotel with a view to transporting its clients from the airport.

(3) Expansion planFF has a strong record of growth and profitability. Having started in 1999with a single boat carrying less than 1,500 passengers a week, the fleet hasgrown to seven boats, carrying more than 20,000 passengers per week. Lastyear passenger journeys on the service increased by over 50%, due mainly tothe increase in commercial and housing developments along the coast.

FF has also benefits from the government’s initiative to promote use of theocean as more environmentally friendly form of public transport. This hasresulted in increased demand for FF’s service, plus government finance. FFwants to expand its services by increasing the capacity and frequency ofservices on existing routes. Research suggests that the recent increase inpassenger volumes is sufficient to merit eight boats a day during peak times,i.e offering a service every one and half hour instead of the current two hoursinterval between boats.

Dar es Salaam will host a major sport event in 2020 which represent anothergrowth opportunity for ocean transport. The sport event will necessitatesignificant increased transport in the months leading up to carter for thespecific transport needs of spectators, athletes and workers at coast-sidevenues.

In addition to the short-term increase in demand generated by the sportevent, the government plans for further commercial and residentialdevelopment of wharf-side indicates that there will be longer termopportunities to provide ongoing commuter services in the future. In orderto capitalize on these opportunities, FF needs to invest in some new, largerboats, for which finance is being sought. Two options are available – FF canpurchase the boats outright or lease them for a minimum period of five years.FF’s existing boats have been financed by a combination of mandatorycontributions from coast side developers, government grants and loans takenout by FF.

(4) CompetitionThe City Coastal Authority (CCA) is a government body responsible forregulating services along the coast and operating the costal piers. FF is theonly company that has fulfilled the necessary criteria to be licensed by theCCA to provide coastal based commuter services, so it has no direct


competition. However, a variety of alternative public transport options areavailable to commuters, including the bus and rail networks.

In addition to these other forms of transport, FF’s tourist business facescompetition from small operators offering ocean boats and specificsightseeing tours by bus. The volume of tourists is very variable and isinfluenced by disposable income, exchange rates and the weather.

REQUIRED:

Acting as a consultant, prepare the following sections for inclusion in thebusiness plan:

(i) A SWOT Analysis of FF’s current strategic position. (12 marks)

(ii) An analysis of FF’s critical success factors. (8 marks)

(b) Remsi Baraka, the CEO of Fahami Enterprises, is considering a merger withEmpire Inc., which is led by Matayo Mtoni. The merger of their two firms willenable the creation of a very large diversified conglomerate, with businessesranging from office supplies sporting goods, industrial paints, consumerelectronics, and video games. A hired consultant has advised Baraka and Mtonithat the merger could create a great deal of value, because the new combinedentity can use several lucrative yet mature “cash cows” within Empire Inc. tofund the growth of several promising, but not yet highly profitable, youngbusinesses within Fahami Enterprises. Baraka and Mtoni have decided to seek asecond opinion from you, a long experienced consultant.

REQUIRED:

Explain to the two CEOs how the Boston Consulting Group (BCG) matrix canbe used in the light of the advice from the consultant. In your explanations,point out the meaning and logic of the model (matrix). (8 marks)

(c) Acquisition is one of growth strategies that a firm can employ. Sometimes anacquisition attempt can turn hostile when management of the target firm resistadvances from the suitor.

REQUIRED:

(i) Explain the meaning of a “hostile takeover” and any two alternatives toa hostile takeover which do not necessarily involve approach to themanagement of the target firm. (4 marks)

(ii) Discuss any four defensive strategies that a takeover target can employin a hostile takeover situation. In your explanation, indicate thecircumstances in which each strategy is likely to work for the takeovertarget and possible adverse consequences if the takeover does not gothrough. (8 marks)

(Total: 40 marks)


------------------------------------------------------------------------------------------------------SECTION B

There are FIVE questions. Answer ANY THREE questions.------------------------------------------------------------------------------------------------------

QUESTION 2

(a) Recent financial information related to Matata Co, a stock market listedcompany, is as follows:

Assets TZS. “000 000”Non-current assets 600Current assetsCash 500Inventory 100Receivables 200LiabilitiesCurrent liabilities 400Non-current liabilities 200EquityOrdinary shares (nominal) 80Reserves 720Profit and dividendsProfit after taxes 70Dividends 40

Financial analysts are forecasting that the dividends of Matata Co. will grow inthe future at a rate of 4% per year. This is slightly less than the forecast growthrate of the profit after tax of the company, which is 5% per year. The financedirector of Matata Co. thinks that, considering the risk associated with expectedearnings growth, an earnings yield of 11% per year can be used for valuationpurposes. Matata Co. has a cost of equity of 10% per year and before-tax cost ofdebt of 7% per year. The 8% bonds will be redeemed at a nominal value in sixyears’ time. Matata Co. pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is TZS.8.50 per share.

REQUIRED:

(i) Calculate the value of Matata Co. using each of the following methods:Balance Sheet approach, Dividend Growth Model and Earnings MultipleModel. (6 marks)

(ii) Briefly explain why the results in (i) above are similar or different andsuggest the valuation method you consider the most appropriate.

(2 marks)


(b) Discuss the weaknesses of the Dividend Growth Model in the valuation of acompany and its shares. (4 marks)

(c) Uyole Company is a medium size Tanzanian company with export and importtrade links with US companies. The following transactions are due within thenext six months:

Purchase of components, cash payment due in 3 monthUSTZS.10,000 Sales of finished goods, cash receipts due in 6 months USTZS.15,000 Purchase of finished goods for resale, cash payment

due in 3 months USTZS.25,000 Sales of finished goods, cash receipt due in 6 months USTZS.24,000

Exchange rates quoted in the foreign currency market are as follows:

Spot (TZS/US TZS.) 2,410 – 2,4303 months forward 8.00 – 10.00 Premium6 months forward 10 – 12 premium

The company decides to cover the above transactions in the forward market andthe actual spot rates in 3 months and 6 months turned out to be as follows:

3 months: TZS/USTZS.: 2,370 – 2,3806 months: TZS/USTZS.: 2,210 – 2,230

REQUIRED:

(i) Determine the net TZS receipts which Uyole Company might expect toreceive for both its three and six-month transactions if the transactionsremained uncovered. (4 marks)

(ii) Determine the net TZS receipts which Uyole Company would receive forboth its three and six month transactions if they were covered in theforward market. (4 marks)

(Total : 20 marks)

QUESTION 3

(a) Pefa Ltd is a clothing company founded five years ago with equity finance. Atthe beginning of last year it had an equity with market value of TZS.200 million,which increased to TZS.215 million by the end of the year. This was aftergenerating TZS.20 million of post-tax profit in the year and the payment of aTZS.6 million dividends. The capital invested in the firm by shareholders overthe company’s life by purchasing shares and retained earnings amounted toTZS.30 million at the start of the year.


REQUIRED:

(i) Briefly explain the market value added concept and its limitations.(4 marks)

(ii) Compute the market value added at the beginning and at the end of thepast year for Pefa Ltd. (4 marks)

(iii) What would have been the market value added at the beginning and theend of the past year had the dividend not been paid? (4 marks)

(b) Explain the meaning of a convertible loan note as a source of long term finance.Briefly discuss any two advantages of using a convertible loan note. (4 marks)

(c) Explain the meaning of term “overtrading”. Discuss any four indications that afirm may be overtrading. (4 marks)

(Total: 20 marks)

QUESTION 4

(a) Using examples, explain each of the following concepts and its applicability incorporate finance:

(i) Forward rate agreement (3 marks)

(ii) Interest rate floor (3 marks)

(iii) Interest rate collar (3 marks)

(b) Maswa Enterprises is a company involved in the manufacture of farmimplements. The managing director believes that one of the reasons mostcompanies in this industry die is poor management of working capital. MaswaEnterprises expects credit sales of TZS.180,000,000 in the next year and hasbudgeted production costs as follows:

TZS.Raw materials 40,000,000Direct labour 50,000,000Production overheads 30,000,000Total production costs 120,000,000

Raw materials are in inventory for an average of three weeks and finished goodsare in inventory for an average of four weeks. All raw materials are added at thestart of the production cycle, which takes five weeks and incurs labour costs andproduction overheads at a constant rate.

Suppliers of raw materials allow four weeks’ credit, whereas customers aregiven 12 weeks to pay.


REQUIRED:

(i) Compute Maswa Enterprises working capital requirement. (8 marks)

(ii) Determine Maswa Enterprises’ cash conversion cycle. (3 marks)(Total : 20 marks)

QUESTION 5

(a) Baama Company has decided to acquire a new truck. One alternative is to leasethe truck on a 4-year contract for a lease payment of TZS.10,000,000 per year,with payment to be made at the beginning of each year. The lease payment istax allowable and includes maintenance. Alternatively, Baama could purchasethe life span of truck outright for TZS.40,000,000 financed with a bank loan.The bank loan will be amortized over 4 years period at an interest rate of 10percent per year, payment to be made at the end of each year. Under theborrow-to-purchase arrangement, Baama would have to maintain the truck at acost of TZS.1,000,000 per year; payable at year-end. After its life span of 4years the truck will have a salvage value of TZS.10,000,000 at which timeBaama plans to replace the truck irrespective of whether it leases or buys.

Baama has a marginal tax rate of 40 percent. The depreciation rates underborrow-to-purchase are 25%, 30%, 14% and 6% of the purchase price for thefirst, second, third and fourth year respectively.

REQUIRED:

Compute the present value of the cost of each alternative and advise whether thetruck should be bought outright or leased. (12 marks)

(b) Explain the meaning of hybrid securities as used by firms in raising finance.Explain the features and advantages of any three hybrid securities. (8 marks)

(Total: 20 marks)

QUESTION 6

(a) On 30th October, 2018 Ibra Trading Company exported goods to a customer inUtopia. The Utopia customer was invoiced for UD100,000 (UD = Utopiandollar) payable on 30th January, 2019. In the foreign exchange market, thefollowing quotes were available:

Foreign Exchange Market Quotes (30th October, 2018)Spot TZS/UD 846 - 85230th December, 2018 Forward 836 - 84230th January, 2019 Forward 833 - 839

The management of Ibra Trading Company wishes to hedge the foreignexchange exposure with traded currency options. January 2019 exchangetraded options have the following characteristics:


UD Exchange Traded optionsUD Calls UD Puts

Exercise price TZS.837 TZS.835Option cost TZS.4 TZS.3Maturity 30th January, 2019 30th January, 2019Option contract Size UD10,000 UD10,000

REQUIRED:

(i) Illustrate how Ibra Trading Company can make use of the UD Optionsto guard its foreign exchange exposure. What will be the cost of the UDoption? (Hint: Set up a hedge position). (5 marks)

(ii) Comment on the UD option position on 30th January, 2019 if theTZS/UD spot rate on that date is TZS/UD 830 – 833 and illustrate theaction to be taken by the company to benefit from the option position.What would be the net receipts from the transaction and the resultingeffective exchange rate? (5 marks)

(b) An investment advisor to your company claimed that buying a call option isvery dangerous because it commits the owner to purchasing a stock at a laterdate. At that time, the stock may be undesirable. Therefore, owning a calloption is a risk position.

REQUIRED:

Give your views on the validity of this claim. (4 marks)

(c) Consider two call options on the same stock with the following features:

Option Exercise Price Time to expiration Premiumx TZS.600 3 months TZS.50y TZS.600 6 months TZS.40

REQUIRED:

If it is possible to take both long and short positions, comment on the pricing ofthese options and possible strategy to exploit any mispricing. In yourexplanations, point out the profit or loss that you will make in three months’time if the pricing of the stock is TZS.550, TZS. 600 or TZS.650. (6 marks)

(Total: 20 marks)

________________ _______________



SUBJECT : PUBLIC FINANCE AND TAXATION II

CODE : C4

EXAMINATION DATE : FRIDAY, 2ND NOVEMBER, 2018

TIME ALLOWED : THREE HOURS (2:00 P.M. – 5:00 P.M.)

---------------------------------------------------------------------------------------------------------


2. There are TWO Sections in this paper. Sections A and B which comprise atotal of SIX questions.

2. Answer question ONE in Section A





7. Calculate your answers to the nearest one decimal point where necessary.


_________________


---------------------------------------------------------------------------------------------------------SECTION A

Compulsory Question---------------------------------------------------------------------------------------------------------

QUESTION 1

A Case

(a) ABBY PLC, a French based manufacturer of high quality watches has recentlyconsidered establishing a subsidiary in Tanzania where its watches are highlydemanded. Various departments of ABBY PLC were asked to supply relevantinformation for a capital budgeting analysis. All relevant information are asfollows:

1. Initial investment:An estimated Euros 300,000 will be needed for the project. Out of thatamount, Euros 50,000 will be used as working capital and the remainingamount will be used to acquire non-current assets for the project.

2. Project life:The project is expected to end in four years. The host government haspromised to make payment to the parent company of TZS.150,000,000(which is equivalent to the salvage value of the non-current assets) in orderto purchase the plant after four years.

3. Price and demand:The estimated price and demand schedules during each of the next fouryears are as shown below:

Year Price per unit(TZS.)

Demand in Tanzania(UNITS)

1 5,000 60,000

2 5,000 60,000

3 6,000 100,000

4 7,000 100,000

4. Costs:The variable costs (for materials, labour and overheads) per unit wereestimated and consolidated as shown below:

Year Variable Costs per unit (TZS.)1 2,0002 2,0003 2,5004 3,000


The company is also expecting to incur TZS.20 million per year as rentalcosts and additional annual overhead expenses of TZS.30 million.

5. Host country taxes on income earned by a subsidiary:The Tanzanian Government will allow ABBY PLC to establish thesubsidiary and will impose a 30% corporate tax rate on its profits. Inaddition, it will impose a 10% tax on repatriated income.

6. French Government taxes on income earned by ABBY PLC’s subsidiary:The French Government will charge 15% of foreign earned income.

7. Capital Deductions:All non-current assets of the subsidiary will qualify for capital deductions.The tax laws in Tanzania will allow the subsidiary to provide depreciationallowance for the company’s non-current assets at a straight line methodafter deducting a salvage value of the assets.

8. Exchange rates: the spot exchange rate for one Euro (€) is TZS.3,000.

REQUIRED:

(i) With the use of the provisions of the Income Tax Act, CAP 332 discussthe nature and taxation of ABBY PLC’s planned subsidiary. (4 marks)

(ii) Calculate the expected net profit and expected corporate tax for thesubsidiary during the whole period of the project as per the requirementof Income Tax Act, CAP 332. (14 marks)

(iii) Calculate the expected repatriated income and repatriated tax during thewhole period of the project as per Section 72 of the Income Tax Act,CAP 332. (16 marks)

(b) Assume AEJ Ltd is a Tanzanian company based in Canada and that during theyear of income ended 31st December 2017, it earned a total profit equivalent toTZS.89,000,000 and it was taxed an equivalent of TZS.7,000,000.

REQUIRED:

With the use of the provisions of the Income Tax Act, CAP 332, determine theamount of tax chargeable in Tanzania with foreign tax relief and without foreigntax relief. (6 marks)

(Total: 40 marks)


---------------------------------------------------------------------------------------------------------SECTION B

There are FIVE questions. Answer ANY THREE questions---------------------------------------------------------------------------------------------------------

QUESTION 2

(a) Analyze the main features which distinguish the concept of ‘permanentestablishment’ from a ‘permanent home’. (2 marks)

(b) Mrs. Twaweza is a resident employee of WAZAWA Investments LimitedCompany (WAZAWA), working as a Consultant and Technical Engineer undera fixed employment contract of five years effective from 1st January 2014.WAZAWA is a resident company with several business lines of which one isdealing with mining activities, for which Mrs Twaweza is solely employed.

The company has a housing scheme, under which it provides accommodation toall employees who then suffer an 8 percent deduction on their salaries as rentcontribution. She was, however, employed under a differential schemearrangement which provided for among other things a free house.

During the year 2017, she was entitled to a monthly salary of TZS.15,000,000;monthly duty allowance, TZS.500,000; entertainment allowance,TZS.1,000,000 per month, which she was required to account; and TZS.300,000per month to meet travelling expenses. She was, however, not required toaccount for the travelling expenses.As part of the contract, she was also provided with the following benefits:

1. A residential house for which she was required to pay a token rentamounting to TZS.100,000 per month in respect of the part occupied. It is amodern 4-rooms house, in which one room is used to keep variousequipments used in her employment. These equipments were bought by theemployer to assist her perform the duties efficiently. Landlords in the nearbyarea charge similar houses a monthly rent of TZS.600,000. Company wasclaiming a monthly deduction of TZS.300,000 in respect of the house.

During the first two years and three months of her employment, that is, until31st March 2017 she was accommodated in a hotel. The employer paid allaccommodation costs directly to the hotel during this period, includingmeals TZS.20,000,000 and TZS.30,000,000 as accommodation. This was alump sum amount.

2. Security and housemaid services and utility charges amounting in aggregateto TZS.3,000,000 per month were met by the employer.

3. Free use of company’s motor vehicle. This was a Toyota Land cruiser(3000cc) newly purchased for her. She was using this car while on dutyonly. Employer was claiming expenditure amounting to TZS.1,500,000 permonth in respect of the car.


4. The company has a loan policy which entitles all employees who havesuccessfully passed 12 months’ probation period a loan of up toTZS.120,000,000 at a subsidized 4 percent annual interest rate. Mrs.Twaweza secured the full amount loan on 1st January 2016 and agreed topay it in 24 monthly instalments, using average method, starting 31st

January 2016. The statutory rate has been stable at 12 percent per monthsince 2014.

5. She was contributing a 5 percent to an unapproved retirement fund, andanother 5 percent to an approved retirement benefit fund.

The employer made the following contributions on behalf of Mrs Twaweza:

6. 10 percent of her monthly basic salary as employer’s contribution to anapproved retirement benefit scheme. This contribution is not included in theemployee’s taxable income.

7. 5 percent of her monthly basic salary as a contribution to a privateunapproved retirement benefit scheme. This was the same scheme in whichthe employee was making her first package of contribution in (5) above.

8. 3 percent of her monthly basic salary to cover life insurance policy for herhusband, five children and herself to an insurance company.

Following her aggressive involvement in political movement during the year2017, her contract was terminated effective from 1st January 2018 as this wasagainst company’s ideology. As a result of this termination, she was paid alump sum compensation of TZS.100,000,000.

Other information:

9. Mrs Twaweza has reported unadjusted trading profits of TZS.60,000,000from her grocery and kuku projects for the year ended 31st December 2017.

10. During the year 2017, she received dividends of TZS.1,500,000 from sharesinvested in a nonresident corporation many years ago. Also, she receivedaccumulated rent of TZS.8,000,000 from one of her tenant in her residentialpremises situated in the nearby area. This rent was outstanding in respect ofeight months of the year 2016, and it was reported as income from tradingactivity. During the same year 2017 she received TZS.2,500,000 as interestfrom the money deposited in a private foreign bank. This interest wascomputed on the basis of bank balance of TZS.125,000,000.

11. During 2017, she received service fees amounting to TZS.10,000,000 inrespect of technical advices provided to a neighbouring mining company.This income is included in her profits from the business activities.

12. Provisional assessment on the income tax payable for the year 2017 on hergrocery and kuku businesses estimated a quarterly instalment of


TZS.1,200,000. This was previously deducted from the books whencomputing reported trading profit.

13. On 30th June 2017 she received TZS.5,300,000 as gains from an interest inan unapproved retirement fund. This was only a part of her 5 percentmonthly contribution made to the fund.

REQUIRED:

On the basis of the above information, and guided by the relevant provisions inthe Income Tax Act, calculate for the year of income 2017.(i) Total taxable income from employment (12 marks)(ii) Taxable compensation and the years of assessment (2 marks)(iii) Total chargeable income (4 marks)

(Total : 20 marks)

QUESTION 3

(a) Ng’aa Cosmetics, a corporation, filed a statement of estimated tax for the year2016 (1st January 2016 – 31st December 2016) on 2nd May 2016, estimating atax payable amounting to TZS.8,300,000. The company paid on this date itsdues for the first two instalments. The 3rd installment was paid on its due dateand on 31st December 2016 the company revised its estimated income toTZS.250,000,000 and paid the respective fourth installment. There was no taxpaid through the withholding system during the year of income. The return ofincome filed by the company on 2nd August 2017 showed a total ‘principal’ taxof TZS.96,500,000 based on the company’s income for the year of income2016, and paid the tax due on the same date.

Where relevant, payments made on each specific dates include any applicableinterest/penalty due at the date of payment. Income tax rate is 30 percent.

REQUIRED:

Calculate:(i) The amount paid on the 2nd May 2016. (4 marks)

(ii) Amount paid on the 3rd instalment. (1 mark)

(iii) Amount paid on the 4th instalment. (1 mark)

(iv) Amount paid on 2nd August 2017 (6 marks)

(b) Mtaita (T) Ltd received a notice of assessment from the Commissioner on 25th

June 2017, showing that its taxable income for the year is TZS.400,000,000, andthey are supposed to pay corporation tax based on this amount. Upon receipt ofthis notice, the accountants and the finance director are surprised as theircomputations reveal an amount of tax payable to be only TZS.35,000,000. They


thus file a notice of objection, with the Commissioner on 8th July 2017 clearlyspecifying the grounds for such objection, and indicating their computationschedules to support that tax should be TZS.35,000,000. However, they missone thing to make their notice of objection valid, i.e. there is an amount of taxthey are supposed to pay pending final determination, and they can’t figure outhow much is this amount.

REQUIRED:

(i) Calculate the amount of tax that Mtaita Ltd was required to pay to maketheir notice of objection valid. (4 marks)

(ii) Explain the rationale for the provision you have applied in computingthe amount in (i) above. (2 marks)

(iii) Calculate the amount in (i) above if the Commissioner’s assessmentshowed a taxable income of TZS.300,000,000. (2 marks)

(Total : 20 marks)

QUESTION 4

Mr. Kweka, Mr. Leka and Mr. Feiza are partners trading under the name KLFEnterprise. They share profit and losses in the ratio of 5:3:2 respectively. Given belowis the Statement of Profit or Loss of the Partnership for the year ended 31st December2017.

TZS. ‘000’ TZS. ‘000’Office expenses 612,000 Gross profit 6,900,000Instalment tax paid 135,000 Discount received 240,000Rent and rates 450,000 Profit on sale of shares 300,000Salaries and wages 840,000 Rent from property 396,000Printing stationery 192,000 Miscellaneous receipts 450,000Advertisement 219,000 Interest on fixed deposit 360,000Interest on capital:Kweka 180,000Leka 210,000Feiza 240,000Commission to partners:Kweka 135,000Leka 105,000Legal charges 246,000Depreciation 276,000Bad debts 204,000Donation to famine relief 300,000Electricity 138,000General reserve 360,000Showroom expenses 351,000General expenses 297,000Net profit 3,156,000 ________

8,646,000 8,646,000


The partners have provided the following information in support of the accounts:

(i) It has been the practice to value the stocks at cost price, however, the closinginventory at 31st December 2017 – TZS.540,000,000 has been valued at amarket price which is less by 10% of its cost price.

(ii) Salaries and wages include ‘salaries’ amounting to TZS.120,000,000 paid toLeka.

(iii) Advertising includes TZS.30,000,000 spent on advertising campaign tointroduce new product in the market.

(iv) Legal charges include TZS.36.000,000 paid as a fine and penalty.

(v) Capital allowance has been agreed with the Commissioner responsible forIncome Tax at TZS.270,000,000.

(vi) Mr. Leka has got no other income.

(vii) Mr. Kweka’s other income includes TZS.360,000,000 from rent. He hasbrought forward business loss of TZS.405,000,000 from the assessment of theyear of income for 2016 of the partnership.

(viii) Mr. Feiza has income for TZS.600,000,000 from gamble winnings. He hasbrought forward business loss of TZS.405,000,000 from the assessment of theyear of income for 2016 of the partnership.

REQUIRED:

(a) Compute the total taxable income from the partnership business. (10 marks)

(b) Distribute the profit amongst the partners for the year 2017. (5 marks)

(c) Ascertain the profit amongst the partners for the year of income 2017.(5 marks)(Total: 20 marks)

QUESTION 5

(a) While governments can borrow to fund expenditure, loans must ultimately berepaid through taxation. Taxation is therefore key to supporting governmentexpenditure, it is important to understand how a government can design aneffective tax system.

REQUIRED:

Explain why an increase in rates of taxation may not necessarily lead to anincrease in net revenue from taxation. (10 marks)

(b) Vavene Company Limited is a mining company in Makete, Njombe. The mainline of business for the company is mining of coal in Makete and sometimes goldin Mbeya.


During the year of income 2016 the company incurred the followingexpenditures in relation to mining:

(i) TZS.800 million to explore the nearby area for an expansion of the mine.The exploration was successful and therefore expanded the mine at a totalcost of TZS.2,150,000,000.

(ii) TZS.100 million to reinforce the underground rails and roads as well asthe underground drainage.

(iii) The only road to the mine (of about 1.5 km) was also improved forTZS.20,000,000.

(iv) Compensation to the residents around the additional mine was to the tuneof TZS.700 million.

(v) Some of the additional capital expenditure was set off to the tax accountsrelated to the Mbeya mining, this was to the tune of TZS.500 million.This was necessitated by the fact that the company made an excessiveloss of TZS.2,200,000,000 during the year of income 2015.

(vi) During the year of income 2016 the company managed to realize a profitof TZS.1,900,000,000.

(vii) In order to make life easy for the mining, the company bought twominibuses worth TZS.20,000,000 each.

(viii) Three lorries worth TZS.40,000,000 each were also bought to facilitatetransportation of the soil to the clearing sites.

REQUIRED:

Compute the Capital deductions admissible to the company during the year ofincome 2016. (10 marks)

(Total: 20 marks)

QUESTION 6

(a) Explain the nature of ‘juridical double taxation’. (2 marks)

(b) Explain three unilateral methods of eliminating double taxation. (6 marks)

(c) Public finance is not just about money. Its subject matter includes not only allaspects of public sector finances but also the structure of the public sector andfiscal institutions as well as the broad objectives and rationale for thegovernment activities.


REQUIRED:

(i) Discuss different forms that the government may use to intervene theeconomy. (4 marks)

(ii) Evaluate how different types of government expenditure affects theGross Domestic Product (GDP) growth in the short run and in the longrun. (8 marks)

(Total: 20 marks)

_______________________


SUGGESTED SOLUTIONSC 1- CORPORATE REPORTING

NOVEMBER 2018

ANSWER 1

(a) Briefing NotesThis part of the questions requires candidates’ judgement to assess therequirements for consolidation as provided by IFRS, particularly IFRS 10:Consolidated Financial Statements.

Relevant issues to be discussed include.1. First, it appears from the scenario that, the voting rights of Utata in TJC

being 71%; might constitute control by Utata over TJC, ceteris Paribas.IFRS 10 (amended); generally, gives limited exemptions from consolidatinga subsidiary once a definition of control is fulfilled.

2. This exemption applies for example to (a) parent, with no public tradedlistings or instruments, and which is a wholly or partially owned subsidiary ofanother entity, say X. In addition, the other entity (X) publishes consolidatedfinancial statements that comply with International Financial ReportingStandards; (b) particular Employment benefit plans and (c) certain investmententities.

3. There is no information in a case as to (a) or (b) relating to Utata, althoughsome directors could argue in line with (c) that Utata qualify as an investmententity.

4. An investment entity referred to in the IFRS 10 is an entity that:

(i) Obtains funds from one or more investors for the purpose of providingthose investor(s) with investment management services.

(ii) Commits to its investor(s) that its business purpose is to invest fundssolely for returns from capital appreciation, investment income, or both,and

(iii) Measures and evaluates the performance of substantially all of itsinvestments on a fair value basis.

5. Other indicative (not conclusive) characteristics of the investment entityinclude: (1) having more than one investment with more than one investorand (2) investors that are not related parties of the entity and (3) hasownership interests in the form of equity or similar interests.

6. Given the definition and characteristics above, it appears therefore that, Utata,being a private held company, is likely to qualify as an investment entity.


7. Given this argument, Utata may be exempted from the consolidationrequirement required by IFRS 10 (consolidating TJC results as its subsidiary).

8. Utata is therefore required to measure an investment in a subsidiary at fairvalue through profit or loss in accordance with IFRS 9 Financial Instrumentsand possibly reference should be made to the compliance of the abovestandards as opposed to “long established internal policies.”

(b) In this case, although entity A can block any decision, it does not control thearrangement alone because it needs the agreement of either entity B or C.Entities A, B and C collectively control the arrangement; however, there is morethan one combination of parties that can agree in order to reach the 75%threshold:

1. Combination of A and B 75% Control2. Combination of A and C 75% Control3. Combination of B and C 50% No control

Consequently, because there is more than one combination of parties that couldcontrol entity X (i.e. either entities A and B, or entities A and C), joint controldoes not exist.

Therefore, the combination of shareholder interests and the contractualarrangement does not give rise to a joint arrangement, and the arrangement fallsoutside of the scope of IFRS 11.

Each of the three entities needs to consider whether it has significant influenceover entity X. If so, if would account for its investment as an associate inaccordance with IAS 28; Investments in Associates and Joint Ventures and, if not,account for its investment as a financial asset in accordance with IFRS 9Financial Instruments: Recognition and Measurement.


(c) Nyangumi Group

Consolidated Statement of the Financial Position as at 31st December 2017

TZS millionNon-current assetsProperty, plant and equipment (2,458 + 1,410 + 870) 4,738Goodwill (W2) 320

5,058Current AssetsInventories (450 + 200 + 260 - ) W2) 52) 858Trade receivables (610 + 365 + 139) 1,114Cash (240 + 95 + 116) 451

2,4237,481

Equity attributable to owners of the parentOrdinary share capital 500Share premium 250Retained earnings (W3) 3,605

4,355Non-controlling interests (W4) 1,193

5,548Current LiabilitiesTrade payables (1,130 + 418 + 385) 1,933

7481Workings:

W1: Group StructureNyangumi

1. 2013Pre. Acq. Reserves, 60%TZS 950 mil

Sato 10% on 30. July,2011

30. July 2011Pre. Acq. Reserves, 80%TZS 100 mil

Kambale

Therefore:The effective interest in Kambale is (60% x 80%) + 10% = 58%Non-controlling interests 42%

100%


W2: GoodwillNyangumi in Sato Nyangumi in Kambale

TZS mil. TZS mil. TZS mil. TZS mil.Consideration transferred 900 144Fair value of non-controlling interests 536 210Fair value of 10% equity interest in Kambale 50Fair value of identifiable net assets at acq’n:Share capital 200 100Share premium 120 50Pre-acquisition retained earnings 950 (1,270) 100 (250)

Goodwill 166 154Total goodwill (166 + 154) 320

W3: Retained earningsNyangumi SatoKambaleTZS mil TZS mil TZS

mil

As given 2,805 1,572 850P/L gain on investment in Kambale (50 – 27) 23Less unrealized profit (W5) (52)Retained earnings at acq’n (W2) (950) (100)

570 750Group share of post acq’n ret’d earnings:Sato (570 x 60%) 342Kambale (750 x 58%) 435Group share of impairment losses to date (0)

3,605

W4: Non-controlling interestsSato KambaleTZS mil. TZS mil.

NCI at acquisition (W2) 536 210NCI share of post acq’n ret’d earnings:Sato (570 x 40%) 228Kambale (750 x 42&) 315Less NCI share of investment in Kambale(240 x 40%) (96) -

668 525Total NCI (668 + 525) 1,193W5: Unrealized profit on inventoriesMark-up = TZS260m x 25 = TZS 52 million

125


ANSWER 2

(a) (i) Creative AccountingHere are a few examples of creative accounting:

Income recognition and cut-offManipulation of cut-off is relatively straightforward.For instance, a company may delay invoicing in order to move revenueinto the following year.

RevaluationsThe optional nature of the revaluation of non-current assets leaves suchpractices open to manipulation. The choice of whether to revalue canhave a significant impact on a company’s statement of financialposition.

Window dressingThis is where transactions are passed through the books at the year endto make figures look better, but in fact they have not taken place and areoften reversed after the year end. An example is where cheques arewritten to creditors, entered in the cash book, but not sent out until wellafter the year end.

Change of accounting policiesThis tends to be a last resort because companies which changeaccounting policies know they will not be able to do so again for sometime. The effect in the year of change can be substantial and primecandidates for such treatment are depreciation, inventory valuation,changes from current cost to historical cost (practiced frequently byprivatized public utilities) and foreign currency losses.

Manipulation of accruals, prepayments and contingenciesThese figures can often be very subjective, particularly contingencies.In the case of impending legal action, for example, a contingent liabilityis difficult to estimate, the case may be far off and the lawyers cannotgive any indication of likely success, or failure. In such casescompanies will often only disclose the possibility of such a liability,even though the eventual costs may be substantial.

(ii) Faithful representation requires that transactions and other events shouldbe accounted for and presented in accordance with their substance andfinancial reality and not merely with their legal form.

This is a very important concept and it has been used to determineaccounting treatment in financial statements through accountingstandards and so prevent off balance sheet transactions.


Group accounting is perhaps the most important areas of off balancesheet finance which has been prevented by the application of thisconcept.The most important point is that the definition of a subsidiary (underIAS 27 and IFRS 10) is based upon the principle of control ratherthan purely ownership. Where an entity is controlled by another, thecontrolling entity can ensure that the benefits accrue to itself and not toother parties. Similarly, one of the circumstances where a subsidiarymay be excluded from consolidation is where there are severe long-termrestrictions that prevent effective control.

Financing Noncurrent assets: Finance leases and their accountingtreatment under IAS 17 Leases are another example.

Operating leases do not really pose an accounting problem. Theleassee pays amounts periodically to the lessor and these are charged toprofit or loss. The lessor treats the leased asset as a non-current assetand depreciates it in the normal way. Rentals received from the lesseeare credited to profit or loss in the lessor’s books.

For assets held under finance leases this accounting treatment would notdisclose the reality of the situation. If a lessor leases out an asset on afinance lease, the asset will probably never be seen on his premises orused in his business again. It would be inappropriate for a lessor torecord such an asset as a non-current asset. In reality, what he owns is astream of cash flows receivable from the lessee. The asset is areceivable rather than a non-current asset.

Similarly, a lessee may use a finance lease to fund the ‘acquisition’ of amajor asset which he will then use in his business perhaps for manyyears. The substance of the transaction is that he has acquired a non-current asset, and this is reflected in the accounting treatment prescribedby IAS 17, even though in law the lessee may never become the ownerof the asset.

With regard to measurement or disclosure of current assets, acommon example where the distinction between financial reality andlegal form is relevant are sale and repurchase agreements. These arearrangements under which the company sells an asset to another personon terms that allow the company to repurchase the asset in certaincircumstances. A common example of such a transaction is the sale andrepurchase of maturing whisky inventories. The key question is whetherthe transaction is a straightforward sale, or whether it is, in effect, asecured loan. In it is necessary to look at the arrangement to determinewho has the rights to the economic benefits that the asset generates, andthe terms on which the asset is to be repurchased.


If the seller has the right to the benefits of the use of the asset, and therepurchase terms are such that the repurchase is likely to take place, thetransaction should be accounted for as a loan.

Another example is the factoring of trade receivables. Where debts arefactored, the original creditor sells the receivables to the factor. Thesales price may be fixed at the outset or may be adjusted later. It is alsocommon for the factor to offer a credit facility that allows the seller todraw upon a proportion of the amounts owed.

In order to determine the correct accounting treatment, it is necessary toconsider whether the benefit of the receivables has been passed on to thefactor, or whether the factor is, in effect, providing a loan on the securityof the receivables. If the seller has to pay interest on the differencebetween the amounts advanced to him and the amounts that the factorhas received, and if the seller bears the risks of non-payment by thedebtor, then the indications would be that the transaction is, in effect, aloan.

(b) (i) The Finance Director may be right in believing that renewing the non-current assets of the company will contribute to generating higherearnings and hence improved earnings per share. However, this will nothappen immediately as the assets will been to have been in operation forat least a year for results to be apparent. Earnings will be higher becauseof the loan being at a commercially unrealistic rate, namely 5% insteadof 9%.

As regards gearing, the Finance Director may well wish to classify theconvertible loan stock as equity rather than debt; thus gearing will belower. He may argue that because the loan is very likely to be convertedinto shares, the finance should be treated as equity rather than as debt.

(ii) IAS 33 Earnings per share requires the calculation of basic earningsper share. The Finance Director believes that the convertible loan he isproposing will not affect EPS and that an interest cost of 5% will notimpact heavily on gearing.

However, IAS 32 will require the interest cost to be based on 9% andIAS 33 also required the calculation and disclosure of diluted EPS

The need to disclose diluted earnings per share arose because of thelimited value of a basic EPS figure when a company is financed partlyby convertible debt. Because the right to convert carries benefits, it isusual that the interest rate on the debt is lower than on straight debt.Calculation of EPS on the assumption that the debt is non-convertiblecan, therefore, be misleading since:Current EPS is higher than it would be under straight debt onconversion, EPS will fall – diluted EPS provides some information


about the extent of this future reduction, and warning shareholders of thereduction which will happen in the future.

IAS 32 Financial instruments: presentation affects the proposed schemein that IAS 32 requires that convertible loans such as this should be splitin the statement of financial position and presented partly as equity andpartly as debt. Thus the company’s gearing will probably increase as theconvertible loan cannot be ‘hidden’ in equity.

(c) Important for transactions to be accounted using substance form ratherlegal form and adversely effects on financial statement when substanceform is not recorded are as follows:In order to be useful information contained in financial statements must berelevant and reliable. This can only be achieved if the substance oftransactions is recorded. If this did not happen the financial statements wouldnot represent faithfully the transactions and other events that had occurred.

Although there are many instances where there are genuine commercialreasons for contracts and transactions adopting the legal form that they do(e.g. to create a secure legal title to assets), equally the legal form is often usedto achieve less desirable purposes. In general, these amount to manipulatingthe financial statements to create a favorable impression.

The typical outcomes of such manipulation are:

The omission of assets, and particularly liabilities, from statement offinancial positon

Improvements to profits and profit smoothing; Improvement of other performance measures such as earnings per share,

liquidity rations, profitability ratios and gearing.

Clearly such effects are not helpful to users of financial statements and thus it isimportant that the substance f a transaction should be recorded in order to avoidthe above distortions.


ANSWER 3

(a) Equivalent rations from the financial statements of Our plan (workings in TZS“000”

Return on year end capital employed (ROCE) 20.9% (1,400 + 590)/(2,800 +3,200

+ 500 + 3,000) x 100Gross profit margin 12.25 2,500/20,500 X 100Operating profit margin 9.8% 2,000/20,500 x 100Current ratio 1.3:1 7,300/5,700Closing inventory holding period 73 days 3,600/18,000 x 365Trade receivables’ collection period 66 days 3,700/20,500 x 365Trade payables’ payment period 77 days 3,800/18,000 x 365Gearing 71% (3,200 + 500 + 3,000)/9,500 x

100

(b) Assessment of the relative performance and financial position of Knowledgeand Ourplan for the year ended 30 September 2017

IntroductionThis report is based on the draft financial statements supplied and the rationsshown in (a) above. Although covering many aspects of performance and financialposition, the report has been approached from the point of view of a prospectiveacquisition of the entire equity of one of the two companies.

ProfitabilityThe ROCE of 20.9% of Ourplan is far superior to the 14.8% return achieved byKnowledge. ROCE is traditionally seen as a measure of management’s overallefficiency in the use of the finance/assets at its disposal. More detailed analysisreveals that Ourplan’s net asset turnover of 2.3 times compared to only 1.2 timesfor knowledge. Put another way, Ourplan makes sales of TZS 2.30 per TZS 1invested in net assets compared to sales of only TZS 1.20 per TZS 1 invested forknowledge. The other element contributing to the ROCE is profit margins. Inthis area Ourplan’s overall performance is slightly inferior to that of knowledge,gross profit margins are almost identical, but knowledge’s operating profitmargin is 10.5% compared to Ourplan’’s 9.8%. In this situation, where onecompany’s ROCE is superior to another’s it is useful to look behind the figuresand consider possible reasons for he superiority other that the obvious one ofgreater efficiency on Ourplan’s part.

A major component of the ROCE is normally the carrying amount of the non-current assets. Consideration of these in this case reveals some interesting issues.Ourplan does not own its premises whereas knowledge does. Such a situationwould not necessarily give a ROCE advantage to either company as the increasein capital employed of a company owning its factory would be compensated by ahigher return due to not having a rental expense (and vice versa). If Ourplan’srentals cost, as a percentage of the value of the related factory, was less than its


overall ROCE, then it would be contributing to its higher ROCE. There isinsufficient information to determine this. Another relevant point may be thatOurplan’s owned pant is nearing the end of its useful life (carrying amount isonly 22% of its cost) and the company seems to be replacing owned pant withleased plant. Again this does not necessarily give Ourplan an advantage, but thefinance cost of the leased assets at only 7.5% is much lower than the overallROCE (of either company) and therefore this does help to improve Ourplan’sROCE. The other important issue within the composition of the ROCE is thevaluation basis of the companies’ non-current assets. From the question, itappears that knowledge’s factory is at current value (there is a propertyrevaluation reserve) and note (ii) of the question indicates the use of historicalcost for plant. The use of current value for the factory (as opposed to historicalcost) will be adversely impacting on knowledge’s ROCE. Ourplan does notsuffer this deterioration as it does not own its factory.

The ROCE measures the overall efficiency of management; however, as wiseplan ltd is considering buying the equity of one of the two companies, if would beuseful to consider the return on equity ((ROE) – as this is what Wise Plan Ltd isbuying. The ratios calculated are based on pre-tax profits; this takes into accountfinance costs, but does not cause taxation issues to distort the comparison.Clearly Ourplan’s ROE at 50% is far superior to knowledge’s 19.1%. Again theissue of the revaluation of Knowledge’s factory is making this ratio appearcomparatively worse (than it would be if there has not been a revaluation). Inthese circumstances it would be more meaningful is the ROE was calculatedbased on the asking price of each company (which has not been disclosed) as thiswould effectively be the carrying amount of the relevant equity for Wise PlanLtd.

GearingFrom the gearing ratio it can be seen that 71% of Ourplan’s assets are financed byborrowings (39% is attributable to Ourplan’s policy of leasing its plant). This isvery high in absolute terms and double Knowledge’s level of gearing. The effectof gearing means that all of the profit after finance costs is attributable to theequity even though (in Ourplan’s case) the equity represents only 29% of thefinancing of the net assets. Whilst this may seem advantageous to the equityshareholders of Ourplan, it does not come without risk. The interest cover ofOurplan is only 3.3 times whereas that of Knowledge is 6 times. Ourplan’s lowinterest cover is a direct consequence of its activity. For example, smallreductions in sales profit margins or small increases in operating expenses couldresult in losses and means that interest charges would not be covered.

Another observation is that Knowledge has been able to take advantage of thereceipt of government grants; Ourplan has not. This may be due to Knowledgepurchasing its plant (which may then be eligible for grants) whereas Ourplanleases its plant. It may be that the lessor has received any grants available on thepurchase of the plant and passed some of this benefit on to Ourplan via lowerlease finance costs (at 7.5% per annum, this is considerably lower than Ourplanhas to pay on its 10% loan notes).


LiquidityBoth companies have relatively low liquid ratios of 1.2 and 1.3 for Knowledgeand Ourplan respectively, although at least Knowledge has TZS 600,000 in thebank whereas Ourplan has a TZS 1.2 million overdraft. In this respect Ourplan’spolicy of high dividend (1 mark) payouts (leading to a low dividend cover andlow retained earnings) is very questionable. Looking in more depth, bothcompanies have similar inventory days; Ourplan collects its receivables one weekearlier than Knowledge (perhaps its credit control procedures are more active dueto tis large overdraft), and of notable difference is that Knowledge receives (ortakes) a lot longer credit period from its suppliers (108 days compared to 77days). This may be a reflection Knowledge being able to negotiate better creditterms because it has a higher credit rating.

SummaryAlthough both companies may operate in a similar industry and have similarprofits after tax, they would represent very different purchases. Ourplan’s salesrevenues are over 70% more than those of Knowledge, it is financed by highlevels of debt, it rents rather than owns property and it chooses to lease ratherthan buy its replacement plant. Also its remaining owned plant is nearing the endof its life. Its replacement will either required a cash injection if it is to bepurchased (Ourplan’s overdraft of TZS 1.2 million already requires seriousattention) or create even higher levels of gearing if it continues its policy ofleasing. In short although Ourprlan’s overall return seems more attractive thanthat of Knowledge, it would represent a much more risks investment. Ultimatelythe investment decision may be determined by Wise Plan Ltd’s attitude to risk,possible synergies with its existing business activities, and not least, by the askingprice for each investment (which has not been disclosed to us).

(c) The generally recognized potential problems of using ratios for comparisonpurposes are:

Inconsistent definitions of ratios Financial statements may have been deliberately manipulated (creative

accounting) Different companies may adopt different accounting policies (e.g. use of

historical costs compared to current values Different managerial policies (e.g. different companies offer customers

different payment terms) Statement of financial position figures may not be representative of average

values throughout the year (this can be caused by seasonal trading or a largeacquisition of non-current assets near the year-end).

When deciding whether to purchase a company, Wise Plan Ltd shouldconsider the following additional useful information:

In this case the analysis has been made on the draft financial statements;these may be unreliable or change when being finalized. Audited financialstatements would add credibility and reliance to the analysis (assumingthey receive an unmodified auditors’ report)


Forward looking information such as profit and financial position forecasts,capital expenditure and cash budgets and the level of orders on the books

The current (fair) values of assets being acquired The level of risk within a business. Highly profitable companies may also

be highly risky, whereas a less profitable company may have more stable‘quality’ earnings

Not least would be the expected price to acquire a company. It may be thata poorer performing business may be a more attractive purchase because itis relatively cheaper and may offer more opportunity for improvingefficiencies and profit growth.

ANSWER 4

(a) (i) How judgement and materiality play a significant part in theselection of an entity’s accounting policies: Judgement and materiality aids in the comparability and consistency

in presentation of Financial Statements for similar – transactions andevents.

When IFRSs doesn’t specifically apply to a particular transaction orevent; the use of management judgement is applied in selecting anddeveloping or applying – accounting policies.

An entity should determine the accounting policies to be applied to aparticular item or transaction with reference to IFRSs; butaccounting policies need not be applied when the effect of applyingthem would be immaterial to the reporting entity.

Materiality and Judgement helps Management of an entity to applyprinciple based and not rule based IFRS when selecting an entity’saccounting policies.

(ii) Circumstances under which an entity may change its accountingpolicies:An entity may change its accounting policies under the followingcircumstances:

When required by a standard (IFRSs) or its Interpretation. When results in the financial statements providing reliable and more

relevant information. This is normally about the effects oftransactions, other events or conditions on the entity’s – financialposition, financial performance or cash flow.

When required by regulatory authority /law.

How the change of accounting policies is applied: The change of accounting policies is applied or accounted for as

required by the new pronouncement/IFRSs, or when the newIFRSs/pronouncement doesn’t include specific transactionprovisions; then the change in accounting policies should be appliedretrospectively; or prospectively. This application (i.e. prospectivelyor retrospectively) depends on the nature of the transaction/event.


Difficulties faced by entity when applying a change in accountingpolicies are: When it is impracticable to determine either the period – specific

effects or the cumulative effect of the chance for one or more priorperiod presented.

Such difficult will lead to a limitation when an entity is eitherapplying prospective or retrospective change in accounting policies.

(b) A disclosure NoteThe IAS 7 amendment requires companies to disclose both cash and non-cashchanges to liabilities arising from financing activities.

The note will show a table which shows opening and closing balances ofliabilities that arise from financing activities which is reconciled byincorporating cash flows and non-cash changes over the reporting period.

Beginning MOVEMENT EndAugust

2016CASH

FLOWSNON CASH FLOWS August

2017Acquisition Foreign Exchange

MovementTZS mil. TZS mil. TZS mil. TZS mil. TZS mil.

Long term borrowing 4,600 5,114 86 - 9,800

Short term borrowing 600 - 47 120 767

Lease liability 310 (210) 400 - 500

Total Liabilities fromfinancing activities

5,510 4,504 533 120 10,667

ANSWER 5

(a) Alternative I

(i) DEFINITIONThe term “property, plant and equipment” includes tangible items that:

Are held for use in the production or supply of goods or services, forrental to others, or for administrative purposes; and

Are expected to be used during more than one period.

RECOGNITION OF A NON-CURRENT ASSETSAn item of property, plant or equipment should be recognized in thebooks if:

It is probable that the economic benefits derived from the item willflow to the business and

The cost/value can be measured with reliability


COST OF A NON-CURRENT ASSET INCLUDES: Purchase price, including import duties and non-refundable purchase

taxes Incidental costs of acquisition – any cost directly attributable to

bringing the asset to the location and condition necessary for it to bebrought into productive use. Examples: Delivery, Installation, Legaland Professional Fees

Finance costs (only those incurred up until the asset is substantiallyready for use) must be capitalized under IAS 23

The initial estimate of the costs of dismantling a removing the itemand restoring the site on which it is located, if the entity has, as thetime of purchase, an obligation to incur such expenditure.

The capitalized cost of any asset cannot exceed its recoverableamount.

The term “capitalize” means that the amount in question is recordedas an asset. The opposite of “capitalize” is to write off as an expensein which case the amount in question is recorded as an expense in theSPLOCI. Although both are debit entries, it is important to choosethe correct class of account asset or expense. The credit entryremains the same regardless.

Alternative II

COST OF A NON-CURRENT ASSET INCLUDES:

Purchase price, including import duties and non-refundable purchase taxes Incidental costs of acquisition any cost directly attributable to bringing the

asset to the location and condition necessary for it to be brought intoproductive use. Examples: Delivery, Installation, Legal and ProfessionalFees

Finance costs (only those incurred up until the asset is substantially readyfor use) must be capitalized under IAS 23

The initial estimate of the costs of dismantling a removing the item andrestoring the site on which it is located, if the entity has, as the time ofpurchase, an obligation to incur such expenditures.

The capitalized cost of any asset cannot exceed its recoverable amount. The term “capitalize” means that the amount in question is recorded as an

asset. The opposite of “capitalize” is to “write off as an expense”, inwhich case the amount in question is recorded as an expense in theSPLOCI. Although both are debit entries, it is important to choose thecorrect class of account asset or expense. The credit entry remains thesame regardless.

(ii) SUBSEQUENT EXPENDITUREFurther expenditures will be treated into two circumstances, all furtherexpenditures incurred and add economic value of assets will becapitalized and those whose value will not bring import or add value toassets should be expensed


(iii) AMOUNTS TO BE CAPITALIZED:TZS ‘000’

Purchase of site 200,000Legal costs and stamp duty on site purchase 16,000Demolition of existing derelict building on site 18,000Design and planning costs 49,000Redesign costs due to conditions of planning permission 15,000Tendering and procurement costs 5,000Construction contractor’s fee to builder’s finish 754,000Completion, painting and furnishing 113,000Total 1,170,000

The following amounts should be expensed:TZS ‘000’

Redesign costs due to errors in the original design 12,000Management time spent on the activities above estimated are 22,000Cost of moving in staff, files and equipment 37,000Cancellation costs of operating lease on previous headbuilding

3,000

Total 74,000

Reasons: Costs due to error do not add to the economic value of an asset.

They are effectively wastage, and should be expensed as incurred Apportionment of management time are indirect costs. They are

not directly attributable to the construction Costs of moving in are not necessary to bring the asset into a

location or condition where it is ready for use Cancellation costs on an old building have nothing to do with a

new building. They do not add any value to the economic benefitsderived from the new building.

Hence the journal entry required to record the new building at 31 December 2017is as follows:

TZS ‘000’ TZS ‘000’Dr Property, plant and equipment 1,170,000Dr Profit or loss 74,000

Cr Suspense 1,244,000

As the building is ready for use 3 months prior to the reporting date, 3 month’sdepreciation should be provided.

Depreciable amount:TZS ‘000’

Total capitalized costs 1 1,170,000Less land component (200,000 + 16,000 + 18,000) (234,000)Less residual value (140,000)Depreciable amount 796,000Annual depreciation charge (796/50 years) 15,920Charge for three months 3,980


Hence the journal entry required to record depreciation of the new building at 31March 2017 is as follows:

TZS ‘000’ TZS ‘000’Dr profit or loss 3,980

Cr Accumulated Depreciation (PPE) 3,980

(b) The proposition not to charge depreciationDepreciation accounting is not undertaken to take care of fall in value of therespective asset.

IAS 16 requires that assets are carried at cost (or fair value) less any accumulateddepreciation and any accumulated impairment losses. Depreciation accounting iseffected to systematically allocate the depreciable amount of an asset over itsuseful life (matching concept).

The proposition to annually test for impairmentIAS 36 only requires impairment testing when an asset is observed to have someindicators of impairment.

For some assets, the standard requires annual testing for impairment i.e.

(i) Goodwill acquired in a business combination(ii) Intangible asset not yet available for use(iii) Intangible assets with indefinite useful life

Buildings do not fall under any of the above assets, thus testing for impairment ofbuildings will have to depend on whether there are indicators of impairment.

ANSWER 6

(a) DefinitionIAS 41 Agriculture, define a biological asset as a living plant or animal

TreatmentIAS 41 Agriculture prescribes the accounting treatment of agricultural activity.This relates to the transformation of biological assets (living animals and plants)into agricultural produce for sale or additional biological assets. Examples ofbiological assets are animals (livestock) such as sheep for wool and foodproduction, or plants for crop such as cotton, sugar, tea, or timber (from forestry).Biological transformation occurs through natural growth procreation (breeding),production (milk) or degeneration (age). These cause qualitative or quantitativechanges in a biological asset. The Standard only applies to the agriculturalproduce to the point of harvest, thereafter the produce is accounted under IAS 2Inventory.

The two main accounting models are based on historical costs or fair values.Under the more traditional historical costing model the effects of biologicaltransformation are not recognized when they occur, but at a later date, usually


when they are realized. For some types of agriculture, for example growth oftimber, this can take many years. If the revenues are recognized only at the endof the biological transformation, and the costs are incurred throughout the period,there is no matching (accruals principle) of costs and revenues.

The fair value model does not apply to agricultural land. This should continue tobe accounted under IAS 16 Property, plant and equipment or IAS 40 Investmentproperty. Both of these standards allow the use of the cost based value or thecurrent (fair value) model.

(b) (i) Amount of Biological Asset to be reports as at 1 July 2017 and 30June 2018

1 July 2017

As at 1 July 2017 the immature trees will be 1-year-old since by 30 June2018 the trees are 2 years’ old

Value of immature trees (1 July 2017) will be present value of futureamount (TZS 6000/=) to be attained in 19 years from 1 July 2017

ie =

19(1.09)

6000/TreTZS

1417.5

6000

r)n1(

6000/Tree

TZS

291,732,306.4

= TZS 1,166.938019/immature tree x 250,000 Trees= TZS 291,734,504.8

30 June 2018

Value of immature trees (30 June 2018) will be the present value of futureamount (TZS 7,000/tree) to be attained in 18 years from 30 June 2018

18

n

(1.09)

7000/treeTZS

7171.4

7000

r)(1

7000/treeTZS

ie

= 1483.956181./immature tree x 250,000 trees = TZS 370,989,045.3370,990,651.0


(ii) Total fair value change

=(FV (30 June 2018) – FV (1 July 2017)

= TZS 370,989,045.3 – TZS 291,734,504.8

= TZS 79,254,540.45 79,258,344.6

(iii) Gain/Loss due change in Fair ValueDue to change in market priceDetermined by changes in prices at different period assuming the physicalappearance is the same

1919 (1.09)

6000TZS-

(1.09)

0007TZS

= 1361.427689 – 1166.938019= TZS 194.48967/Tree. (Gain)= 194.48967/Tree x 250,000 trees

= TZS 48,622.417.51 (Gain)

(iv) Gain /loss due Due to Physical ChangeDetermined by changes in physical appearance assuming prices remain constant

= Price at 30 June 2018 (1 year old) – price at (30 June 2018) 2 year old

1819 (1.09)

7000-

(1.09)

7000

= 1,361.427689 – 1483.956181

= 122.5284921/tree. Gain= 122.528492/tree x 250,000 trees= TZS 30,632,123.01 (Gain)

Note:Effect of change in FV due to price change (iii) 48,622,417+ Effect of change in FV due to physical change (iii) 30,632,123= Total FV change (ii) 79,254,540

______________ ______________


SUGGESTED SOLUTIONSC2 – AUDITING AND ASSURANCE

NOVEMBER 2018

ANSWER 1

(a) (i) 1. Appointment as external auditorMatters to considerThe reasons for the previous auditors not being reappointed should beunderstood.

Consideration should be given to the firm’s ability to undertake theexternal audit engagement, including factors such as the level ofexperience within the firm of music events companies, ability to dealwith online sales processes and availability of staff to undertake thenecessary level of work particularly in light of the time pressure. Thefirm may conclude that an opinion cannot be reached in the timeframeavailable and in light of the fact that no assurance can be gained fromprocedures or attendance at festivals for 2018 (as appointment is postyear-end). The prevalence of cash based transactions may also limitthe firm’s ability to reach an opinion.

The firm should consider whether Nguvu is a client with which itwishes to be associated. The adverse publicity arising from the legalclaim may impact the firm’s own reputation. In addition, issuesraised regarding going concern, the possibility of internal controlweaknesses at festivals as cited by the FD and the reliance by thebank on the financial statements increases the risk associated with thisaudit.

Ethical issues surrounding acceptance should be considered,particularly whether any conflicts of interest are likely to arise withexisting clients (given firm’s current specialism in entertainmentindustry) and the likely proportion of total fee income that will begenerated from Nguvu.

Procedures to performEnquire of management why previous auditors were not reappointed.Obtain written permission from Nguvu to communicate with theprevious auditor, if this is refused the firm should decline theappointment. Write to the previous auditors seeking any informationrelevant to the firm’s decision as to whether or not to accept theengagement.

Undertake a preliminary risk assessment of Nguvu, including areview of prior year financial statements of Nguvu. Carry out clientidentification procedures (as required by money launderingregulations) and undertake research to establish management’s


integrity, for example, director’s search at Companies House andreview of press cuttings and the internet.

(ii) Additional work on controlsMatters to considerAttendance at board meetings may be perceived as undertaking amanagement role. It is also unclear what level of assurance isrequired by the directors in respect of this work.Work on controls may lead to a self-review threat if the work is reliedon as part of the external audit.

Whether the engagement proposed is commercially viable.

Whether staff will be available on appropriate weekends and inappropriate locations.

Procedures to performDiscuss the scope of the additional work with directors to ensure nomisunderstanding arises, in particular, in relation to undertaking amanagement role.Explain to directors that the work is not part of the statutory audit andthat it represents a separate engagement.

(iii)

(1) Audit risk and factors (2) Procedures to address auditrisk

1. Going concern presumptionmay be inappropriate/issue notadequately disclosed: Falling ticket sales/adverse

weather Increased supplier costs Adverse press for injured

customer Lost revenue if police/local

council refuse permissionor reduce ticket numbers

Bank loan increases debt

Review level of advanced ticketsales and compare toforecast/prior year

Review press for further adversereporting

Review correspondence withpolice/local council to ascertain Ipermission granted/ticket volumeschanged

Review management forecasts inlight of increased debt/undertakeworking capital review

2. Errors/omissions undetectedby audit procedures/lack ofassurance over openingbalances/ Deliberatemisstatement or bias: First year audit – lack of

cumulative audit knowledgeand experience

Tight reporting deadline Reliance by bank on

Ensure sufficient staff madeavailable to complete worksatisfactorily in time available

Thorough planning/research togain understanding of clientbusiness

Focus on areas ofsubjectivity/estimate, secondpartner review of such areas

Performance substantive



audited financial statementsto approve loan

FD concerned re controls atfestivals

procedures on opening balances ifthey cannot be verified by othermeans

3. Unrecordedliabilities/undisclosedcontingent liabilities: Possible liability relating to

injured customer

Review correspondence withlawyers regarding legal claim andlikely outcome

Nature of events give rise torisk of non-compliance withhealth and safety

Risk of breaching maximumcustomer numbers allowed bylocal council

Casual staff employed – risk ofnoncompliance with tax andemployment laws

Ascertain if any events after theyear end indicate if a liability islikely to arise

Ascertain if the claim is coveredby insurance policy

Review correspondence withauthorities to ascertain if manyother dispute/liabilities regardinghealth and safety have arisen

Compare total actual ticket salesto correspondence with localcouncil re maximum, numberspermitted

Review Human Resource recordsto ascertain whether appropriatedocumentation is obtained whenhiring temporary staff

Review payroll records toascertain whether appropriatetaxes are deducted for temporarystaff

4. Under or overstatement ofrevenue: Tickets for next year’s

festivals are on sale incurrent year

Online ticket sales couldlead to fraudulent creditcard transactions

Tickets sold on gate forcash – risk of not beingrecorded

Ascertain that sales of tickets fornext year are treated as deferredincome/carry out cut-off testing

Ascertain what security existsregarding online ticket sales andtest the website/system

Ascertain what controls were inplace over cash takings recorded –obtain evidence that thosecontrols were exercised at 2018events.

5. Unrecorded cashtransactions/netting off ofreceipts and payments: Cash received on site from

Review reconciliations of cashpaid/collected on site

Review records from on-site cashoffices and compare to:



ticket sales AND paid outto artists/stewards

o Agreements with artists forpayment on site

o Number of temporary staffemployed and paid

o Level of ticket sales recordedat entrance gate

6. Cut off errors in expenditure Advance payments made to

artists

Review pre and post year-endpayments to artists, ascertainwhich year they relate to and traceto appropriate accounting period.

Compare 2018 actual musiciancosts to 2018 budget

7. Foreign currency translationerrors: Some artists are paid in

their local currency

Check appropriate currencytranslation rate for invoices inforeign currency

Re-perform calculation ofconversion

(b) Ethical issues Objectivity and independence could be compromised Manager will have carried out work whilst negotiating position: might

overlook errors Manager’s relationship with client could be too close (familiarity threat) Fear of offer being withdrawn (self-interest threat) Familiarity threat once position taken up (i.e. knows audit team) Possible intimidation of audit team by manager once position taken up

Safeguards Remove manager from audit immediately Review, and re-perform if necessary, any work, including planning,

undertaken by manager Re-review any work of team previously reviewed by manager/independent

partner review Review composition of audit team Firm to consider if it can be independent going forward/consider resignation

(c) (i) The primary responsibility for the prevention and detection of fraud restswith both those charged with governance of the entity and management. Itis important that management, with the oversight of those charged withgovernance, place a strong emphasis on fraud prevention, which mayreduce opportunities for fraud to take place, and fraud deterrence, whichcould persuade individuals not to commit fraud because of the likelihood ofdetection and punishment.

This involves a commitment to creating a culture of honesty and ethicalbehavior which can be reinforced by an active oversight by those charged


with governance. Oversight by those charged with governance includesconsidering the potential for override of controls or other inappropriateinfluence over the financial reporting process, such as efforts bymanagement to manage earnings in order to influence the perceptions ofanalysts as to the entity’s performance and profitability.

An auditor conducting an audit in accordance with ISAs is responsible forobtaining reasonable assurance that the financial statements taken as awhole are free from material misstatement, whether caused by fraud orerror.It is useful to consider the responsibilities of the auditor and the directors ofan entity with respect to fraud under the following headings:

s/no Directors Auditorsi. Active role Should have active

oversight of the day today running of an entitywhich includesconsidering the potentialfor override of controlsor other inappropriateinfluence over thefinancial reportingprocess, such as effortsby management tomanage earnings inorder to influence theperceptions of analystsas to the entity’sperformance andprofitability

They have no active rolein the management of theentity. During the courseof heir work they maydetect weaknesses ininternal controls and makerecommendations to theentity to address thesewhich may assist inpreventing possible futurefraud.

ii. Preventative As discussed above theyshould place a strongemphasis on fraudprevention, which mayReduce opportunities forfraud to take place, andfraud deterrence, whichcould persuadeindividuals not tocommit fraud because ofthe likelihood ofdetection andpunishment

They have no active rolein the management of theentity. During the courseof their work they matdetect weaknesses ininternal controls and makerecommendations to theentity to address thesewhich may assist inpreventing possible futurefraud

iii. Detection The primaryresponsibility for theprevention and detectionof fraud rests with boththose charged with

An auditor conducting anaudit in accordance withISAs is responsible forobtaining reasonableassurance that the


s/no Directors Auditorsgovernance of the entityand management

financial statements takenas a whole are free frommaterial misstatement,whether caused by fraudor error? Owing to theinherent limitations of anaudit these can only be areasonable expectation anauditor may detect fraud.There is an unavoidablerisk that some materialmisstatements, due toerror or fraud, of thefinancial statements maynot be detected, eventhough the audit isproperly planned andperformed in accordancewith the ISAs

iv. DeterrentRole

It is argued that activeoversight by thosecharged by governancecan act as a deterrent tofraud

The risk of possible fraudbeing detected by anauditor can act as adeterrent

(ii) The following procedures will be used by the audit team when gatheringevidence where fraud is suspected:1) Determine the facts before indicating suspicions to anyone outside of the

audit team.2) Obtain evidence.3) Speak to appropriate level of management as long as you feel they have no

involvement of fraud (without accusation – just present the facts). Once inagreement, the auditor must tactfully ensure that officials understand thepossibilities inherent in the facts.

4) Reach a clear understanding with the client as to the extent of further specialinvestigation work necessary and whether the client or the auditor isexpected to carry it out.

5) Determine if it will materially affect the financial statements and in turn theimplications for your report.

If Error – request management to make necessary amendment If Fraud – notify directors in writing of their need to report the issue,

if they are subsequently unable to provide evidence that the matterhas been reported then the auditor should report the matterthemselves.


(d) This gives rise to a limitation of scope imposed by management resulting in theauditor being unable to obtain sufficient appropriate audit evidence relating to theexistence of an element of inventory at 31 December 2016.

The item is material because it exceeds the materiality threshold of TZS25,000,000. However, the auditor could form the view that it is not so material orpervasive so as to impact on the entire set of financial statements. If the auditorformed that view and regardless of this matter that the financial statements give atrue and fair view, then she/he would express a qualified opinion.(except for)

The auditor is required to include in the Basis for Opinion section of the report adescription and quantification of the financial effects of the misstatement, unlessimpracticable. If it is not practicable to quantify the financial effects, the auditoris required to so state in this section.

When, as in the question scenario, the modification arises from an inability toobtain sufficient appropriate audit evidence, the auditor shall use thecorresponding phrase “except for the possible effects of the matter(s)…” for themodified opinion.

ANSWER 2

(a) Materiality

(i) Need for determining materiality level at planning stage:Auditors are concerned with material issues during the conduct of an audit.Materiality is an important aspect of auditing and materiality levels are setby auditors at the planning stage of the audit. Material items/amounts arethose that if omitted or misstated they could influence the economicdecisions of the users of the financial statements.Further the auditors will wish to ensure that the risk of not detect anymaterial misstatements if reduced to acceptable levels.

Determination of materiality at the planning stages is essential as it will helpauditors know from the start what errors and omissions are consideredmaterial to the financial statements. Further, materiality levels will helpdetermine the nature, timing and extent of audit procedures to be conducted.

(ii) Distinction between materiality for the financial statements as a whole andperformance materiality

Materiality for the financial statement as a wholeBefore commencement of the audit materiality levels for the financialstatements as a whole are set using the recommended criteria.It is also normal that to set materiality levels for individual classes oftransactions or balances such as inventory where misstatements less than themateriality for the financial statements as a whole could be expected toinfluence the economic decisions of users.


This is the materiality level which if the uncorrected errors/omissionsexceed this amount to financial statements are considered to be materiallymisstated

Performance materialityThis is the amount or amounts set by the auditor at less than the materialityat the financial statements as a whole. This is in order to reduce to a lowlevel the probability or chance that the aggregate of uncorrected errors andundetected misstatements exceed the materiality for the financial statementsas a whole.

Performance materiality could also be set for any classes of transactions orbalances for which specific materiality levels have been set. This way theauditor is playing it safe by taking a lower figure as material.

(b) Audit opinion

Tegeta LtdThe parent company has stated that it will give financial support to thiscompany and the letter of comfort is evidence of this. If management gives thenecessary representations and other evidence obtained, then this would give theauditor some comfort. Further, the directors have made the necessarydisclosure in the director’s report.Going by the above recommendation by the audit senior that a modified reportbe issued seems inappropriate. Modification could be unsuitable as the letter ofcomfort had been obtained.

An unmodified opinion is recommended and if necessary the auditor may wishto restate what management has disclosed in their report in an emphasis ofmatter paragraph.

Maringo LtdThe form of modification that should be given in this case will depend on twofactors. The materiality of the matter and whether it is pervasive to the financialstatements. The question states that the matter is material but it does not statewhether or not the matter is pervasive.

In the event that the matter is material and not pervasive, the appropriateopinion would be a qualified report with an except for opinion.

If the matter is both material and pervasive then the opinion will be an adverseopinion stating that the financial statements do not show a true and fair view

ConclusionThe use of a qualified opinion and an emphasis of matter as suggested by theaudit senior is wrong. An emphasis of matter paragraph is not a modification ofthe audit report.


Makuti LtdThe event of a large customer of Mikonge ltd going into liquidation after theyear end is an adjusting event subject to the provisions of IAS 10 Events afterthe reporting period.The fact that the customer has gone into liquidation and the amount to be settledto creditors determined gives additional information of the conditions thatexisted at the period end. There is need to make a provision for the amount thatmay not be collected from this customer.

Under ISA 560 the auditor has a responsibility under ISA 560 Subsequentevents to identify any such events and ensure they are correctly accounted forby management. Management’s refusal to make a provision is not correct andthe auditor should ensure correct treatment of this event.

Conclusion:The audit senior is not right in suggesting that an unmodified opinion be issued.If management insist that they cannot amend the provision at the period end,depending on the materiality and pervasiveness of the matter the auditors shouldconsider modifying the audit opinion.

ANSWER 3

(a) The circumstances which indicate the company is not going concern aredivided into two major groups such as financial indictors and operatingindicators

(i) Circumstances (ii) Why cause for concern?Fall in gross profit % and fall of revenue. While the fall in absolute revenue has been

explained, the fall in gross profit margin is moreserious.This will continue to be a problem, as expensesseem constant and interest costs are growing.This will make a future return to profitabilitydifficult.

Losses TZS 2,490,000. Such levels of losses by comparison to2017 profitwill make negotiations with the bank difficult,especially with the loss of a major customer.

Increased receivables balance andincreased ageing2017 74.8 days2018 98.9 days

Worsening debt collection is bad news when thecompany is making loss and has a deterioratingliquidity position.The increase in average debt collection periodMay be due to an irrecoverable receivable on theaccount of the major customer lost in the year.An irrecoverable receivable write-off would causeincreased losses.

Worsening liquidity ratio2017 1.052018 0.89

This is a significant fall which will worsen furtherif an allowance for irrecoverable receivables isrequired.The company has loan and lease commitments


(i) Circumstances (ii) Why cause for concern?which possibly may not be met.

Increasing reliance on short-term finance This does not secure the future.With the company going through so much changethis may cause difficulties for the bank overdraftfacility negotiations.

Gearing has increased This leads to an interest commitment which is adrain on future profits.This may also cause a problem in negotiating newfinance arrangements.

Loss of major customer to competitor Risk of unallowed-for irrecoverable receivables inthe financial statements.Other customers could follow suit, worsening thecompany’s future prospects.

Draft accounts – final adjustments areoutstanding

The company’s net asset position could beworsened considerably if non-current assets arewritten down to their recoverable amount, and therepairs inventory is written down to net realisablevalue.As mentioned before further allowances forirrecoverable receivables may be necessary.The closure may necessitate redundancyprovisions.All of these factors could increase lossesconsiderably.

Overdraft facility to be reviewed sixmonths after the year end

This time period is probably not long enough tosee a real improvement in the company’sfortunes.As auditors we will be reporting when faced withfundamental uncertainty.Trying to anticipate the bank’s likely reaction tothe financial statements would be a high risk.

Future return to profits anticipated at atime when competitors are achievingsuccess

The concern should be whether this is overoptimistic. If so, too much reliance being placedupon written representations would be a high riskstrategy.

Decreased in production such as reducedin repair business

The reduce of repair its show company is notgoing concern because the company operateunder capacity

Shutdown of workshop and sell ofequipment and spare inventory

Lack of capital to run out the workshop

Summary. If the company is not a going concern, then the financial statementswould be truer and fairer if prepared on a liquidation basis. Material adjustmentsmay then be required to the financial statements.


(b) Audit work to be performed in respect of going concern at Crash Bang(i) Analyse sale proceeds for non-current assets, inventory and cash received

from customers occurring after the end of the reporting period.(ii) Review the debt ageing and cash recovery lists. Ask directors if outstanding

amounts from lost customer are recoverable.(iii) Discuss the optimistic view of likely future contracts with the MD. Orders

received after the end of the reporting period should be reviewed to see ifthey substantiate their opinion.

(iv) Obtain their opinion about future contracts in a written representation letter.(v) Review bank/loan records to assess the extent to which the company has

met its loan and lease commitments in the period after the end of thereporting period.

(vi) Review sales orders/sales ledger for evidence of additional lost custom afterthe year end.

(vii) Obtain cashflow and profit forecasts: Discuss assumptions with the directors; Perform sensitivity analysis flexing the key assumptions i.e. interest

rates, date of payment of payables and receipts from customers; Check all commitments have been cleared in accordance with legal

agreements; Agree budgets to any actual results achieved after the year end; Assess reasonableness of assumptions in the light of the achievement of

the company’s budgets set for 2015; discuss with the directors anytargets not achieved;

Re-perform calculations; Ensure future budgeted profit are expected to meet likely interest

charges(viii) Review bank records to ensure that the company is operating within its

facility after the end of the reporting period. Review bank certificate forterms and conditions of the facility. Review bank correspondence for anysuggestion the bank is concerned about its current position.

(ix) Ask management whether the new motorcycle fleet is attracting newcontracts as anticipated. Scrutinize any new contracts obtained and checkimproved gross profit margins will be achieved.

(x) Obtain written representations as to the likelihood of the company operating12 months from the date of approval of the financial statements.


ANSWER 4

(a) KIBO TEXTILE MILLS LTD. (NTML)(i) Internal control weaknesses and remedial recommendations:

Internal control weakness Remedial recommendationA clerk transfers informationfrom the order requisition to anorder form. This could resultin errors in orders being madeafter the buyer has authorizedthe requisition.

The order form should be signed off asauthorized to confirm that the details onthe requisition match those on the orderform.

The order requisition is thrownaway once the chief buyer hasauthorized it. Any subsequentqueries on the orders cannot bechecked back to the originalrequisition.

The order requisition form should beretained with the order form in case ofany query or dispute regarding itemsordered.

No copy of the order form isretained by the OrderingDepartment. This means thatgoods could be ordered twiceby error or deliberately. It alsomeans that queries ondeliveries cannot be chased up.

A three-part pre-numbered order formshould be used and one copy should beretained by the Ordering Department withthe requisition form.

The Goods Inward Departmentdoes not retain a copy of theDamaged Goods Note. If thenote is lost on the way to theOrdering Department, or thereis a query, the Goods InwardDepartment has no record ofgoods returned.

Four copies of the Damaged Goods Noteshould be retained. One could be retainedby the Goods Inward Department, onecould be sent to the Ordering Department,one could be sent to the department whichrequested the goods so that they canbecome aware that there will be a delayand one could be sent to the supplier.

The Ordering Department doesnot keep a record of goodsreceived, so it is unable tocheck which orders are closedor to chase up suppliers.

The Ordering Department should matchorders with Goods Received Notes(GRNs) and mark orders as closed onceall goods have been received.

The Goods Inward Departmentfiles GRNs in order ofsuppliers’ goods references.This could make it difficult tofind a GRN at a later date if thedepartment is not aware of thesupplier’s reference.

GRNs should be filed in date order, or bypurchase order number


(ii) Additional weaknesses under Value for Money (VFM) audit andRemedial recommendations:

Additional weakness Remedial recommendationThere is no delegated level ofauthority for authorizing orderrequisitions – The chief buyerhas to authorize allrequisitions.

A delegated level of authority should beintroduced for the authorization of orderrequisitions.

The Ordering Departmentreceives many orders in the dayand some of these are forduplicate items. Any volumediscounts for ordering bulkitems would therefore not beobtained.

Orders should be reviewed on a daily orweekly basis so that orders for the sameitem from different departments can beaggregated to take advantage of volumediscounts.

The structure of the departmentcould be improved: There isjust one buyer and fivepurchasing clerks. This couldcause problems when the buyeris on holiday, sick or leavespermanently. It may indicateinefficiency

The department’s staffing structureshould be reviewed with a view totraining one of the purchasing clerks tofill the buyer’s role in instances ofholiday, sickness or permanent departure.

There is insufficientcommunication to thedepartment that created thepurchase requisition of how theorder is progressing. They donot know that their order hasbeen made and would not findout if the goods have beendelivered but have to bereturned due to damages.

A tracking system should be developedfor orders so that the department thatmade the requisition can check when theirgoods have been ordered, the expecteddelivery date and hen find out about anyproblems with the delivery.

(b) Independence in the Public SectorIndependence of the external audit function is the critical component required forthe establishment of a positive statutory environment for the work of theController and Auditor General (CAG). However, despite the requirement for theauditor becoming independent, various factors such as ineffective legislature, badvices such as corruption, and political, economic, and social influences mayaffect the impact of audit findings. In these circumstances completeindependence is unrealistic. It is therefore important when seeking to establishand maintain adequate independence, to look into the following criteria: Appointment and dismissal of the CAG not to be within the prerogative of the

executive; And CAG’s salary to be a direct charge on public funds and not subject to

annual appropriation; The CAG’s right to report directly to the legislature (rather than to or through

the executive) and to decide the nature and timing of the report;


The CAG to have power to appoint audit staff with the approval of thelegislature or similar authority appointed by the legislature;

The CAG to have discretion to decide the nature and conduct of the auditincluding value for money investigations, and to decide whether or not toaccede to requests emanating from outside the Controller and CAG’s officeproposing matters for audit;

The CAG to have right or access to papers and information and to obtainexplanation and information;

The audit mandate to cover all public enterprises.

ANSWER 5

(a) There has been much talk recently of improving the image of audit so that itappears more worthwhile. Constructive advice on systems has long beenconsidered an obvious spin off benefit to be publicized. However, the adviceitself has always been given confidentially to management of the business andcareful consideration must be given to the implications of making the advicepublic.

ConfidentialityClearly this must be the biggest concern. The matters likely to be dealt with inthe report such as weaknesses in systems and failures in operation of the systemsare not matters which it is in the interests of the company and owners to publishto competitors or to many employees. These third parties may be able to use theinformation to their benefit at the expense of the company. However, the adviceitself has always been given confidentially to, management of the business andcareful consideration must be given to the implications of making the advicepublic.

Usefulness to shareholdersThe shareholders do not in general have the technical or commercial awareness tounderstand properly the report to management. They may be confused as to thepurpose of the report and also the limitations i.e. the report does not include allweaknesses but only those which came to light during the audit.

They may also be unaware of commercial reasons why it is not cost effective toremove certain weaknesses or implement the auditor’s suggestions.

Confusion of responsibilitiesNot only the shareholders but also the directors may become confused as to theactual responsibility for systems. If the report is published and hence comes to beregarded as part of the auditors’ duties, the directors may feel that systems are nolonger their primary responsibilities. They may start to assume that anyweaknesses will be reported by the auditor and therefore failure to report willimply that there are no weaknesses. This is clearly not desirable position.


Spur to action on reportThe major benefit of showing the report to management and to shareholders isthat there will be a stronger pressure brought to bear on the management toimplement suggestions. However, it is not necessarily good for the managementadvice to become effectively a directive to management. It may for exampleprejudice the independence of the auditor when considering systems which hehimself suggested.

There is also the problem of the auditor giving advice which then turns out to beincorrect or inappropriate.

Effect on the nature of the reportThis leads to the final point, which is that wider publication of the report wouldmake the auditor very cautious about the contents of the report. Commentswould have to be carefully reviewed to ensure there was no risk of a defamationaction. Overall the report would become defensive rather than constructive andagain the benefits of the current situation would be lost.

ConclusionAs can be seen from the above the drawbacks of reports to management beingshown to shareholders far outweigh any benefits. However, practically thebenefit is retained by reporting directly to an audit committee of non-executivedirectors.

(b) In dealing with these regulators and police professional accountant shall considerthe followings before agreeing to disclose or not to disclose the clientinformation:i)Respect the confidentiality of information about a client’s or employer’s affairs

acquired in the course of professional services even after the end of therelationship between the professional accountant and the client or employer.

ii) Observe confidentiality of information unless specific authority has beengiven or there is a legal requirement or professional duty to disclose thatinformation.

iii) Ensure that staff under his control and persons from whom advice and otherassistance is obtained respect the principle of confidentiality.

Disclosure of information to policeThese are law enforcers and may call and question any person in search for evidencesto be relied on during prosecution.

The auditor may disclose information to the police upon satisfying himself that there isa pending case against the managing director.

Disclosure of information to revenue authorityThe auditor has no responsibility to reveal information to the revenue authority. Hehowever may do so upon getting client consent to disclose. This is because there is nospecific provision of law tying up the auditor to break the confidentiality principle.


In the alternative, depending on his own judgment the auditor may decide to disclosesuch information to the revenue authority if, in his opinion, the matter constitutespublic interest.

Disclosure of information to government body supervising the licencesThe auditor has to maintain his confidentiality unless there is a specific provision oflaw in the country authorising the said body to access the information from theauditors.Otherwise the auditor will only be obliged to disclose if he operates under explicitconsent of his client.

Disclosure of information to in respect with healthThe auditor has to maintain his confidentiality unless there is a specific provision oflaw in the country authorising the said body to access the information from theauditors.Otherwise the auditor will only be obliged to disclose if he operates under explicitconsent of his client.

Disclosure of information to trade unionThe auditor has to maintain strict confidentiality in this case unless has been requestedby the client to disclose.

NOCLARThis is a recent development where by the auditor may decide to disclose theinformation in responding to Non-compliance with Laws and Regulations in acting infavour the public interest when they become aware of a potential illegal act (NOCLAR)committed by a client or employer. This is however a new development and due caremust be exercise so that the public interest as well as client and auditors interests aresafeguarded. Not exercising caution may land the auditor in civil suits instituted againstthem by the clients

ANSWER 6(a) (i) The service could be delivered by an internal function of the organization,

staffed by its own employees, with only internal clients who work for thesame organization.

(ii) Delivery of the service could be outsourced to an external firm.(iii) The service could be delivered by a consortium arrangement or similar

‘shared services’ arrangement, popular where a number of smallerorganizations are each unable to support a viable, effective internal auditservice on their own.

(b) The following are audit procedures to be carried on event belowAudit procedures on Customer going into liquidation

Assess the likelihood of recovery of this amount by discussion with thedirectors of MONO

Confirm the amount of the amount outstanding as at the year-end byinspection of the receivables ledger and correspondence with the customer

Review any correspondence between the company and the customer toassess the likelihood of recovery of any amounts


Obtain a written representation point regarding the amount outstandingfrom the customer from the directors of MONO

Confirm the details of the liquidation to documents received by MONOfrom the liquidator

Audit procedures on Claim for unfair dismissal Discuss the case for unfair dismissal with the directors of MONO to find

out background of the case, date when claim was lodged and assessmentof success

Review lawyer’s correspondence regarding this case as it may have animpact for next year’s audit

Review any press reports in the local or national papers about this claimagainst the company

Review minutes of board meetings regarding this case and any other claimcases against the company

Obtain written representations on this matter from the directors of MONO

Audit procedures on Fire event Discuss fire with management of MONO to clarify facts of the situation Read minutes of board meetings and any reports submitted by insurers Review insurance documents to confirm that damage cause by the fire is

covered

(ii) The Need weather to amend accounts or not and its reasons are as follows

Customer going into liquidationThe financial statements will need to be amended as this is an example of anadjusting event after the reporting period. It provides additional informationconcerning the recoverability of the debt at the reporting date.

Revenue, profit and net assets will all be overstated by TZS 7.5 million if theaccounts are not adjusted. The amount represents 10.7% of profit before taxand 1.4% of revenue so is clearly material. An adjustment is required in thefinancial statements to reduce the receivables balance and profits.

Claim for unfair dismissalA provision for this claim is not required since the requirements for recognizinga provision under IAS 37 Provisions, contingent liabilities and contingent assetsare not met. Under IAS 37, a provision should be recognized when there is apresent obligation as a result of a past event, it is probable that a transfer ofeconomic benefits will be required to settle it and a reliable estimate can bemade. In this case, it appears unlikely that Mr Mwakaje Njeri will be successfulin his claim and so no provision should be recognized in the financialstatements for the year ended 31 December 2015. Disclosure of a contingentliability is also unlikely to be required since the possibility of any transfer insettlement appears to be remote.


FireThe fire at the storage depot is a non-adjusting event after the reporting period –it does not relate to conditions which existed at the year-end. It is unlikely thatthe fire is significant enough to impact on the going concern of the company.Disclosure of the event surrounding the fire should be made, together with anestimate of the financial effect.

(iii) The following are impact on audit report for each event below Customer going into liquidation

The effect of the matter on the financial statements is clearly material. Ifthe adjustments required are made, then there would be no effect on theaudit report. If the directors refused to make the adjustment required, theaudit opinion would be modified on the basis that the accounts are not freefrom material misstatement and a qualified ‘except for’ opinion would beissued, as the matter is material but not pervasive.

Claim for unfair dismissalThere would be no effect on the audit report as a result of this matter as noamendment would be required to the financial statements. An unmodifiedreport on the financial statements could therefore be issued.

FireProvided that adequate disclosure has been made of the event and itsfinancial impact, there would be no need to modify the audit opinion as aresult of this incident. An emphasis of matter paragraph drawing attentionto this issue is probably not likely to be required, provided adequatedisclosure has been made in the notes to the financial statements.

______________ ____________


SUGGESTED SOLUTIONSC3 – BUSINESS AND CORPORATE FINANCE

NOVEMBER 2018

ANSWER 1

(a) (i) A SWOT ANALYSIS OF FF’S CURRENT STRATEGICPOSITION

Strengths FF holds unique position with possession of the sole licence to

operate from the government.

Successful business with a good record of growth and profitability.

Anton and Adriano have lots of experience within the industry and asa result have a number of good contacts.

Ferry service has a number of advantages over the bus/tubealternatives in terms of speed and reliability and so is attractive tocommuters.

More than one product stream so risk is diversified (business andleisure).

Consistent with government’s transport initiatives/desire to be moreenvironmentally friendly.

Networked with other transport providers.

Weaknesses More expensive than alternative transport options, and recession

meaty mean users are less willing to pay a premium.

Tourist element of trade is very seasonal and dependent on factorsbeyond FF’s control such as exchange rates and the weather.

Reliant on licence from CRA in order to operate.

Regulatory driven business – constraints have been imposed, andconditions may be attached to government funding.

Very seasonal business has cash flow implications e.g. low usageduring off peak hours.

Dependent on 2-man team with limited finance background.

Opportunities The Olympics – transport spectators to and from the games.

Freight transport – a new market, but would need different boats andno experience to date.


Further commercial and residential development of wharf-sideprovides increase passenger numbers.

More conference/exhibition trade provides increased passengernumbers.

Possible contract with top London hotel provides increasedpassenger numbers.

Could hire out boats privately e.g. for evening fictions/parties.

Increase volume of commuters tied in with season tickets.

Currently sterling is weak so volume of tourists likely to increase.

Threats Recession reduces the prices that travellers are prepared to pay.

Subject to government involvement / affected by governmentinitiatives /transport policies.

o Government grants other business a license to compete

o Government withdraws subsidy for river transport

o Government decide to subsidies other forms of transport, insteadof the river, making FF uncompetitive.

o Risk that government does not spend as committed ondevelopment of the river or the work is delayed.

The Olympics expansion causes short term growth but then leavesFFT with expensive spare capacity.

Lose licence to operate because breach terms/have Health & Safetyissue.

Restrictions on speed/volume of river services impact on speed orfrequency of FF’s service.

Health & Safety issues could lead to accidents/bad publicity.

Poor weather may make people more likely to take alternative formsof transport e.g. Underground.

Rising fuel costs reduce margins.

Small operators offering similar services.

Alternative public transport


(ii) AN ANALYSIS OF FF’S CRITICAL SUCCESS FACTORSFF’s critical success factors are those features that are particularlyvalued by our customers:

We have an excellent track record for:

Reliability of services (lack of cancellations) Frequency of services/ability to meet demand On-time running and speed of journey (lack of delays/interruptions) Well-publicized safely record.

We believe that there are a number of factors that give FF a uniquecompetitive advantage and allow us to out-perform any direct/indirectcompetition:

We have strict controls in place to ensure compliance with regulatoryrequirements and licence conditions. This allows us to maintain ourunique position as sole licensee for the commuter ferry service.

Differentiate product – our commuter service is unique is terms of theenvironmental benefits, the riverside views and the conform andfacilities on board, including will access.

A major factor in delivering the service is the acquisition andmaintenance of our fleet – our boats are fast, modern, comfortable andfuel efficient. We are now seeking finance to develop the fleet furtherand ensure that we maintain this key resource.

Internal factors that allow us to create a sustainable financial position andwhich we monitor using key performance indicators are:

Fuel efficiency Cost per passenger journey Utilization of capacity

(b) FAHAMI ENTERPRISES AND THE BCG MATRIXThe BCG matrix, and strategic portfolio planning, in general grew up during atime (1970’s) when conglomerates of un related businesses were common amongU.S. corporations. Strategists needed some way to understand the sometimescomplex (maybe even bizarre? Combinations of businesses within their purview.How should keep a business in the portfolio or divest it? The Boston ConsultingGroup (BCG came up with an easy to understand tool to address this issue. Thetool has come to be known as the BCG matrix.

The matrix is structured along two dimensions. The first dimension summarizesan industry’s attractiveness in terms of its rate of growth. The second dimensionindexes the strength of a business unit’s position within an industry in terms ofthe unit’s market share. Four cells within the matrix are thus defined: businessunits having high market share within a high growth industry ((“stars”), unitshaving low share within a high growth industry (“question marks”), units havinghigh share in slow growth industries (“cash cows”), and units having low share inslow growth industries (“dogs”).


The logic behind this segmentation was that industry attractiveness andcompetitive dominance within an industry are two crucial metrics that must beevaluated when assessing the viability of a business unit’s future. By classifyingfirms into categories defined by those two dimensions, strategies were given aclear strategic mandate: divest “dogs” with no future, and use “cash cows” tofund the further growth of “stars” and “question marks.”Hints: A well-drawn BCG matrix linking the four cells with the logic behind thesame, shall attract additional marks.

(c) (i) A hostile takeover allows a suitor to bypass a target company’smanagement (when they are unwilling to agree to a merger or takeover). Atakeover is considered “hostile” if the target company’s board (and themanagement) resists/rejects the acquisition offer, but the bidder continuesto pursue it anyway.

The alternative to a hostile takeover is that the bidder makes the offerwithout informing the target company’s board beforehand. There areseveral ways of conducting it:

A tender offer can be made where the acquiring company makes a publicoffer at a fixed price above the current market price.

Engaging in a proxy fight, whereby the suitor tries to persuade enoughshareholders, usually a simple majority, to replace the management witha new one which will approve the takeover.

Quietly purchasing enough stock on the open market (a creeping tenderoffer) to effect a change in management.

(ii) There are different defence strategies that a firm can employ to thwart ahostile takeover. A strategy will work if the firm meets (or has) theconditions, and has sufficient, time to use such a strategy. Some of thestrategies may require approval by shareholders. The following are some ofdefence strategies in a hostile takeover situation and candidates areexpected to explain briefly any four of them:

Eliminate cash via a dividend payment – if it has the excess cash orcan borrow.

Buy/sell a material asset – if it has a crown jewel that is consider as themost likely asset that the suitor is interested in.

White knight acquisition – if there is alternative suitor that is moreacceptable.

Counter-after (Packman’s defence) – works when the suitor has someshares in the target, and the price offered is “right”.

Golden parachutes to management – works if the management isimportant to the future of the entity and/or the amount involved assignificant.


Bear hug – embracing the suitor – works if the relationship is not yetacrimonious.

Other strategies include, create pyramid to entrench control, Issuedebentures which must be repaid in event of a merger. Poison pilltactics. Green mail. People’s pill, ensure company is well run and goingprivate).

ANSWER 2

(a) Value Matata Company

Balance Sheet ApproachNet assetsAs no additional information is available, this is based on book values.

Non-Current Assets TZS600 millionCurrent Assets

Cash TZS500 millionInventory TZS100 millionReceivables TZS200 million TZS800 million

Less: Current Liabilities TZS400 millionNet Current Assets TZS400 millionNon-Current Liabilities (TZS200 million)Net Assets TZS800 million

Hints: Alternative approaches are acceptable as well.

Dividend growth modelDividends are expected to grow at 4% per year and the cost of equity is 10%.

Value of Matata Company = Current Dividends (1 + Growth Rate in Dividends) / (ke – g)= TZS40 million (1 + 0.04) / (0.1 – 0.04)

= TZS41.6 million/0.06

= TZS693.3 million

gKe

DVb

1

gKe

gDoVb

)1(


Earnings yieldEarnings are the profit after tax figure of TZS70 million and the earnings yieldthat can be used for the valuation is 11%.

Value of Matata Company = Current Earnings (1 + Growth Rate in Earnings) / (Earnings Yield– g)

= TZS70 million (1 + 0.05) / (0.11 – 0.05)

= TZS73.5 million/0.06

= TZS1,225 million

(ii) Different because they are based on different assumptions

- B/Sheet - existing assets & liabilities

- DGL - earnings and growth

- EY - Part performance

DGL can be viewed as the most appropriate as it in future oriented hencecapturing the earning power of the firm.

(b) The Weakness of Dividend Growth ModelThe dividend growth model (DGM) is a widely used method for valuing ordinaryshares and therefore also companies, however there are a number of weaknessesto the model.

The dividend growth rateThe DGM assumes that there is a constant growth in dividends in perpetuity. Thisis extremely unlikely in practice. If the growth rate is assumed to be an averagegrowth rate is assumed to be an average growth rate though, this may be seen asless of a problem. The future growth rate can only be an estimate and it is oftenbased on historical data. The assumption that the past can be used to predict thefuture may not hold as it is future decisions that will determine the future resultsof a company. The DGM is also very sensitive to changes in the growth rate, a1% change in the growth rate can give a significantly different valuation.

It is unable to capture investors preference (or lack thereof) of dividend.

Cost of equityThe DGM assumes a constant cost of equity, but it represents the return requiredby shareholders which will change frequently depending on many differentfactors. The cost of equity can be calculated by the CAPM formula, but again thisis often based on historical information.

Zero dividendsIt is claimed that DGM cannot be used where dividends have not been paid.However, this is not true if dividends are expected to be paid at some point in thefuture. In this case the DGM can be applied at that point to create a value for theshares which can then be discounted to give the current ex dividend share price.


In a situation where dividends are not paid and are not expected to be paid theDGM has no use.

(c) UYOLE COMPANY(i) NET TZS RECEIPTS: UNCOVERED POSITION

Gross ReceiptsTZS

Sales of goods (US$ 15,000 x TZS 2210/US$) 33,150,000Sales of goods (US$ 24,000 x TZS 2210/US$) 53,040,000Total Sales 86,190,000Purchases of components (US$ 10,000 x TZS 2380/US$) (23,800,000)Purchases Goods (US$ 25,000 x TZS 2380/US$) 59,500,000)Net Receipts 2,890,000

(ii) NET TZS RECEIPTS: COVERED POSITION

Gross ReceiptsNet receipt/payments (Covered Position)

Sales of Finished goods US$ 15,000 due in 6 months TZSUS$ 15,000 x TZS 2420/US$ 36,300,000Sales of Finished goods US$ 15,000 due in 6 monthsUS$ 24,000 x TZS 2420/US$ 58,080,000Total 94,380,000Purchases (PAYMENTS)Purchases of Components: US$ 10,000 due in 3 months (24,400,000)US$ 10,000 x TZS 2440/US$Purchases of Finished goods: US$ 25,000 due in 3 monthsUS$ 25,000 x TZS 2440/US$ (61,000,000)Net Receipts 8,980,000

Workings: Exchange RatesBid Ask

Spot TZS/ US$ 2410 2430Less Premiums 8 103 months forward 2418 2440

Bid AskSpot 2410 2430Less Premium 10 126 months forward 2420 2442


ANSWER 3

(a) (i) Market Value added is the difference between the capital contributed tothe

company by bondholders/investors and shareholders and the marketvalue of the product. It is the measure of the performance ofManagement and reflects the general market.

Problems associated with using Market Value Added

Estimating the amount of cash investedMeasuring the amount of capital put into and retained within a businessafter it has been trading for a few years is fraught with problems. Forexample, does R&D expenditure produce an asset (i.e. become part ofshareholders’ funds) or is it an expense to written off the profit and lossaccount? How do you treat goodwill on acquisitions? The accountants’balance sheet is not designed for measuring capital supplied by financeproviders, but at least it is a starting point.

When was the value created?The fact that a positive MVA is produced is often of limited use when itcomes to evaluating the quality of the current managers. For a companythat is a few decades old the value drivers may have been put in place bya previous generation of directors and senior managers. The MVAmeasure can pinpoint when it was created. Nor does it indicate whethervalue creation has stopped and the firm is living off accumulated fat interms of strong market positions, patents, etc.

Is the rate of return high enough?If it is not specified when value is created, it is difficult to know whetherthe amount generated is sufficiently in excess of capital used to providea satisfactory return relative to the risk-adjusted time value of money.Positive MVA companies can produce poor rates of return.

Inflation distorts MVAIf the capital element in the equation is based on a balance sheet figure,then during times of inflation the value of capital employed may beunderstated. If capital is artificially lowered by inflation vis-à-vis currentmarket value for companies where investment took place a long timeago then MVA will appear to be superior to that for a similar firm withrecently purchased assets.

MVA is an absolute measureJudging companies on the basis of absolute amounts of pounds meansthat companies with larger capital bases will tend to be at the top (andbottom) of the league tables of MVA performance. Size can have a moresignificant impact on MVA than efficiency. This makes comparing firmsof different sizes difficult.


(ii) Market Value Added at the beginning and end of the yearStart of Year End of Year

MarketValue 200,000,000 215,000,000

Capital 30,000,000 30,000,000

Plus earnings 20,000,000

Less Dividend 6,000,00044,000,000

MVA 170,000,000 171,000,000

(iii)Start of Year End of Year

Market Value 200,000,000 221,000,000

Capital 30,000,000 50,000,000

MVA 170,000,000 171,000,000

If the company had not paid the dividend then, both the market value and the capitalincrease by TZS6m and MVA would remain at TZS71m

(b) Convertible:Has an option to the holder to convert to another instrument mostly equity, at apredetermined rate and in a specified time frame.

The following advantages of using convertible loan notes as a source of long-term finance could be discussed:

Conversion rather than redemptionIf the holders of convertible loan notes judge that conversion into ordinary shareswill increase their wealth, conversion of the loan notes will occur on theconversion date and the company will not need to find the cash needed to redeemthe loan notes. This is sometimes referred to as ‘self-liquidation’.

Lower interest rateThe option to convert into ordinary shares has value for investors as ordinaryshares normally offer a higher return than debt. Investors in convertible loannotes will therefore accept a lower interest rate than on ordinary loan notes,decreasing the finance costs for the issuing company.

Debt capacityIf the company issued convertible loan notes, its gearing and financial risk willincrease and its debt capacity will decrease. When conversion occurs, its gearingand financial risk will decrease and its debt capacity will increase because of theelimination of the loan notes from its capital structure. However, there will afurther increase in debt capacity due to the issue of new ordinary shares in orderto facilitate conversion.


Attractive to investorsCompany may be able to issue convertible loan notes to raise long-term financeeven when investors might not be attracted by an issue of ordinary loan notes,because of the attraction of the option to convert into ordinary shares in thefuture.

Facilitates planningIt has been suggested than an issue of fixed-interest debt such as convertible loannotes can be attractive to a company as the fixed nature of future interestpayments facilitates financial planning.

(c) Overtrading – also known as undercapitalizationIt occurs when a firm tries to support a large volume of operations/trade using asmall working capital base.

It is about disparity between the working capital base and the level of operations.

Indications that a company may be overtrading could include:

Rapid growth in sales over a relatively short period;

Rapid growth in the amount of current assets, and perhaps non-current assets;

Deteriorating inventory days and trade receivables days’ ratios;

Increasing use of trade credit to finance current asset growth (increasing tradepayables days);

Declining liquidity, indicated perhaps by a falling quick ratios;

Declining profitability, perhaps due to using discounts to increase sales;

Decreasing amounts of cash and liquid investments, or a rapidly increasingoverdraft.

ANSWER 4

(a) Brief explanations(i) Forward Rate Agreement (FRA):

FRA is an agreement between two parties who wishes to protect themselvesagainst fluctuations in interest rates. The parties agree on an interest rate fora specific period of time on a specified Principal amount. The buyer of anFRA is a party wishing to protect itself against a decline. The price of FRAwill depend on the slope of the yield curve which reflects interest rateexpectations – FRAs now cover a wide selection of currencies andmaturities. Helps a corporate crystallize its interest costs – Banks can offerFRAs linked to the LIBOR.


(ii) Interest Rate Floor:Variable rate investors are the typical users of Interest Rate Floors. Theyused Floors to obtain certainly for their investments and budgeting processby setting the minimum interest rate they will receive on their investments.By implementing this type of financial management, variable rate investorsobtain peace of mind from falling interest rates and the freedom toconcentrate on their aspect of their business/investments. An Interest RateFloor enables variable rate investors to retain the upside advantages of theirvariable rate investment while obtaining the comfort of a known minimuminterest rate. In addition to that FRA becomes an effective interestregardless of the prevailing market rates. In this regards compensation bythe dealer to the customer or from the customer to the dealer must takeplace only to make sure that FRA is an effective interest rate.

(iii) Interest rate collarAn interest rate collar is a combination of a cap and a floor transactedsimultaneously. The buyer of an interest rate cap purchases an interest ratecap while selling a floor indexed to the same interest rate, for the sameamount Benefits of a collar.

Cost reduction: a collar can be structured with no upfront paymentwhile providing the same protection against rising interest rates as aninterest rate cap. The premium paid for the purchase of the optionswould be partly or wholly offset by the premium received from the saleof options. A complete offsetting of premiums results in a zero collarand effectively a fixed rate loan or deposit is created dependent onwhether the company is borrowing or depositing.

Flexibility: subject to approval, companies can enter into an interest ratecollar at any time, for any term, on any portion of their variable ratedebt.

Certainty: Interest rate options provides certainty to floating rate loansas to what interest streams the parties will pay or get

(b)Raw materials 40m x (3/52) = 2,307,692.00Work-in-progress

Raw materials 40m x (5/52) = 3,846,154.00

Labour costs 50m x (5/52 x 0.5 = 2,403,846.00

Overheads 30m x (5/52) x 0.5 = 1,442,308.007,692,308.00

Finished goods 120m x (4/52) = 9,230,769.00

Trade receivables 180m x (12/52) = 41,538,462.00

Trade payables 40m x (4/52) = (3,076,923.00)

Working capital required 57,692,308.00


(c) (i) Maswa Enterprise’s cash conversion cycle is:Formula (R + W + F + D) – C = CCC

(3 + 5 + 4) + 12 – 4 = 20 weeks

ANSWER 5

(a) (i) Cost of leasing0 1 2 3

TZS “000” TZS “000” TZS “000” TZS “000”Lease payment (AT)a (6,000) (6,000) (6,000) (6,000)

PVIFs (6%)b 1.000 0.9434 0.8900 0.8396

PV leasing (6,000) (5,660) (5,340) (5,038)

Total PV cost ofleasing

(22,038)

aAfter tax payment = 10,000 (1 – T) = 10,000 (0.60) = 6,000bThis is the after-tax cost of debt: 10% (1 – T) = 10% (0.60) = 6.0%

(ii) Cost of owningHere is the cash flows under the flows under the borrow and buy alternative

0 1 2 3 4TZS ‘000’ TZS ‘000’ TZS ‘000’ TZS ‘000’ TZS ‘000’

1. Depreciation schedule

4

1040 mm

Depreciation basis = 7,000,000

Allowance 40,000 40,000 40,000 40,000

Depreciation 0.25

10,000

0.30

12,000

0.14

5,600

0.06

2,400

2. Cash outflows TZS ‘000’ TZS ‘000’ TZS ‘000’ TZS ‘000’ TZS ‘000’ Net purchase price (40,000)

Depreciation tax saving 4,000 4,800 2,240 960

Maintenance (600) (600) (600) (600)

Salvage value 6,000

Total (40,000) 3,400 4,200 1,640 6,360

PVIF 6%1.00 0.9434 0.8900 0.8396 0.7921

PV of owning (40,000) 3,207.56 3,738 1,376.944 5,037.756

Total PV cost of owning (26,619.74)Depreciation (T) = 10,000,000 (0.40) = 4,000,000


Note: Because the present value of the cost of leasing is less than that ofowning the truck should be leased:

TZS 26,619,740 – TZS 22,038,000 = TZS 4,581,740 net advantageof leasing

(b) Meaning of Forms of hybrid securitiesIs a generic term used to describe a security that combines elements ofdebt securities and equity securities. Hybrid securities typically promise to pay arate of return until a certain date, in the same way debt securities do.(i) Preference shares

Preference shares are a classic case of hybrid securities since they havefeatures of both equity and debt. The features of debt include:

o Fixed rate of returno No control on company managemento Their claims rank above equity in the event of liquidation of the

companyo Returns restricted to pre-determined dividend

(ii) Convertible debentures / bondsConvertible bonds are fixed interest debt securities, which the holder canchoose to convert into ordinary shares of the company. This conversiontakes place at a predetermined rate and on a predetermined date.

(iii) WarrantsWarrants provide a right to buy equity shares in a company at a future dateat an exercise price. The exercise price is fixed and pre-determined.Usually warrants are issued along with loan stock, in order to make the loanstock attractive.

Advantages of warrants for the investoro A potential for a higher percentage of profits due to the gearing effect

discussed above.o Low initial investment. An investor requires lower funds to purchase the

warrant.o Due to lower investment, the risk of loss of investment is also lower.

ANSWER 6

(a) (1) The Option Hedge and Its CostThe company is about to receive UD100,000. It will need to sell theUD100,000. At the options market the company should buy the right to sellthe UD100,000 on the 30th January 2019 i.e. by UD Puts. The number ofRG Puts needed would be:

Number of UD Puts = UD100,000/RG10,000 = 10 Contracts. The hedge istherefore: Buy 10UD Puts with an exercise price of TZS835 at an optioncost of TZS3/UD


Option CostOption Premium Payable = TZS3/UD x UD10,000 x 10 = TZS300,000

(2) Comments on Option Position on 30th January, 2019As the spot price [TZS830/UD] is less than the Exercise Price(TZS835/UD) the UD Put is in the money. The company should exercisethe option.

IllustrationExercise Value [TZS835/UD x UD10,000 x 10] TZS83,500,000Less: Spot Value [TZS830/UD x UD100,000] TZS83,000,000

Gross Gain TZS 500,000Less: Option Premium Payable TZS 300,000Net Gain TZS 200,000

Net Receipt = Exercise Value – Option Premium Payable= TZS83,500,000 – TZS300,000= TZS83,200,000

Effective Exchange Rate = [Exercise Value – Option PremiumPayable]/UD

Receivables= TZS83,200,000 UD100,000= TZS832/UD

(b) Owning a call option does not involve any commitment to purchase a stock. Itgives the owner the option to buy a stock if he or she wishes, but it is completelydiscretionary. The line of reasoning is completely incorrect. Owning a call optionis a risky position, however, because the value of the option is uncertain.

(c) Since the two options are on the same stock and have the same exercise price, theoption with longer time to expiration should have higher price. This is not thecase hence Y is undervalued and X is overvalued which does not expose todownward price risk but leave open the potential for profit with upward pricemovement will not.

(i) Buy a 6 month option at 40, and sell a 3 month option at 50

Net cash flow = 10 Buy Y Sell X

The longer maturing option, the risk is covered

(ii) If the stock price in three months is: TZS550The 3 month option will not be exercised and you can keep the TZS10, plusyour long position in the call

If TZS 600The 3 month option will not be exercised and you can keep the TZS10, plusyour long position in the call.

If TZS 650


The 3 month option will be exercised against you. You must surrender thestock and receive TZS50. You exercise your call, and pay TZS50 to acquirestock. This generates a zero net cash flow, but leaves you with the TZS10from the original.

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SUGGESTED SOLUTIONSC4 – PUBLIC FINANCE AND TAXATION II

NOVEMBER 2018

ANSWER 1

(i) The subsidiary is taxed as a permanent establishment under section 70 of theITA, 2015 which is taxed as per section 4 and section 72 of the Act. (Refer tothe Act).

Year 1 Year 2 Year 3 Year 4

Sales300,000,000

300,000,000600,000,000

700,000,000

Variable Costs120,000,000

120,000,000250,000,000

300,000,000

Overhead Costs30,000,000

30,000,00030,000,000

30,000,000

Rental Costs20,000,000

20,000,00020,000,000

20,000,000

Depreciation (300,000€-50,000€ x 3,000) –Tshs.150,000,000)/4 years 150,000,000 150,000,000 150,000,000 150,000,000Net Profit Before Tax

(20,000,000)(20,000,000)

150,000,000200,000,000

Tax (30%)(6,000,000)

(6,000,000)45,000,000

60,000,000

Net Profit /Loss after Tax(14,000,000) (14,000,000) 105,000,000

140,000,000

(iii)Year 1 750,000,000 Net cost of the assets at the beginning of year 1Depreciation (150,000,000)

Year 2 600,000,000 Net cost of the assets at the end of year 1/beginning of year 2Depreciation (150,000,000)



150,000,000 Net cost of the assets at the end of year 4


Year 1 Repatriated Tax750,000,000 -14,000,000 – 600,000,000= 136,000,000 x 10%= 13,600,000Year 2600,000,000 -14,000,000 – 450,000,000= 136,000,000 x 10%= 13,600,000Year 3450,000,000 + 105,000,000 – 300,000,000= 255,000,000 x 10%= 25,500,000Year 4300,000,000 + 140,000,000 – 150,000,000= 290,000,000 x 10%= 29,000,000

Corporate Tax without Tax relief 89,000,000 x 30% = 9,000,000Corporate Tax with Tax Relief 9,000,000 – 7,000,000 = 2,000,000

ANSWER 2

(a) Main features one should consider to distinguish permanent establishment from apermanent home

‘Permanent Establishment’ means a place where a person carries on businessand includes a place where a person is carrying on business through an agent,other than a general agent of independent status acting in the ordinary course ofbusiness a such:

A place where a person has used or installed, or is using or installingsubstantial equipment or substantial machinery, and

A place where a person is engaged in a construction, assembly orinstallation project for six months or more, including a place where aperson is conducting supervisory activities in relation to such a project.

In contrast, a permanent home is any form of accommodation (owned orrented) which is continuously available to you for your personal use.

Total chargeable incomeEmployment incomeBasic salary (15,000,000*12) 180,000,000Duty allowance (500,000*12) 6,000,000Entertainment allowance (excluded) -Travelling expenses (300,000*12) 3,600,000Security, house maid, utility (3,000,000*9) 27,000,000Motor vehicle benefits (wholly for duty purpose) NilLoan benefit (Note 1) 7,200,000Compensation for termination (Note 2) -Life Insurance 3% x 180,000,000 5,400,000Employee’s contr to un approved ret fund 5%*(15,000,000*12) 9,000,000

238,200,000


Deduct: Employee’s contr to approved ret fund5%*(15,000,000*12) (9,000,000)

229,200,000Housing benefits (Note 3) 3,150,000

232,350,000Investment IncomeDividend income 1,500,000Rent income 8,000,000Bank interest 2,500,000Gains from an interest in an unapproved retirement fund 5,300,000

17,300,000Business incomeTrading profits (including service fees) add back provision tax 61,200,000Less: Rent income (Investment income) (8,000,000)

53,200,000302,850,000

Note 1: Loan benefitNecessary conditions for a loan benefit to be taxed:

Must have a period of more than 12 months

Amount of loan (plus any outstanding loan, which is nil) exceeds 3 times thebasic salary, i.e. shs.120,000,000 against shs.4,500,000 (1,500,000*3)

Hence, loan benefit in this case constitute taxable benefits in kind

Computation of taxable loan benefit using average methodDate Principal Loan; average loan;

computationsLoan balance; taxable

loan1st January, 2016 Loan given Tshs.120,000,00031st December, 2012 Shs.120,000,000 – 60,000,000* 60,000,000Opening loan balance1.1.2017

60,000,000

Average loan balance 180,000,000/2 90,000,000Taxable loan benefit 90,000,000*(12% - 4%)*12/12 7,200,000

Note 2: Computation of taxable termination benefit (taxable compensation),and the year in which it is taxable (2 marks)

For a fixed employment contract (as it was, for Mrs. Twaweza, 5 yearscontract) taxable termination benefits should not exceed the amount whichwould have been received in respect of the unexpired period.

The amount is assumed to have accrued evenly in such unexpired period.


Taxable termination benefits is the lower of actual compensation receivedand the amount would be received in unexpired period.

A 5 year contract was terminated after 4 years, hence, unexpired period = 12months (1 year) commencing from 1.1.2018 to 31.12.2018

Therefore, taxable termination benefits is the lower of 180,000,000 and theactual compensation of shs.100,000,000

This amount will be taxed in the unexpired period, i.e. year 2018

Note 3: Computation of house benefitsIs the lesser of:-(a) Annual market rental value of the house and(b) The greater of:

(i) 15% of employee’s total income for the year of income excluding HouseBenefit

(ii) Expenditure claimed as deduction by the employer.Reduced by the employee’s rental contribution.

So, for the case of TWAWEZABenefit is the lesser of:

(a) (600,000×9months ×3/4 rooms) 4,050,000(b) the greater of:

(i) 15% x (232,350,000+17,300,000+53,200,000)×9/12×3/4 rooms =25,536,094

(ii) Expenditure claimed (300,000×9months ×3/4 rooms) = 2,025,000

Hence the greater of Tshs 25,536,094 and Tshs 2,025,000 is Tshs 25,536,094and the lesser of Tshs 4,050,000 and Tshs 32,523,750 is Tshs 4,050,000. Hencethe Housing Benefit is Tshs 4,050,000 -(100,000×9)=Tshs 3,150,000

ANSWER 3

(a) Ng’aa Cosmetics

(i) Amount paid on the 2nd May 2016

Estimated tax payable 8,300,0001st instalment (without interest and penalty) 2,075,000Due date for filing the statement 31-Mar-17Date filed 2-May-17Periods late 2Penalty per period: 15 currency points 225,000Penalty per period: 2.5% of 8,300,000 207,500Penalty 450,000Interest for late payment of 1st instalment


Principal amount (1st instalment) 2,075,000Statutory rate 7%Periods late 2Interest factor 0.0117Interest 24,279

Tax paid on 2nd May (two instalments + penalty = Interest) 4,174,279

(ii) Amount paid on the 3rd installment3rd installment (A-C)/B = (8,300,000 – 4,150,000)/2 – TZS 2,075,000

Amount paid on the 4th installment4th installment (A-C/B = (75,000,000 – 6,225,000)/1 = TZS 68,775,000

Amount paid on 2nd august 2017Correct tax 96,500,000Estimated tax 75,000,00080% of the correct tax 77,200,000

There is underestimationInterest for underestimationNumber of period 15Principal (TZS 96,500,000 –75,000,000)

21,500,000

Statutory rate 7%Interest factor 0.0912Interest 1,960,044

Interest for late payment of tax

Due date 30-Jun-18Date filed 2-Aug-18Number of periods late 2Principal (TZS 96,500,000 – 75,000,000 21,500,000Statutory rate 7%Interest factor 0.0117Interest for late payment of tax 251,565

Penalty for late filing of return

Due date 30-Jun-18Date filed 2-Aug-18Number of periods late 2Penalty per period: 15 currency points 225,000Penalty per period: 2.5% of TZS 21,500,000 537,500Penalty 1,075,000


(b) Mtaita

(i) Amount required to be paid:The company is required to pay the greater of either tax not in dispute orone-third of the tax assessed.

In this case:Tax not in dispute = TZS 35,000,000One third of the tax assessed = 1/3 of 30% (TZS 400,000,000) = TZS40,000,000The amount required is thus TZS 40,000,000

(ii) RationaleThe rationale is to prevent situations where tax objections are used astechnique to delay payment of tax due.

(iii) If the taxable income was TZS 300,000,000One-third of tax assessed would have been:

1/3 x 30% x (300,000,000) = TZS 30,000,000The amount required would thus be TZS 35,000,000

ANSWER 4

(a) KLF Enterprises Computation of Taxable Income:Profits per accounts 3,156,000

Instalment tax paid 135,000Salaries –Leka 120,000Interest on capital:

Kweka 180,000Lela 210,000Feiza 240,000

Fine and penalty 36,000Commission:

Kweka 135,000Feiza 105,000

Depreciation 276,000Donation 300,000General Reserve 360,000 2,097,000

5,253,000Less: Income exempt or not related:Rent from property 396,000Profit on sale of shares 300,000Interest on deposits 360,000 1,056,000

4,197,000Less: allowable deductions:Depreciation allowance as per ITA 2004 270,000Adjusted Partnership Income 3,927,000


(b) Distribution of income among partners:TZS’000’

Taxable profit 3,927,000

Less: Partners Income

Salaries-Leka 120,000

Interest on capital(180,000+210,000+240,000) 630,000

Commission to partners(135,000+105,000) 240,000

Partners Distributable income 2,937,000

(c) Calculations of partners taxable Income:

Kweka Leka FeizaTZS’000’ TZS’000’ TZS’000’

Partners Distributable income 1,468,500 881,100 587,400

Salaries - 120,000 -

Interest on capital 180,000 210,000 240,000

Commission 135,000 105,000 -

Other income

Rent 360,000 - -

Gambling - - 600,000

Taxable Income 2,143,500 1,316,100 1,427,400

ANSWER 5

(a) Increased rates of taxation may lead to reduced tax revenue for the followingreasons: Higher rates or taxation create greater incentives for avoidance and evasion,

which reduces the amount of tax collected.

This can include “capital flight”, where wealthy individuals or companiesremove themselves and/or their wealth to another jurisdiction where the taxrates are lower.

Greater incidence of avoidance and evasion require the tax administrationauthorities to engage in greater audit and investigation activities and todesign more administrative and statutory measures to counter avoidanceand evasion. Such extra measures increase administration costs andtherefore reduce net tax revenue.

Higher rates of taxation create disincentives for individuals and businessesto engage in those activities that are taxed because of the reduction in thenet benefit they receive. This can result in a reduction in the size of the taxbase, therefore less tax revenue is collected.


Where the costs of tax are passed on to the customer via an increase inprices, higher tax rates may result in reductions in demand and so reducetax revenues.

(d) Capital deductions /capital allowancesImprovement of the road to the mine 20,000,000Minibuses (20,000,000 x 2) 40,000,000Lorries (40,000,000 x 3) 120,000,000Reinforcement of underground rail,road and drainage 100,000,000

280,000,000

20%56,000,000

ANSWER 6

(a) Juridical double taxation occurs when the same person is taxed more than once(usually twice) on the same income by more than one tax jurisdiction.

(b) The unilateral methods of eliminating double taxation include: Exemption: Where the foreign income is excluded in the tax base of the

taxpayer Deduction: This treats the foreign tax paid as an allowable deduction

Credit: This reduces the amount of tax payable by the amount of foreigntax paid.

(a) (i) - Governments may be directly involved in production.

- Governments may influence private economic activities by subsidies ortaxes or they may exercise direct control over behavior in the privatesector through regulations.

- Governments may deliberately alter their total spending and taxation toinfluence the level of national income.

- Governments may transfer purchasing power for some persons to others

- Introducing of new laws or amending of existing laws and regulations


(ii) Production expenditure This has a direct impact on the GDP growth especially in the short run

because it affects directly spending on productive in agriculture, industryand other economic services. This is because in the short run, mostindustrial projects will ear fruits within five years.

In the long run, production expenditure will have a negative impact onthe GDP growth because it will bring the crowding out effect.

Social Expenditure Involves spending on basic needs like food, housing, health, water and

education. This will have a positive impact on social development,though its effect will be felt on the long term because if funds are used tobuild schools and hospitals, this expenditure will not contribute to GDPgrowth in the short term.

Infrastructure Expenditure This involves spending on roads, electricity and transportation which

provides a positive environment for investment to flourish and thus briga positive impact on the GDP growth in the long run.

Military Expenditure There are theorists who argue that this expenditure has favorable impact

on employment generation, technological innovation, skill formation,construction of basic infrastructure and increased aggregate demandgenerated by military spending.

However, critics argue that military expenditure creates high opportunitycost through diversion of scarce resources from productive civilian uses.

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