management case study - familiarisation and practice workbook - february 2016.pdf

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Professional Examinations

Management Level

March 2016

Case Study

FAMILIARISATION AND PRACTICEWORKBOOK



CIMA MARCH 2016 – MANAGEMENT CASE STUDY

Published by: Kaplan Publishing UK

Unit 2 The Business Centre, Molly Millars Lane, Wokingham, Berkshire RG41 2QZ

Copyright © 2015 Kaplan Financial Limited. All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system or transmitted in anyform or by any means electronic, mechanical, photocopying, recording or otherwise without theprior written permission of the publisher.

Notice

The text in this material and any others made available by any Kaplan Group company does notamount to advice on a particular matter and should not be taken as such. No reliance should beplaced on the content as the basis for any investment or other decision or in connection with anyadvice given to third parties. Please consult your appropriate professional adviser as necessary.Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability toany person in respect of any losses or other claims, whether direct, indirect, incidental,consequential or otherwise arising in relation to the use of such materials.



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CONTENTS

CHAPTER

1 Introduction 12 Familiarisation Quiz 3

3 Pizzatime Familiarisation 7

4 Advanced Management Accounting (P2) Familiarisation 9

5 Project and Relationship Management (E2) Familiarisation 11

6 Financial Reporting (F2) Familiarisation 13

7 Pizzatime Practice Tasks 15

8 Advanced Management Accounting (P2) Practice Tasks 21

9 Project and Relationship Management (E2) Practice Tasks 28

10 Financial Reporting (F2) Practice Tasks 31

11 Suggested Solutions 35

Quality and accuracy are of the utmost importance to us so if you spot an error in any of ourproducts, please send an email to [email protected] with full details.

Our Quality Co-ordinator will work with our technical team to verify the error and take action toensure it is corrected in future editions.



CIMA MARCH 2016 – MANAGEMENT CASE STUDY



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Chapter 1

INTRODUCTION

1 INTRODUCTION TO CASE STUDY EXAMS

The Case Study Exam is an attempt to simulate workplace problem solving, and allows examinersto move one step closer to the assessment of competence than is possible with objective test

questions.The Case Study is assessed by way of a three hour computer based examination. You cannot takethe examination until you have successfully completed all the Objective Test Examinations for therelevant level. The exam comprises a series of requirements which aim to integrate and apply thetechnical knowledge tested in the Objective Test Examinations.

The exam is based on:

• pre-seen material issued in advance of the exam day, supplemented by

• additional, previously unseen material given to you in the exam room.

There will be several requirements, comprising:

(a) Triggers - information and updates regarding situations in which the company finds itself

(b) Tasks - work you will need to carry out based on the trigger

2 ESSENTIAL SKILLS

The CIMA syllabus is based on a series of four generic competencies that underpin the skillsrequired of a management accountant. These skills are Technical, Business, People andLeadership. More detail on the skills and the competency framework can be found in the OfficialCIMA Case Study Textbooks.

However, rather than focussing on the distinctions between the different competences, the mostimportant skill on the day of the exam is to be able to answer the tasks set with sufficientapplication to the company concerned. The main reason candidates fail is that their answers aretoo generic with little application. Broadly speaking you will need to ensure you have properlyprepared the pre-seen information in advance of the exam and also be comfortable with how toreact to the unseen information provided in the exam.

We have split the preparation into these two broad areas - familiarisation with the pre-seen andpractice for the unseen and have included exercises and tasks for each of the three technicalpapers at this level. Depending on your chosen method of study, you may also have theopportunity to practice the integration of all technical areas when you attempt mock exams.



CIMA FEBRUARY 2016 – MANAGEMENT CASE STUDY

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3 HOW TO USE THIS WORKBOOK

It is essential that, before you begin the exercises and tasks provided here, you have workedthrough the Official CIMA Case Study Textbook and read the relevant pre-seen information at

least twice. You can then work through the Familiarisation Exercises for a particular technicalsubject (the ‘E’ papers often give a good overview and introduction into the Case Study) beforeattempting the Practice Tasks from the same subject. This will help you to identify any last minuteknowledge gaps as you prepare. Alternatively you can complete all of the familiarisation sectionsbefore you begin the Practice Tasks.

It is strongly recommended that when working through the Practice Tasks, you plan and writeyour own answer prior to reviewing the suggested solutions. This is an important part of thelearning process.



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Chapter 2

FAMILIARISATION QUIZINTRODUCTION

Attempt this quiz after you have read the pre-seen at least twice. Try not to refer to the pre-seenmaterial when answering the questions unless you really can’t remember.

However it is better to look for the answers in the pre-seen if necessary rather than turningstraight to the quiz solutions.

Question Your response

When was Pizzatimeformed?

What are principal methodsby which Pizzatime haschosen to expand?

How many restaurants doPizzatime operate as at 31December 2015? Where are

they based?

What do Pizzatime menusoffer? Are they licensed tosell alcohol?

Where is the doughprepared for therestaurants? Where do theingredients come from?

How are the ingredients forthe pizzas reordered?

What is Pizzatime’s currentbusiness model?

What % ages of Pizzatime’srestaurants are operated byfranchisees?

How is revenue earned from

the franchisees?




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What standards areexpected of the franchiseesand why?

What are the four aspects ofthe PCCS programme?

What is the key customergroup for Pizzatime? Whatfacilities are provided fortheir use?

How is Pizzatine structured?How many regional offices

are in operation?

What was the Gross Profit ofPizzatime in 2015?

Has Pizzatime’s operatingprofit increased ordecreased in 2015?

What is the “quick ratio” forPizzatime?

Has gearing increased ordecreased during theperiod?

What does Pizzatimerevenue comprise of?

How does Pizzatime mitigatethe risk of poor customerservice?

Who has responsibility formanaging risks in Pizzatime?

How does Pizzatimepromote healthy eating?

How does Pizzatime hope toachieve an increase inshareholder value?

Where is Pizza2Go wellestablished? What was their

gross margin in 2015?



FAMILIARISATION QUIZ

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Chapter 3

PIZZATIME FAMILIARISATION

1 INTRODUCTION

It is absolutely crucial that you completely familiarise yourself with the pre-seen information priorto attempting the Case Study exam. Merely reading through the materials is unlikely to besufficient and it is also important that you consider which aspects of the three technical subjectsmay be useful and relevant for the Case Study.

The exercises in the following three chapters will help you to gain a thorough understanding ofthe Case Study scenario and ensure you are fully prepared to attempt the Practice Tasks later inthis Workbook.

Solutions to these exercises are provided but are not exhaustive. It is important that you attemptthe exercises yourself and makes notes of your answers before reviewing the solutions.

2 OVERVIEW OF PRE-SEEN

Originally formed in 1969 by two brothers in the country of I-Land, Pizzatime(PT) offers a widerange of pizzas and complementary such as dough balls, salads, desserts and beverages via itschain of restaurants.

From these humble beginnings, the business has grown to 970 outlets represented in threedifferent countries, the most recent of which opened in C-Land (one of the World’s fastestgrowing economies) in 2014 to test the potential for wider global development. The vast majorityof the outlets are based in the original home country of I-Land where PT is known for good qualityfood and fast and friendly customer service.

The expansion of PT has taken place in three ways i.e. leasing new premises; acquiring failing

restaurant businesses and franchising, the latter of these making up some 50% of the restaurants.The remaining 50% being owned and operated by PT. The current business model is to locate PTrestaurants where there is considerable passing trade in shopping malls, town centres, airportdeparture food courts and motorway service areas.

Critical to business success in this industry, where customers have a huge choice of alternatives isthe protection of the PT brand. In this context, customer satisfaction is very important andparticular attention has recently been paid to four key areas to support this objective, namelyProduct Quality, Cleanliness, Customer Satisfaction and Speed of Service via the rollout out of aprogramme called PCCS designed to educate and motivate staff to monitor and improve levels ofcustomer service.

The company is structured on a decentralised basis with Head Office remaining in control offinance, central purchasing and franchise management. There is also a central processing plant




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and logistics which produces and transport s frozen dough for the pizzas to the restaurants. Thedecentralised approach allows PT’s regional managers to respond quickly to changing marketconditions which is one of three key strategic objectives, the others being to increase shareholdervalue through efficient use of resources (with a target of 10% annual revenue growth) and toexpand the number of restaurants globally and improve returns from existing restaurants.

The restaurant managers are responsible for ordering dough each week with the additionalresponsibility of ensuring that there is enough dough available in an appropriate condition fordaily pizza production. In addition the restaurant managers order the ingredients for the pizzatoppings and “other menu items” from local suppliers who are approved centrally by Head Officeusing a formal stock control model.

Revenue for PT is earned via retail sales from the company owned restaurants; franchise fees(including margins on central purchases, royalty income and a proportion of an up-frontfranchisee fee); royalties and sales of dough, packaging and equipment to franchisees. Thecompany remains profitable despite the increasing competition which comprises of other pizza

restaurants, substitute forms of “fast food” such as burgers, tacos and sushi and in additiondelivery only pizza chains. The latter of these presents the key competitive threat to PT fromPizza2Go, a well-established chain in the countries of I-Land, P-Land and C-Land.

Despite revenue not achieving expectations, gross profit and net profit have remained stable forPT in the year to 31 st December 2015 although there may be some concerns over the liquidity ofthe business. The main opportunities and threats facing PT are detailed in an extract from theirSWOT analysis, the result of a recent management away day. From an opportunities perspective,the need to expand and update products is a key driver of business growth. On the other hand thethreats of an increase in competition as a result of a saturated home market and that of lowercost competition are prominent. The mitigation of the risks which these threats generate will

need careful consideration, making the challenges facing PT substantial.



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Chapter 4

ADVANCED MANAGEMENTACCOUNTING (P2) FAMILIARISATION

1 QUALITY COSTS

Dennis Chan, the Operations Director, is reviewing Pizzatime’s progress towards achieving itsobjective of having a reputation for producing high quality products. The most common complaintfrom customers is that dough is uncooked or worse, still frozen. This can happen because ofdefective thermometers in the refrigerated storage units. If the issue is not spotted by restaurantstaff (chefs and/or waiters), the pizza may sometimes be served with dough that has not thawedand cooked properly.

Extracts from the company’s records for each of the years ended 30 December 2014 and 2015 areshown below:

2015 2014% of pizzas sent back by customers 5% 9%% of pizzas sent back by waiters before being served 6% 3%Costs as a % of revenueDough and raw materials quality control / inspection costs 5% 3%Dough and raw materials purchase costs 18% 20%Direct labour – chefs and waiters costs 13% 12%Training 8% 4%Preventative maintenance on refrigerated storage units 6% 2%Refrigerated storage units breakdown maintenance 5% 10%

EXERCISE 1

Prepare a report to Dennis Chan covering the following:

• Explain each of the four quality cost classifications using examples from the above data.• Discuss, using the above data, the relationship between conformance and

non-conformance costs, and its importance for Pizzatime.




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2 PARTICIPATIVE BUDGETING AND DECISION MAKING

As the financial manager based in Pizzatime’s Head Office in I-Land, you are responsible forpreparing the group budget.

Edward Grange, Pizzatime’s chairman, has stated that ‘ our decentralised structure is proving to be

a great advantage, as it allows regional managers to quickly respond to local market conditions .’However, head office currently imposes strict targets on regional managers. Edward is undecidedabout whether to keep a centralised budgeting function in Head Office, or to involve the regionaloffice managers in the budgeting process as well as the decision-making process.

EXERCISE 2

Prepare a report addressed to Edward Grange that discusses participative budgeting, as well asperformance and control in a decentralised structure. Your report should:

• Explain potential benefits and potential disadvantages of involving the new and existingmanagers in the budget setting and decision making processes.

• Provide a recommendation to Edward Grange.

3 BENCHMARKING

The regional manager in P-Land is ‘continually looking for opportunities to open new restaurants

and grow towards becoming the dominant pizza chain in the country.It has been suggested that he undertakes a benchmarking exercise to compete against the currentmarket leader, Let’sPizza, and eventually become the dominant pizza chain in P-Land.It is generally accepted that Let’sPizza dominant position is due to the business’s ability to adaptmenus (using only ritually slaughtered meat) and working methods to the specific environment ofP-Land.

Exercise 3

Prepare a report on benchmarking addressed to the P-Land Pizzatime manager. Your reportshould:

• Explain the concept of benchmarking• Explain the different types of benchmarking the P-Land manager could implement in order

to become the market leader in the country.



MANAGEMENT ACCOUNTING (P2) - FAMILIARISATION

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Chapter 5

PROJECT AND RELATIONSHIPMANAGEMENT (E2) FAMILIARISATION

1 STRATEGIC MANAGEMENTDespite the attention given to employees by the introduction of the PCCS initiative, Monica Lall

the Chief Executive, is concerned that Pizzatime is not considering all of the interest groups whocan affect or be affected by the strategic objectives.

EXERCISE 1 (a)

• Identify and explain a methodology to assess the influence of stakeholders with referenceto Pizzatime.

• Provide examples of categories of stakeholders which are likely to affect or be affected byfuture decisions and suggests a strategy for managing stakeholder expectations.

EXERCISE 1 (b)

In addition the Chief Executive is also concerned that whilst attention is paid to the activities ofthe competition and time has been recently spent producing an overview SWOT analysis, there isno formal methodology in place to ensure that other external developments are not ignored orassumptions made without evidence to support claims .

• Outline an appropriate methodology to analyse external industry developments withreference to Pizzatime.

• Provide examples of key areas of concern which are likely to affect future strategic decisions for Pizzatime.

2 THE HUMAN ASPECTS OF THE ORGANISATIONThe Finance Director, Matt Spot, is concerned that given the strategic objective of Pizzatime toexpand the number of restaurants via global coverage, there are potential issues with theintegration of new businesses into the Pizzatime culture.

EXERCISE 2

Using an appropriate framework, identify the ways it could be used to assist Pizzatime in theintegration of new businesses. Provide illustrations of questions that could be asked to analyse atarget company’s culture.





3 MANAGING RELATIONSHIPS

With the plans for expansion and the decentralised structure adopted by Pizzatime, newchallenges will arise as the business strives to deal with the variety of people in an ever increasingrange of locations.

EXERCISE 3

Given the likelihood of conflicting objectives within Pizzatime in the implementation of itsstrategic objectives, suggest what form this conflict may take, how it may manifest itself and whatsteps could be taken to manage this conflict with reference to Pizzatime.

4 MANAGING CHANGE THROUGH PROJECTS

Given the likelihood of Pizzatime commissioning impromptu projects Dennis Chan is currentlyreviewing procedures, particularly in the light of future opportunities identified, and is consideringthe introduction of a more formal project acceptance process. This will include the creation of afeasibility report which will be produced for all future projects.

EXERCISE 4

Prepare a briefing note for Dennis Chan which covers the following:

• Why should Pizzatime introduce a feasibility study for projects?

• Outline the key contents of such a study for Pizzatime.



PROJECT AND RELATIONSHIP MANAGEMENT (E2) - FAMILIARISATION





Chapter 6

ADVANCED FINANCIAL REPORTING(F2) FAMILIARISATION

1 ANALYSIS OF FINANCIAL PERFORMANCE & POSITION

EXERCISE 1(a)

Analyse the profitability and financial position of Pizzatime depicted in their financial statements,using suitable ratios to support your analysis. Compare the performance and position ofPizzatime with Pizza2Go and consider the implications of the share price and EPS history.

EXERCISE 1(b)Prepare & briefly comment on a cash flow statement for Pizzatime using the followingassumptions:

Depreciation expense for the year was I$25m No items of PPE were sold during the year The breakdown of non-current liabilities is:

2015 2014I$m I$m

Interest bearingborrowings

120 110

Deferred tax 6 5Deferred income 29 35

155 150

The breakdown of current liabilities is:

2015 2014I$m I$m

Trade payables 68 66Income tax 30 28Deferred income 7 6

105 100

The foreign exchange loss relates to PPE





2 FINANCIAL REPORTING

EXERCISE 2

Discuss how the following accounting standards / topics may be relevant to Pizzatime and the pre-seen information:

IAS 17: Leases IAS 18: Revenue IAS 21: Foreign currency IAS 37: Provisions IFRS 2: Share based payments Group accounting

3 SOURCES OF LONG-TERM FINANCE

EXERCISE 3

Consider why Pizzatime may need to raise finance. Discuss the options available to Pizzatime forraising finance, together with their relative advantages & disadvantages.

Consider and explain how the weighted average cost of capital would be calculated for Pizzatime,

together with its uses.




Chapter 7

PIZZATIME PRACTICE TASKS

1 EXAM PRACTICE

Now you have thoroughly worked through the pre-seen materials and are familiar with the keyissues it is time to think more about the exam environment and your strategy for three very

important hours. Before you attempt any full mock exams it is necessary to consider the skillsneeded to approach each individual task.

2 IMPORTANCE OF TIME MANAGEMENT

Someone once referred to case study exams as "the race against time" and it's difficult to imaginea more accurate description. Being able to do what the examiner is wanting is only half of thebattle ; being able to deliver it in the time available is another matter altogether.

For this reason, time management is a key skill required to pass the Case Study Examination.

Successful time management requires two things:• A tailored time plan – one that plays to your personal strengths and weaknesses ; and• Discipline in order to stick to it!

The first part of each task must be spent actively reading, processing the information andconsidering the impact on the organisation, how the issues link together and what could be doneto resolve them. You will not have time to have a second detailed read and so these thoughtsmust be captured first time around.

You will be writing your answer in software with some similarities to Microsoft Word however theonly functions available are• Cut• Copy• Paste• Undo• Redo• Bold• Italic• Underline

The temptation to make various words bold or italics or underlined, is very hard to resist. But,resist you must! There are very few marks available for having a response that is well presented,and these finer details will be worth nothing at all.





As we've said earlier, typical reasons for failing the Case Study Examination are not finishing youranswer and/or not having sufficient application to the scenario. A major cause of both failings is alack of discipline when writing about an issue. Some students feel they have to get all of theirpoints down rather than selecting the better points, applying them to the specific circumstancesof the company concerned where possible and then moving on. If a task requires you to discuss

three different areas it is vital that you cover all parts adequately.Often students can reread paragraphs three or more times before they move on to writing thenext part of their report. Instead, try to leave the read through until the final few minutes of thetask and try to correct as many obvious errors as possible. The CIMA marker will be reading andmarking your script on screen and it is harder to read and understand the points you are making ifthere are many typing errors.

3 ASSIMILATION OF INFORMATION

One of the most challenging things to deal with in a case study examination is the volume ofinformation which you have available. This is particularly difficult when you have both pre-seenand unseen information to manage and draw from. It is important that you refer to relevant pre-seen information in your responses as well as incorporating the unseen information. The keythings that you need to do to assimilate the information effectively and efficiently are:• Read about and identify each event• Consider what the issue is• Evaluate the impact of the issue. Who is affected, by how much are they affected and what

would happen if no action was taken?• Determine the most useful and relevant exhibits from the pre-seen

Capturing all of your thoughts and ideas at this stage can be difficult and time consuming. Thechapter in the CIMA Official Case Study Textbook on planning your answer will show you how todo this effectively without wasting time or effort but we have given some simple guidance below.

4 PLANNING YOUR ANSWERS

To make sure the time spent now is of use to you throughout the task, you will need considercarefully how best to document your thoughts. You will be provided with an on-screen notes page(‘scratchpad’) as well as a wipe-clean laminated notes page and marker pen. Any method youadopt to plan must be concise whilst still allowing you to capture all of your ideas and see thebigger picture in terms of how the issues interrelate with one another (see additional guidancebelow). Furthermore, the method must suit you! Everyone is different and what might work forone person could be a disaster for another. For example, some people prefer to work with lists,other with mind maps.

Most people find that some form of central planning sheet (to enable the bigger picture to beseen) is best. How you prepare the central planning sheet is a matter of personal preference andwe've given illustrations of two different methods below. Practise each one to find out which youprefer and then tailor it further to settle on something that works for you.



FLOTE PRACTICE TASKS


Method 1 – The ordered listThis process is ideally suited to people who prefer lists and structure.

• Step 1:

Begin by reading everything in the task exhibit. Ensure you have identified all aspects of thetask and then write this on the left hand side of your planning sheet

• Step 2:

Read everything in the trigger exhibit, making notes next to the relevant task

• Step 3:

Review your list to identify any linkages to information provided in the pre-seen and note nextto the task on your planning sheet

• Step 4:

Brainstorm any technical knowledge you can use in responding to the task and note this onyour planning sheet

Method 2 – The extended mind mapThis process is ideally suited to those who prefer pictures and diagrams to trigger their thoughts.

• Step 1:

Read the unseen information and identify the key tasks required

As you read, write each task in a "bubble" on your planning sheet.

• Step 2:

Keep adding each new part of the task you identify to your sheet. At the end you should havea page with a number of bubbles dotted about.

• Step 3:

Review your bubbles to identify any linkages to the trigger information or pre-seen exhibits.Add any relevant information to your planning sheet in a bubble attached to the appropriatepart of the task.

• Step 4:

Review the task bubbles and brainstorm any relevant knowledge which you can use inresponding to the task. Add this to bubbles attached to the task

With detailed information provided in the exam it would be very likely that your brain wouldthink of a wide range of ideas which, if left uncaptured, would be forgotten as quickly as you

thought of them. This is where mind mapping comes in handy.





5 WRITING STYLE

Introduction

Writing style is something that develops over time. It is influenced by your education andexperiences. To some it comes easily, they enjoy words – but remember, you are not looking towin any prizes in literature. It’s about putting facts, ideas and opinions in a clear, concise, logicalfashion. Some students get very worried about their writing styles. As a general rule you shouldtry to write as you would talk.

Logical flow

A typical point starts with a statement of fact, either given in the case or derived from analysis –‘what?’

This can then be followed by an interpretation – ‘so what?’ followed by ‘now what?’, or ‘whatnext?’

For example:(1) What? – The project looks as if it will be profitable.

(2) So what? – Suggesting we should go ahead with the project.

(3) Now what? – Arrange board meeting to discuss strategic implications.

A similar structure can be obtained using the Socratic approach – what, why, how?• So what?• Why should we use it?• How does it work?

Who is reading the response?

Failure to pitch the level correctly will inevitably result in failure to communicate your ideaseffectively, since the reader will either be swamped with complexity, or bored with blandness.

The recipients of the report should also dictate the level of tact required.

Tactless Tactful

The directors have clearly madeerrors

There were other options open to the board that, withhindsight, would have been beneficial

The marketing director is responsiblefor this disastrous change in strategy

The board should consider where this went wrong? It wouldappear that the marketing department may have made somemistakes



FLOTE PRACTICE TASKS


6 ATTEMPTING THE PRACTICE TASKS

In the following chapters, practice exercises are provided which will help you prepare for differentscenarios arising in the exam. This will also give you an opportunity to revise some key aspects of

the syllabus and consider how they may be applied to the scenario. It is crucial that you gothrough this process to fully prepare yourself for the exam. Be careful – this is NOT an exercise inquestion spotting. We are aiming to revise the knowledge required and practise the skills neededto perform well in any exam rather than guess what may come up.

Each task begins with a small scenario (or trigger) to introduce the topic and set the scene. Youshould be using the skills developed so far to work through these tasks. These tasks are discretei.e. they do not follow on from each other but stand alone as sample exercises.

It is very important that you attempt these tasks yourself before reviewing the suggestedsolutions. Practising writing out full solutions is a key part of developing the required skills for thecase study exams.




Chapter 8

ADVANCED MANAGEMENTACCOUNTING (P2) PRACTICE TASKS

EXERCISE 1 – PERFORMANCE MEASUREMENT

Trigger

An extract from Monica Lall’s recent communication to the Board of Directors after thepublication of the 2015 group financial statements:

From: Monica Lall

Date: December 2015

Subject: Performance Management in Pizzatime

I have just returned from a conference on different approaches to performance management. Theworkshop I enjoyed the most was entitled ‘Selection criteria for performance measurement’. I amconvinced we need to be able to translate our corporate objectives, both financial and non-financial and including those linked to our PCCS programme, into a performance measurementframework.

I feel this is particularly timely if we are to open new restaurants in C-land to boost revenue.





Task

You have received the following email from the Finance Director:

From: Matt Spot

Date: December 2015

Subject: Performance Management in Pizzatime

I assume that you have seen the CEO’s email about a Pizzatime and performance management. Iam sure there are many advantages in applying a suitable, all encompassing approach.

I would be interested to hear your thoughts on the proposal.

Please send me an email that expresses your thoughts on the following points:

- A briefing for the benefit of the Management Board, on a suitable method to define financialand non-financial objectives, which also analyses its usefulness for Pizzatime.

- Examples of measures that would be incorporated within such an approach, along with yourthoughts on what the four most important measures are when considering expansion into C-land,and why.

Prepare the work that Matt has requested.

(Time allocation 30 minutes)



ADVANCED MANAGEMENT ACCOUNTING (P2) - PRACTICE TASKS


EXERCISE 2 – RISK

Trigger

Monica Lall has forwarded the following email to you:

From: Maya Lee CC: Donald Bruce

Date: December 2015 To: Monica Lall

Subject: Risk Management

Monica,

As non-executive directors, we need to ensure that Pizzatime can manage its risks – or moreaccurately, Donald and I need to satisfy ourselves that a robust system of risk management is inplace in the business.

May we discuss at the next Board meeting?

Maya

Task


From: Monica Lall

Date: December 2015

Subject: Risk Management

I assume that you have seen the communication from our non-executive directors, Maya andDonald.

Identify and explain the main stages of the risk management cycle, with a focus on business risks,within a memo for the Board of Directors of Pizzatime that explains how such a process might beused to understand and control such risks.

In your memo, please also include a brief assessment of the likelihood and impact of each risk.

Prepare the work that Monica has requested.

(Time allocation 30 minutes)





EXERCISE 3 – INVESTMENT APPRAISAL

Trigger

The finance team have completed the following investment appraisal analysis:

From: Finance Team, Head Office Date: December 2015

Subject: Investment in new ovens in P-Land

We need to increase production capacity in P-Land in order to meet expected demand for thenew ‘healthy pizza reduced salt and sugar content’ range. These new pizzas may not be baked inthe existing, inefficient, old ovens.

The Regional Manager can partially upgrade the P-Land ovens; but he has also identified a suite ofbrand new pizza ovens which could bake the healthy pizza as well as significantly increase theoutput on the current range by being fitted in new restaurants. Both options would enablePizzatime in P-Land to meet the demand of 60,000 ‘healthy’ pizzas a year.

Details are as follows:

Option 1 – Partial upgrade of existing ovens

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5P$m P$m P$m P$m P$m P$m

Revenue 40 40 40 40 40Maintenance costs (10) (15) (20) (25) (30)Equipment (70)Net cash flow (70) 30 25 20 15 10

Payback period = 2.75 yearsNet Present Value (discounted at 10%) = P$9.4mInternal Rate of Return = 16%

Option 2 – Substantial upgrade (purchase of new ovens)Year 0 Year 1 Year 2 Year 3 Year 4 Year 5P$m P$m P$m P$m P$m P$m

Revenue 50 60 70 80 90Maintenance costs (15) (20) (25) (30) (35)Equipment (150)Net cash flow (150) 35 40 45 50 55

Payback period = 3.67 yearsNet Present Value (discounted at 10%) = P$17.0mInternal Rate of Return = 14%

Minimum targets Payback period = 3 years

Net Present Value = NilIRR = 10%



ADVANCED MANAGEMENT ACCOUNTING (P2) - PRACTICE TASKS


Task


From: Matt Spot

Date: December 2015

Subject: Investment Appraisal

In order to meet the demand for the new pizza we will need perform, at the very least, a partialupgrade to our existing ovens. This would cost P$70 million. However, it would only create theadditional capacity that we need to meet the needs of the customers requiring the new pizza.

As there is an increasing demand for our current range (partly due to new restaurants openingplans), this may be the ideal time to perform substantial upgrades and acquisitions in order toincrease our earning potential. This will cost P$150 million and although it may take time to buildup the additional customers I believe that it is an option worth considering.

Whichever option we decide to choose, the equipment would be expected to last for five yearsafter which time it would need to be replaced.

I have prepared a very quick investment appraisal analysis that I would like you to look at. Pleasereview the results and send me a report containing the following:

• A detailed interpretation of the results of the investment appraisal analysis, including yourconclusion on the option which would be most financial beneficial

• An explanation of any other issues that should be considered before making the finaldecision

Prepare the work that Matt has requested. (Time allocation 30 minutes)




Chapter 9

PROJECT AND RELATIONSHIPMANAGEMENT (E2) PRACTICE TASKS

EXERCISE 1 (EXPANSION PLANS)

Trigger and Task

You receive the following email from the Finance Director

To: Financial ManagerFrom: Finance DirectorDate: TodaySubject: Strategic growth opportunity

As you are aware, one of Pizzatime’s strategic objectives is to expand the number of restaurants.At our recent “away day” the senior management team felt that the potential for future growth in

I-Land is limited, with the market reaching saturation. A proposal put forward is that to achievegrowth we should move into new markets in other countries, offering its existing product range.

The Chief Executive has decided that Pizzatime should create a business development team tolook at various possibilities to achieve this growth objective and are currently undertaking afeasibility study to explore the viability of the proposed strategy to expand into Country K.

As part of the feasibility study they have will need to be some assessment of industry competitionand the attractiveness of the market in Country K and they have requested our help.

I remember vaguely some approaches to assessing the competitive nature of an industry but as

we are helping out the senior team a more comprehensive note is required.

Can you prepare a briefing note for the benefit of the management team which:

• Outlines a suitable method to assess industry competition

• Discusses how such a method could be useful for Pizzatime to analyse its proposed expansioninto Country K.

Prepare the briefing note Matt has requested(30 minutes)





EXERCISE 2 – (WEBSITE PROJECT) Trigger and Task

To: Financial Manager

From: Finance DirectorDate: TodaySubject: New website project

The senior management team gave the go-ahead to redesign the company’s website to make itmore convenient for customers to use.

The project is currently having problems with the functionality of the site and the fact that it is not

easy to navigate. The Project Manager has expressed concern about the rising costs of the projectand the time needed to improve the functionality. He estimates that the change to thefunctionality will delay the project by three weeks. Whilst he understands that improved

customer satisfaction (by making the website easy to use) is important. There will also bediminishing returns since the increased levels of customer satisfaction obtained by the change infunctionality will be offset by the increased time and cost spent.

The Operations Director has called an emergency meeting with the Project Manager in order tocome up with some immediate solutions which address the project slippage and asked for ourhelp in his preparations for that meeting.

Please can you prepare some brief notes for the following:

• Identify the areas that the Operations Director needs to address in his discussion with theproject manager

• Discuss how the project manager may address the issues within the website project.

Prepare the work that Matt has requested

(30 minutes)



PROJECT AND RELATIONSHIP MANAGEMENT (E2) - PRACTICE TASKS


EXERCISE 3 – (INTERNAL REVIEW)

Trigger

To: Finance Director

From: CEODate: TodaySubject: Internal Review

It is clear that we are facing a maturation of our product offering and to prosper in this industryproduct update and innovation is critical. In addition, and to match our strategic objective of theefficient use of resources I am concerned about the internal capability of Pizzatime to achieve thisinnovation, particularly given the increase in competition and the fact that we have not reviewedour internal processes for a long time. To that end I would like us to conduct a review of ourinternal capabilities to establish where we can really add value. I would like you and your team totake the lead in this initiative.

I am particularly concerned about the transport logistics who seem to be continually the subjectof complaints both as result of late deliveries, vehicle breakdown. From what my regionalmanagers tell me we could obtain a faster more reliable and effective service by outsourcing thefunction. In addition I am also concerned that the Operations Director has voiced some concernsover the quality of the dough from the central processing plant and that they may struggle tocope with our expansion plans.

Can you provide the board with a briefing note to address our concerns please? I would like theseto be a formal agenda topic at the next board meeting which we can discuss prior tocommissioning any further in depth reviews.

Thanks

Monica





Task

To: Finance ManagerFrom: Finance DirectorDate: Today

Subject: Board request

Please see attached an email I received earlier today.

As you will see the CEO requires us to take the lead on this new initiative and provide them with arecommended approach to perform the desired internal review, to consider the efficiency of thetransport logistics section and the concerns expressed over the central processing plant.

To that end, please can you prepare a briefing note which addresses the following:

• How Pizzatime could better understand its internal capability and discuss appropriatemethodologies which we could use to achieve this goal.

• Discuss the advantages and disadvantages of outsourcing the central processing plant and thetransport logistics section.

Thanks

Matt

Prepare the work that Matt has requested

(45 minutes)




Chapter 10

ADVANCED FINANCIAL REPORTING(F2) PRACTICE TASKS

EXERCISE 1 (ACCOUNTING TREATMENT)

Trigger

Pizzatime are keen to ensure that franchisees adopt high standards within their restaurants toprotect the brand of Pizzatime. In particular, high standards of décor are required. Fullrefurbishments of restaurants occur every 4 years with restaurants being closed for a week or twofor such work to be carried out. During this time, staff are required to attend training courses toensure that high standards of customer service and food hygiene are maintained.

The HR director, Helga Schmidt, has recently emailed you with regard to the training courses thatare due to the take place over the next 12 months.





Task

E-mailFrom: Helga Schmidt, HRTo: Financial ManagerDate: January 2016

I have been talking to the operations director, Dennis, toensure that the next round of restaurant refurbishmentprogrammes and staff training programmes are timetabledsimultaneously for minimum disruption to the business. As aresult of these conversations we would both like to gain abetter understanding of how the refurbishment & trainingcosts are accounted for.

As you know, we are a company that likes to invest in theirpeople by continually increasing their skills and knowledgewith training courses. Now that we have reached the “other

side” of the recession, I would like to reward our staff bysending them on these training courses in more glamorouslocations. I think the benefits of doing this in terms of teambuilding and increasing morale would far outweigh the costsof sending them to hotels for their next round of training. Ialso believe that we are more likely to retain staff for thelong-term by providing them with this treat.

We understand that the refurbishment costs are capitalisedand written off over the next 4 years. I was hoping that wewould be able to adopt a similar treatment for the increasedtraining costs. I know that there is a limit under which allcosts are expensed rather than capitalised. As the trainingcourses will now exceed this limit if we send them to hotels, Ibelieve this will also enable us to capitalise the costs. Dennisis also aware that budgets for his refurbishment programmesare incorporated within the management accounts.However, he can’t find reference to such provisions withinthe financial statements and is wondering why.

Could you explain to us:

• The correct treatment for the increased trainingcosts

• Why a budget for refurbishment costs is included inthe management accounts but not in the financialstatements?

We look forward to hearing from you.

TaskDraft a suitable response to Helga and Dennis’ queries .

(45 minutes)



ADVANCED FINANCIAL REPORTING (F2) - PRACTICE TASKS


EXERCISE 2 (ACCOUNTING FOR PREMISES)

Trigger and Task

As part of Pizzatime’s expansion plans into C-land, the recently appointed regional

manager has been viewing potential premises for new restaurants.

The regional manager has provided you with the following information in relation totwo potential premises in a particular area.

Premises A

This site has previously operated as a restaurant and so only relatively minorcosts would need to be incurred to bring it to a suitable condition to operate asa branch of Pizzatime such as redecoration in line with the brand. Furniture andkitchen equipment however would need to be purchased.

The lease would be a 25 year lease with penalty payments incurred if Pizzatimewish to terminate the lease early. Pizzatime would be responsible for bothbuildings and contents insurance. Pizzatime would be given the option toextend the lease at a substantially lower rental at the end of the term.Pizzatime will be responsible for all maintenance costs associated with thebuilding such as plumbing and electrical issues that may arise.

Premises B

The site has not previously operated as a restaurant and requires somesubstantial internal building work in order for it to be suitable. A clause withinthe lease would require Pizzatime to return the building to its original conditionat the end of the lease.

The lease would be for 5 years. A lump sum would be paid at the start of theterm with 5 smaller payments paid annually thereafter.

The landlord would be responsible for buildings insurance whilst Pizzatimewould be responsible for contents insurance. The landlord will also providecontractors to deal with maintenance issues that may arise such as leaks orblocked pipes.

To encourage investment in this particular area of C-land, the governmentwould allow 100% capital allowances immediately against the costs incurred in

modifying the building to make it suitable to operate as a restaurant.(You may assume that all costs for both premises would be incurred in thefunctional currency of Pizzatime).

• Please can you prepare a summary of how each scenario would beaccounted for so that he can consider the information when making arecommendation to head office as to which would be the best option.

• He has also asked that you explain how the leases will impact on thereturn on capital employed and gearing ratio’s as these are key ratiosused in the decision making process.

Prepare the work requested by the regional manager .(60 minutes)





EXERCISE 3 (SEGMENTAL ANALYSIS)

Trigger and Task

You receive the following email:

To: Financial ManagerFrom: Finance DirectorDate: TodaySubject: Strategic analysis

The senior management team have asked for an analysis of the segmental report to assist in thefuture strategic planning for Pizzatime.

I have received the attachments below, prepared by the Finance Assistant, but haven’t had timeto perform any further explanatory detail. The meeting is scheduled for this afternoon and I don’thave the time to do any more work on the numbers.

Please can you prepare an analysis of the 2015 segmental report so that I can take it to themeeting when the strategic direction of Pizzatime will be discussed? They will be particularlyinterested to draw comparisons between the three regions in terms of revenue growth and profitand to establish reasons for these movements if possible.

Attachments to your assistants email:

The segmental report from the 2015 financial statements Ratio’s as calculated by your assistant

Prepare the analysis as requested by Matt(30 minutes)

Attachment 1 – Segmental report

2015 2014 I-land P-land C-land Total I-land P-land C-land Total

I$m I$m I$m I$m I$m I$m I$m I$mRevenue 556.7 39.5 0.8 597 524.8 43.9 0.3 569

Operatingprofit

146.5 8.2 0.3 155 136.7 7.2 0.1 144

Unallocatedexpenses

(20) (16)

Finance

costs

(8) (7)

Profit beforetax

127 121

Assets 377 28.6 0.4 406 365.3 25.3 0.4 391Unallocated 51 61Total assets 457 452

Liabilities 96.4 7.5 0.1 104 100 6.8 0.2 107Unallocated 156 143

Totalliabilities 260 250



ADVANCED FINANCIAL REPORTING (F2) - PRACTICE TASKS


Attachment 2 - Ratios

2015 2014I-land P-land C-land Total I-land P-land C-land Total

I$m I$m I$m I$m I$m I$m I$m I$mRevenue change +6.0% -11.1% +267% +4.9%

Profit change +7.2% +13.9% +300% +7.6%

Profit margin 26.3% 20.8% 37.5% 26.0% 26.0% 16.4% 33.3% 25.3% Return on netassets

52.2% 38.9% 100% 51.3% 51.5% 38.9% 50% 50.7%

Assets:Liabilities 3.91 3.81 4.0 3.65 3.72 2.0



CIMA FEBRUARY 2016– MANAGEMENT CASE STUDY


Chapter 11

SUGGESTED SOLUTIONS

CHAPTER TWO


When was Pizzatimeformed?

1969

What are principal methodsby which Pizzatime haschosen to expand?

Leasing new premises; acquiring failing restaurant businesses andfranchising

How many restaurants doPizzatime operate as at 31December 2015? Where arethey based?

970 – 900 in I-Land; 69 in P-Land and 1 in C-Land

What do Pizzatime menusoffer? Are they licensed tosell alcohol?

A wide choice of pizzas and complementary products such asdough balls, salads, desserts and beverages.

No information as whether the restaurants are licensed or not.

Where is the doughprepared for therestaurants? Where do theingredients come from?

Prepared at a central processing plant in I-Land

Ingredients for the pizzas toppings and other menu items aresourced from local, head office approved, suppliers.

How are the ingredients forthe pizzas reordered?

Items are replenished using a pre-determined optimal re-orderpoint calculated using the EOQ model.

What is Pizzatime’s currentbusiness model?

To locate restaurants in places that has lots of passing trade e.g.shopping malls.

What % ages of Pizzatime’srestaurants are operated byfranchisees?

50%




What standards areexpected of the franchiseesand why?

High standards of food safety, customer service and décor aeexpected to protect the Pizzatime brand.

What are the four aspects ofthe PCCS programme?

Product quality, customer enjoyment, speed of service andcleanliness.

What is the key customergroup for Pizzatime? Whatfacilities are provided fortheir use?

Families with young children. Light and attractive eatingenvironments, simple seating and tableware and highchairs forinfants.

How is Pizzatine structured?How many regional officesare in operation?

Structured on a decentralised basis there are 8 regional offices in I-Land and one in P-Land. As yet there is no regional office in C-Land

What was the Gross Profit ofPizzatime in 2015?

74.2%

Has Pizzatime’s operatingprofit increased ordecreased in the period?

Slight increase from 22.5% to 22.6%.

What is the “quick ratio” forPizzatime?

0.73:1 falling from 0.85:1 in 2014

Has gearing increased ordecreased during theperiod?

Gearing has increased from 42.6% to 44.0%

What does Pizzatimerevenue comprise of?

Retail sales from company owned restaurants, royalties and salesof dough, packaging and equipment to franchises and franchisefee recognised during the year.

How does Pizzatime mitigatethe risk of poor customerservice?

Close monitoring of franchises and investing in programmes toimprove and monitor levels of customer service.

Who has responsibility formanaging risks in Pizzatime?

No information provided

How does Pizzatimepromote healthy eating?

Introduction of low salt and low sugar items and listed calories forapprox. 25% of the products.

How does Pizzatime increaseshareholder value?

Efficient use of resources, strong growth and high returns oncapital – targeting a 10% growth in total revenue.

Where is Pizza2Go wellestablished? What was their

gross margin in 2015?

C-Land - 37.5%





CHAPTER FOUR

EXERCISE 1

QUALITY COSTSTo: Dennis ChanFrom: Financial Manager Subject: Quality Costs Date: Today

Introduction

This report looks at the quality costs classifications and the relationships between conformance andnon-conformance costs.

• Prevention costs are costs that are incurred in order to prevent poor quality. Examples fromthe data provided are expenditure on staff training, and preventative maintenance

• Appraisal costs are costs incurred to measure or appraise the quality of the items produced.An example from the data provided is finished goods inspection cost.

• Internal failure costs are costs that are incurred in rejecting or correcting faulty goods wherethe quality failure is discovered before the item is despatched to the customer. An examplefrom the data provided would be the costs related to the goods that are rejected beforedelivery.

• External failure costs are costs that are incurred as a result of customers rejecting goods thathave been delivered to them. In the data provided there are goods that have been rejected bycustomers. The costs associated with these rejects would include collection and re-deliverycosts and the loss of customer goodwill.

Conformance costs are prevention and appraisal costs. Non-conformance costs are internal andexternal failure costs. The relationship is that higher conformance costs should in the long run leadto lower non-conformance costs.

In the data provided it can be seen that costs incurred on prevention and appraisal costs were a

greater percentage of turnover in 2015 compared to 2014, and as a result the level of externalfailures reduced.

This would improve the perception of Pizzatime in the market. It can also be seen that the level ofuncooked dough ‘failures’ identified before despatch increased. This could be because of the greaterexpenditure on appraisal costs. However it would appear that there are far too many ‘rejects’ beingbaked, and that Pizzatime needs to work towards improving the quality of its cooking processesrather than relying on quality inspections to identify sub-standard production. The company shouldwork towards ‘designing quality in’ as opposed to ‘inspecting poor quality out’.



EXERCISE 2

PARTICIPATION IN BUDGETING AND DECISION MAKING

REPORT

To: Edward Grange, ChairmanFrom: Financial Manager Subject: Participative budgeting and decision making processesDate: Today

Introduction

The following report identifies advantages and disadvantages of involving regional managers in the

setting of budgets, and some behavioural consequences of performance management and control ina divisionalised structure like Pizzatime.

Advantages

1. Regional Office Managers have specialist knowledge of their geographical area of thebusiness. They are more likely to be much closer to customer needs and better able torespond to local circumstances (which differ a lot in our three countries of I-land, P-land andC-land).

2. If Regional Office Managers are involved in decision making and setting budgets, then the

budgets may be more relevant to the business, because the manager can incorporate this intotheir budgets. For example, if not restricted by imposed cost targets, regional managers mayfeel more free to sue higher quality ingredients.

3. This should lead to a ‘superlative’ level of customer service and, in turn get us closer tomeeting our stated corporate objective of 10% annual growth.

4. If Regional Office Managers are involved in the budget setting process (or any key decision),they are likely to take ownership of the budget and feel that failing to achieve it is a personalfailure. This means that managers will be motivated to achieve the targets they have set andagreed, and consequently the target is more likely to be achieved than one that is simplyhanded to them without their involvement.

Disadvantages

Centralised purchasing decisions, as well as a centralised budgeting function (I prepare the groupbudget and ensure that regional budgets are maintained and adhered to) are a way to ensure thatcontrol is maintained over almost a thousand outlets.

1. If we allow more decentralisation, managers may deliberately set themselves targets that areeasier to achieve by the inclusion of budgetary slack. This may result in the company’sperformance being lower than it would have been, had more difficult targets been imposed

on the managers.





2. Some of the managers may have less experience than others in managing fast food restaurantoperations. Consequently they may not understand the relationships that exist betweendifferent budgets and the impact that one has on the other and they may take decisions intheir own area that are detrimental to another area of the business and to the company as a

whole.

Recommendation

It is important that the regional managers work together as a team to prepare the company’sbudgets. In this way they can share their expertise and produce a set of budgets that are realisticand for the benefit of the company as a whole. It is generally agreed that manager involvement inthe budget setting process is likely to lead to better budgets and better performance.

However, in the face of the current threats we face, the need to ensure consistency of customer

experience and quality at every single one of our 970 locations is greater, in my opinion. Commonpolicies and practices are easier to implement and control. This is especially true for budgets -central purchasing decisions will enable us to still benefit from economies of scale and overheadsavings are easier to achieve.



EXERCISE 3

BENCHMARKING

REPORT

To: P-Land Regional Manager

From: Financial Manager

Subject: Benchmarking

Date: Today

Introduction

The following report explains the concept of benchmarking and the different types of benchmarking

that can be applied in a business like ours in P-Land.

Benchmarking

Benchmarking is to study a competitor's product or business practices in order to improve theperformance of one's own company. It is a systematic comparison of the processes and practices oftwo or more companies or two or more units of a company, and gauging the performance of abusiness relative to a peer.

When executed well, benchmarking prominently reveals gaps between the performance of thebenchmarker (Pizzatime in P-Land) and the performance of a benchmarked "best practices" leader,and often suggests the means by which the benchmarker might close those gaps.

A benchmarking exercise in P-Land is a good idea. It could include one or more of the followingapproaches:

Internal benchmarking : the most performing Regional unit in I-land can be used as the benchmark,and we can compare your own P-land performance with the best in I-land.

Competitive benchmarking : With competitive benchmarking, the most successful competitors(Let’sPizza in your case) are used as the benchmark. Competitors are unlikely to provide willingly anyinformation for comparison, but it might be possible to observe the following:

• Competitor performance: How does the market leader ‘do’ customer service? You couldcompare our performance against theirs in terms of speed-of-service, friendliness of service, itcould mean an in-store culture, or it could simply mean an accurate order served. Byunderstanding the scope of customer service venues, we in P-Land could focus and build bestpractices around that.

• Menu performance: A competitor's pizza might be ‘dismantled’ in order to learn about itsinternal ‘design’ or ingredients, and its performance: this technique of benchmarking is calledreverse engineering. At the moment, your menus are identical to those in I-land, but it may

not be the best business step. Remember benchmarking always considers 'best practices.' Itmeans that we need to understand P-Land’s market leader for executing a pizza-based menu –





how different is it from your current offer? Once you understand the best practices, then youcan build my menu strategy, equipment strategy, and operations strategy against the menubenchmark.

For example, do Let’sPizza use fresh or frozen dough? Do they make the most of locally sourcedingredients or do they import a proportion? What would be the impact of adapting ingredients andworking practices to the specifics of P-Land?

By understanding the various differences within the pizza industry, we may use benchmarking forrefining our own business identity in P-land.

Functional benchmarking: In functional benchmarking, comparisons are made with a similarfunction (for example selling, order handling, despatch) in other organisations that are not directcompetitors. For example, we could compare our speed of service, or our pricing, with a fast foodrestaurant operator.



CHAPTER FIVE

EXERCISE 1 (a)

Strategic decision making requires the consideration of stakeholders when setting the corporateobjectives. This is required as a result of two parameters:

Stakeholder PowerThis term suggests is that management must recognise that stakeholders can affect the success of astrategy, depending on whether they support or oppose it. For example, the availability of staffwithin the restaurants would disrupt any strategic development and affect the customer experience.The senior management team must therefore consider stakeholders before setting or revisingstrategic objectives.

Power may be assessed by considering for example:

• The status of the stakeholder• The claim on resources that the stakeholder has• Level of representation in the decision making process

Stakeholder InterestThis term suggests that although working primarily for the shareholders, management must ensurethat its decisions do not ignore the interests of other stakeholders, for example the suppliers ofingredients to Pizzatime restaurants, the wellbeing if which is fundamental to business success. Asresult they should not abuse their power.

Interest may be assessed by considering for example:

• employees – require payment, job security, good working conditions

• customers – require fair prices, quality food and service

• suppliers – require payment on time, accurate delivery information

• regulators - potential to be called to account

Stakeholders may be categorised for Pizzatime as follows:

• internal stakeholders those individuals inside the company who’s objectives are likely to have astrong influence on how it is run. Internal stakeholders for Pizzatime would include the employees,regional managers and directors

• connected stakeholders either invest time, money in the business or have dealings with thecompany. For Pizzatime this would include suppliers and those who have invested i.e. shareholdersand providers of loan finance. Customers, for example, would expect value for money and speed ofservice. Providers of finance will expect their interest payments to be made on time.• external stakeholders are those with no direct link to Pizzatime but who can influence or be

influenced by its activities. For Pizzatime this can include the government or regulators wherechanges in the legal requirements for health and safety will affect future revenue generation.





A suggested process for managing stakeholders might be:

• Identify stakeholders and determine each group's objectives• Analyse the level of interest and power each group possesses• Classify each stakeholder group in accordance with the level of interest and power• Determine an appropriate management strategy

For example:

• Low Interest – Low power:Their lack of interest and power makes them open to influence and are likely to accept whatthey are told and follow instructions e.g. casual employees in restaurants.

Suggested strategy to manage stakeholders in this category - Direction

• High Interest – Low power:These stakeholders are interested in the strategy but lack power e.g. pressure groups such asThe Food Commission in the UK

Suggested strategy to manage stakeholders in this category - Education/communication

• Low Interest – High power: InterventionThe key here is to keep these stakeholders satisfied to avoid them gaining interest andexercising power e.g. national government.

Suggested strategy to manage stakeholders in this category - Education/communication

• High Interest – High power: ParticipationThese stakeholders are the major drivers of change and could prevent the achievement ofplans if not satisfied. There is a need to communicate plans to them and then discussimplementation issues e.g. local government, regulators

Suggested strategy to manage stakeholders in this category - Participation

It is however worthy of mention that stakeholders can move between these categories in certaincircumstances. For example, even the casual seasonal employee may directly affect service in therestaurants and can therefore be a key player in the customer experience.



EXERCISE 1 (b)

It is important for Pizzatime to regularly look at the various factors within its environment that mayrepresent threats or opportunities to its future success in addition to the competition it faces. Thisrequires an appraisal to be undertaken by scanning the business external environment for factors

relevant to the organisations current and future activities and the collation of evidence to supportsuch claims.

There are a number of strategic management tools that can assist in this process, these include thePEST(EL) framework which helps in the analysis of the macro or general environment, and dividesthe business environment into six main areas:

• Political• Economic• Social (and cultural)• Technical/technological• Ecological/environmental• Legal

Applying these to ABC we will need to consider the following:

• political influences and events – government legislation and changes to policies etc. In thecase of Pizzatime we will need to be aware of all such in countries where we have a tradingpresence. This may be of particular concern given the strategic objective of global expansion andthe recent venture into C-Land.

• economic influences – Pizzatime must be concerned about international economic

situations in this context as they will have a direct effect on their future growth plans. Particularareas of concern might include: changes in employment, changes in consumers’ income andexpenditure, (for example the increasing number of self-employed in I-Land).

• social influences are of a particular concern for Pizzatime and will includes social, cultural ordemographic factors (i.e. population shifts, age profiles, etc.), attitudes, value and beliefs held bypeople and how these change over time. Similarly changes in lifestyles, education, health andwork patterns may have a direct effect on the need for pizza restaurants in the future.

• technological influences – changes processing methods and new productdevelopment is similarly of significant concern, particularly given the rise of new innovations in

food such as healthy eating options

• ecological/environmental influences – includes the impact the organisation has on itsexternal environment in terms of pollution and sustainability which is of high relevance toPizzatime’s packaging storage service centre and data servers.

• legal influences – changes in laws and regulations affecting, for example,working regulations, industrial standards and in particular health and safety which could affectany of our restaurants.





EXERCISE 2

The Cultural Web identifies a number of elements that can be used to describe or influenceorganisational culture.

These are:

The Paradigm : What the organisation does ; it’s mission, values, beliefs etc which can be influencedby six elements:

Control Systems : The processes in place to monitor systems and processes. These include internalcontrol systems, performance measurement and reward structures. Any future target companyshould be subject to due diligence before any final deal is struck which would require detailedunderstanding of such controls and how they were being implemented.

Example of a suitable question would be “are all employees aware of the controls, and of anyimplication of non-compliance would be very relevant in this context”?

Organisational Structures : Reporting lines, hierarchies, and the way that work flows through thebusiness. These include both the formal structure defined by the organisation chart, and theinformal lines of power and influence.

Example of a suitable question would be “what type of structure is in place – a tall or flat structure -are there any informal reporting lines in operation?”

Power Structures : The real power in a company may involve one or two key senior executives. Thekey is to establish who has the greatest influence on decisions, operations, and strategic direction.

Example of a suitable question would be “Is power concentrated at the top of the organisation and ifnot who has the power to make decisions?”

Symbols : These include organisational logos and designs, and the formal or informal dress codes.This also extends to symbols of power such as parking spaces, or corner offices etc

Example of a suitable question would be “does the organisation have a recognisable corporateimage” and “is there a dress code within the organisation?

Rituals and Routines : The daily behaviour and actions of people that is considered acceptable

behaviour which determines what is expected to happen in given situations, and what is valued bymanagement.

Example of a suitable question would be “What do customers expect when they use our services orbuy our products?

Stories and Myths : The past events and people talked about inside and outside the company. It isoften the case that who and what the company chooses to “immortalise” can convey a key messageas to what is really valued within the organisation.

Example of a suitable question would be “What is the reputation of the organisation?” and “What do

current staff tell new staff about the organisation?”



EXERCISE 3

Conflict can occur in a variety of forms and at different levels, for example organisational, group orindividual level.

As conflict can arise for many different reasons, it is important to distinguish between the threedifferent elements of conflict which can be summarised as causes of conflict, types and symptoms ofconflict. The latter of these will relate to the behaviours associated with conflict situations

Causes of conflict

The causes of conflict are wide and varied and may result as a consequence of any of the followingas Pizzatime continues its strategic objective to expand:

• Differences - in particular of interests, objectives, priorities and ideologies. This could be of

particular significance as Pizzatime grows and attempts to achieve gains in efficiency

• Limited resources - where there are limited resources, there may be a battle for availability.Conflict will exist between the regions of Pizzatime, particularly as the demand for dough willincrease from the newly acquired restaurants or franchises.

• Interdependencies – between relationships, responsibilities or boundaries are not clearly defined,and/or where they are perceived to be unfair. This may affect Pizzatime in the context of theincreasing dependency on systems to produce accurate information for dough and ingredientreplacement.

• Misunderstandings – for example, communication failures. It will be essential that all strategicmoves are communicated to all affected. This maybe challenging for Pizzatime, particularly as thenumber of restaurants increases in different countries and locations.

• Change - individual, group and organisational change creates new relationships, objectives,perceptions, problems and possibilities. There is no doubt that Pizzatime will face significant changeas the number of restaurants increases.

Types of conflict

There are two major types of conflict, both if which will be relevant for Pizzatime. These are

categorised as horizontal and vertical conflict

Horizontal conflict occurs between groups and departments at the same level in the hierarchy andsources for Pizzatime are for example:

• Size – as organisations grow, regions can begin to consider themselves as autonomous separate,and barriers are created between themselves and others.

• Technology – the increasing dependency on information and the supporting IT systems, currentlynot represented as a separate department within Pizzatime, may create an opportunity for conflict.

• Structure – divisionalisation and departmentalisation create competition which can lead toconflict.





• Goal incompatibility – regional operational goals, resulting from the strategic objectives, may beincompatible with each other. Alternatively the achievement of goals by one department mayprevent achievement of goals by others. As Pizzatime expands, this may become a serious issue andwill need careful management.

Vertical conflict occurs among individuals and groups at different levels in the hierarchy. Individualemployees may have conflicts with their bosses. Managers of international regions may experienceconflict with senior executives located at Head Office. Many of the sources of horizontal conflictabove may apply here as well and, in addition, other primary sources of vertical conflict are oftenabout perceived power and differences in status and power.

Symptoms of conflict

The management of conflict is likely to be easier and more effective if symptoms of conflict arerecognised and dealt with at an earlier stage. It will be by considering all three aspects that the waysto manage conflict may be determined.

Such symptoms for Pizzatime are likely to be, problems being passed up the hierarchy because noone takes or is allocated responsibility for resolving them; lack of or poor communications within thehierarchy, and/or between regions and departments; problems being associated with people,personalities and groups rather than issues. In this context, the HR function under Helga Schmidt islikely to play a significant role in the implementation of future changes within Pizzatime.

It is therefore worthy of note that certain aspects of the strategic development objectives are likelyto cause these conflicts and will need to be addressed. For example:

• Task interdependence – dependence on other department for resources and information willincrease the potential of conflict. Increased attention to the training of new managers will need tobe a priority.

• Reward system – if regions are rewarded only for their performance, managers are motivated toexcel at the expense of the rest of the organisation. This may have a demotivational effect on othersand challenge the Chairman’s that Pizzatine has the “right people and right strategies”. The rewardsystems adopted by Pizzatime will need to be seen to be fair and closely mirror regional andcorporate objectives

• Power and status – at the bottom of the hierarchy, workers often feel alienated. This may apply tothose working in the restaurants. Frequent staff communications are critical to ensure compliancewith corporate goals and remove feeling of isolation.

• Psychological distance – employees may feel isolated from the organisation as it continues toexpand. This maybe particularly relevant for development in C-Land which is a considerable distancefrom I-Land and the Head Office functions. Communication is again critical to maintain businesssolidarity

• Scarce resources – financial and operational resources affecting remuneration, working conditions,and costs. The involvement of regional managers in the budget setting process and thedissemination of this information to affected personnel will be vital.



CHAPTER SIX

EXERCISE 1(a)

Pizzatime2015 2014

Revenue growth 597/569 + 5%

Pre-tax profits 127/121 +5%

Gross profit margin 443/597 74.2% 428/569 75.2% Operating profitmargin

135/597 22.6% 128/569 22.5%

Pre-tax margin 127/597 21.3% 121/569 21.3% Interest cover 135/8 16.9 times 128/7 18.3 times Return on capitalemployed

135/(155+197) 38.4% 128/(150+202) 36.4%

Non-current assetutilisation

597/(52+309) 1.65 times 569/(52+296) 1.64 times

No. of shares =Profit / EPS

90/2 45m Check:86/45m

EPS:$1.91

Current ratio 92/105 0.88:1 100/100 1:1 Quick ratio 92-15/105 0.73:1 100-15/100 0.85:1 Gearing 155/(155+197) 44.0% 150/(150+202) 42.6%



Profitability

Both revenue & pre-tax profits for Pizzatime have grown by 5% on the previous year. This is belowthe target revenue growth of 10% as stated by the Chairman. Pizza2Go have achieved revenue

growth of 10% and have achieved considerable pre-tax profit growth of 35%.

Pizzatime operates with high profit margins which have remained stable when compared to lastyear. Pizza2Go’s gross and operating profit margins are significantly lower. This may seem strangegiven that Pizza2Go do not provide seating and are take-away/delivery only. They therefore wouldnot have the overheads of Pizzatime and so would be expected to achieve higher margins.

On the other hand, presumably the difference is because Pizza2Go are exclusively a franchisebusiness. Consequently their revenue will only be made up of the franchise fee income and royaltieson sales and they will not have the costs of operating branches that Pizzatime does such as dough,other ingredients, labout & premises costs.

In calculating non-current asset utilisation only PPE & intangible assets have been used. PPE willrepresent the properties and equipment in their restaurants and so are the resources that primarilycreate the revenue. Intangible assets have been included on the basis that this includes goodwill ofacquired restaurants which will also contribute to the revenue. Other non-current assets are likelyto be financial assets which will not contribute to revenue.

For Pizzatime, this ratio is again stable compared to last year. The ratio for Pizza2Go is much higherwhich is not surprising since they operate on a purely franchise basis. Their properties will also beconsiderably smaller due to not operating seat-in restaurants.

In calculating ROCE it has been assumed that all non-current liabilities represent debt finance. Thisis an unrealistic assumption as this category would at least include deferred tax liabilities but couldalso include other liabilities such as pensions or provisions. It is also known that non-currentliabilities includes deferred franchise income. Pizzatime’s true ROCE is therefore likely to be higherthan calculated.

For Pizza2Go it has been possible to calculate a more accurate ROCE as the breakdown of non-current liabilities has been provided.

Despite their higher margins the return on capital employed of Pizzatime is much lower than that of

Pizza2Go. This is due to the significantly lower non-current asset utilisation of Pizzatime.

Again, the ROCE of Pizzatime is relatively stagnant compared to last year but that of Pizza2Go showssignificant improvement demonstrating the improved profitability of Pizza2Go.





Financial position

The current & quick ratios initially appear quite low. However, given the nature of the industry thisis not surprising. The perishable nature of food results in low inventory levels. For Pizzatime’s ownrestaurants, all sales are on a cash basis and so receivables are also low. However, they will stillpurchase supplies on credit and so will have “normal” levels of payables. The relatively lowinventory levels also explains why there is not a considerable gap between current & quick ratio’s.

For Pizzatime, both ratios have deteriorated on last year. The fall in cash balances is a cause forconcern. This is considered further in the preparation & analysis of Pizzatime’s cash flow statementbelow.

Pizza2Go’s liquidity ratios have shown a similar pattern although they are not as low as Pizzatime.This is likely to be because they have relatively higher trade receivables on the basis of being afranchise only business. They also have similar cash balances to Pizzatime despite appearing to be asmaller business based on revenue. They have also increased their cash balances compared to lastyear.

On first inspection, the gearing of Pizzatime appears relatively high. However, again because of thelimited information available it is overstated due to using the total non-current liabilities figureinstead of just the relevant debt element. Combined with Pizzatime’s high interest cover, thegearing of Pizzatime does not seem to be a cause for concern.

The gearing of Pizza2Go however is now considerably lower than Pizzatime and lower compared tolast year. This is due to the reduction in long-term debt of Pizza2Go. They also have very highinterest cover, indicating debt levels are not a particular area of concern.

Share price & EPS history

There has been no issue of shares during the year and on the basis of 2015’s profits being $90m andEPS being $2 per share, Pizzatime has 45m shares in issue. This also supports last years’ EPS of $1.91per share. The fact that EPS is published as part of their financial statements indicates that Pizzatimeis a listed company.

The growth in EPS graph (page 16) shows that following high levels of growth in 2011 and 2012,growth rates are now falling. Assuming that Pizzatime have not increased their share capital in thistime this demonstrates that profits of Pizzatime have been increasing by smaller amounts in the last

three years.

The share price reached its high point in 2014 but has fallen very slightly in 2015. It is likely that ifthe trend of reduced growth in profits continues then demand for the shares will also fall and hencethe share price will continue to decline.

This is a concern when compared with the considerable growth in profitability of Pizza2Go.



EXERCISE 1(b) CASH FLOW

Cash flow statement for the year ended 31 December 2015

I$m I$m

Cash flows from operating activitiesProfit before tax 127Finance costs 8Depreciation 25Increase in inventory (15-15) 0Increase in receivables (30-28) (2)Increase in payables (68-66) 2Decrease in deferred income ((6+35) – (7+29)) (5)Cash generated from operations 156Finance costs paid (8)Tax paid (28+5+37-30-6) (34)

113

Cash flows from investing activitiesSale proceeds of PPE 0Purchases of PPE (296-25-3-309) (41)

(41)

Cash flows from financing activitiesIssue of shares 0Increase in loans (120-110) 10Dividend paid (122+90-120) (92)

(82)

Decrease in cash & cash equivalents (10)Opening cash & cash equivalents 50Closing cash & cash equivalents 40

Any analysis based on the above cash flow statement is limited by the fact that assumptions havehad to be made in order to produce the above cash flow statement in the first place.

The increase in receivables has contributed to the decrease in cash although this has been off-set by

the increase in current liabilities.

It would appear that there has been investment in PPE during the year which has utilised cashbalances. Normally it might be expected that such long-term investment would have been financedby long-term sources of finance rather than using up cash resources.

However, the main reason behind the worsening liquidity is due to the payment of a dividend inexcess of the profit for the year. It is stated within the strategic objectives that the Board are awareof needing to reward investors through increased earnings and dividends. However, to pay such asignificant dividend that then raises concern for the company’s liquidity position does not seemappropriate.





EXERCISE 2

Why raise finance?Pizzatime would need to raise finance in relation to the following:

Its’ cash balances have fallen and need to be replenished before liquidity becomes a moreserious issue

To invest in R&D to develop new product lines such as healthy food ranges To invest in technology such as online ordering/mobile phone apps to expand its take-

away/delivery sales To fund expansion in C-land

Debt finance

Pizzatime could borrow funds from its’ bank or other organisations that specialise in lending to thefood & beverage industry. Pizzatime has relatively high values of PPE and if necessary, these assetscould be used as security.

Pizzatime could issue bonds. From the information provided Pizzatime is a listed company and sowould be able to issue bonds on the stock market. This would have the benefit of being able to raisefinance from many different investors and so probably raise higher amounts.

Debt is generally considered a cheaper source of finance compared to equity. Also, the interestcover of Pizzatime is currently high and gearing seems moderate indicating that they have thecapacity to be able to increase borrowings. Pizzatime would need to be aware of any covenantssuch as dividend restrictions that may be placed on the loans by the debt investors.

Equity finance

As a listed company, Pizzatime could issue new shares on the stock market. Alternatively Pizzatimecould consider a rights issue to its’ existing shareholders. A rights issue would have the advantage ofmaintaining the current ownership and would avoid any dilution of ownership. However, as sharesin a rights issue are typically priced lower than market value the disadvantage is that it may not raiseas much as a new placement of shares.

A rights issue would be a cheaper way to raise equity finance compared to a new share issue.However, rights issues are not always viewed positively by markets.

Given that in 2015 the company has paid more out in dividends than profit for the year and that theBoard recognises the need to reward investors with dividend payments, to increase the number ofshares may not be the most suitable way of raising finance. Although it should also be rememberedthat dividends are not compulsory.

Pizzatime could consider issuing preference shares that can be classified as equity tomaintain a low gearing ratio. However, it would need to be considered whether suchpreference shares would be attractive to investors.



Compound instrumentsAn alternative option would be to issue a convertible bond. This would enable Pizzatime to raisefinance at a lower cost compared to simple debt finance but would result in no further dividendshaving to be paid until the investors elect to convert the debt into shares. Hopefully by this stagePizzatime’s profits will have increased such that acceptable levels of dividends can be paid without

resulting in a decrease in retained earnings.

Since convertible bonds will be recorded partly as debt and partly as equity they would also have aless adverse effect on their gearing ratio compared to simple bonds.

Investors may also consider convertible bonds to be a less risky way of investing in Pizzatime at themoment.

Cost of capital

On the basis that the company’s share price is approximately $61 (page 16) and the dividend paid in2015 was $2.04 ($92m / 45m – see answer to exercise 1) the cost of equity is currently in the regionof 3.4% (assuming no growth in dividends).

If a growth rate of say 3% were assumed, then the cost of equity would be:(($2.04 x 1.03) / $61 + 0.03) = 6.4%.

Finance costs were I$8m in 2015. Average non-current liabilities were I$152.5m ((150+155)/2).Therefore the effective rate of borrowing is 5.2% (8/152.5).Pizzatime’s effective tax rate in 2015 is 37/127 = 29%. Hence the cost of debt would be in the regionof (1-0.29) x 5.2% = 3.7%.

A weighted average cost of capital would be calculated by taking an average of the cost of debt andthe cost of equity, using the market values of the debt & equity finance as the weights.

Although the share price is available of $61, no detail is given of how much of the non-currentliabilities actually represent debt finance or the market value of debt.

On the basis of book values, which are available, a calculation would be:

(6.4% x I$80m) + (3.7% x I$152.5m) / (I$80m + I$152.5m) = 4.6%

The weighted average cost of capital would be used in investment appraisal.

However, it is only appropriate to use WACC when the following conditions are met: The capital structure is constant, since if this changes the weightings in the WACC calculation

will also need to change The new investment does not have a different risk profile to the existing entity’s investment

projects. The new investment is marginal to the entity. Any substantial new investment is likely to

result in a change to the WACC.





EXERCISE 3

IAS 17 LeasesPizzatime lease premises and hence will need to apply the requirements of IAS 17, classifying themas either finance or operating leases.

The fact that Pizzatime is reporting significant PPE balances would suggest that at least some of theleases are classified as finance leases. However, if this were the case it would perhaps be expectedthat the liabilities of Pizzatime would be higher. The SWOT analysis states that Pizzatime are lockedinto long leases. Therefore this indicates there are finance leases.

Pizzatime sub-let premises to franchisees on rolling 10 year operating leases. They thereforebecome the lessor in these situations. As a lessor in an operating lease, Pizzatime should recogniserental income on a straight line basis over the length of the lease.

It is possible that Pizzatime takes out a lease that is classified as a finance lease and then sub-lets itto a franchisee on an operating lease.

IAS 18 RevenueFor sales within their own restaurants, revenue will simply be recorded as the pizza/drinks are soldi.e. cash sales.

In terms of the franchised resturants, there are several elements to consider:- franchise fee paid every 10 years- royalties on sales- margin on central purchases of dough, packaging and equipment.

The royalties on sales will be recognised as they are earned i.e. as the related franchise makes thesale.

The revenue recognised in relation to dough, packaging and equipment will be recognised on thebasis of these items being delivered to the franchises and so the risks & rewards of the items beingtransferred.

The franchise fee that is paid upfront at the start of a 10 year agreement will initially be recorded asdeferred income i.e. a liability in the SFP. It will then be transferred to revenue over 10 years,probably on a straight line basis. The deferred income will then be split between current and non-

current liabilities. The amount that will be transferred to profit within the next year will be reportedas a current liability and the remainder will be reported as non-current.

IAS 21 Foreign currencyPizzatime was founded in I-land. The presentation currency of their financial statements is I$. Itwould therefore seem probable that their functional currency is I$.

Pizzatime have branches in P-land and C-land which use P$ and C$. Pizzatime will therefore need totranslate the financial statements of these branches into I$ in order to consolidate them into thegroup financial statements.



This involves translating assets (including goodwill) and liabilities at closing rates. Income &expenses are translated at average rate. Foreign exchange gains/losses are reported in OCI andrecorded in a foreign currency translation reserve within equity.

Although the financial statements provided do not show other comprehensive income, the foreign

currency reserve can be identified in their statement of financial position.

We are also told that currency fluctuations are a threat to Pizzatime within the SWOT analysis whichis supported by the fact that the currency reserve is indicating foreign exchange losses are arising.

Derivatives would be a way of hedging against exchange rate fluctuations. However, hedging is notexaminable until F3 and so cannot be tested in the exam.

IAS 37 ProvisionsPizzatime will be subject to high levels of food hygiene regulation. It is possible that if these werebreached, the company may find themselves being fined or involved in legal cases that may require

them to consider IAS 37.

IFRS 2 Share Based paymentPage 8 tells us that Pizzatime believe their corporate social responsibility to be an important aspectof their business and that in particular they invest in their people.

We are also told that staff members have been issued with pedometers and that the company haslaunched a competitive motivational programme to encourage staff to become more active.

It could be that activity targets / walking challenge (per page 19) are then used as a vesting conditionwithin a share based payment scheme.

GroupsPizzatime are preparing financial statements as a group. They acquire other restaurant businessesand presumably these acquisitions are accounted for as subsidiaries and so consolidated.

Page 3 of the pre-seen refers to acquiring failing restaurant businesses. Therefore Pizzatime mayfind itself with negative goodwill at acquisition. Under IFRS 3 negative goodwill is viewed as a gainon a bargain purchase and is credited to profit.

The financial statements do not reflect any non-controlling interests indicating that subsidiaries are100% owned.





CHAPTER EIGHT EXERCISE 1 – PERFORMANCE MEASUREMENT


From: Financial ManagerDate: December 2015Subject: Performance Measurement

Many organisations measure performance ratios that are primarily focused on historical, financialfigures, and may have little to do with future success. In our case in Pizzatime, indicators such as thegrowth in EPS, the share price in I$ or revenue growth targets are the most visible indicators ofperformance. Although such ratios are important, they do not address key aspects of futurestrategy, particularly those concerned with the satisfaction of customers and their loyalty,organisational learning and the commitment of employees.

Additionally, these often have little impact on organisational behaviour or performance since theywere not translated into the recently published PCCS measures which management and staff couldunderstand and use.

Moving away from purely financial measures, a Balanced Scorecard approach was developed toaddress any deficiencies in these areas and encompasses four key principles :

1 Translating the vision through clarifying and gaining consensus;

2 Communicating and linking by setting goals and establishing rewards for success;

3 Business planning to align objectives, allocate resources and establish milestones;

4 Feedback and learning to review the subsequent performance against the plan.

With a Balanced Scorecard, we recognise that there should be, on every scorecard, fourperspectives :

1 Financial perspective – ‘To succeed financially, how should we appear to our shareholders?’

2 Customer perspective – ‘To achieve our vision, how should we appear to our customers?’

3 Internal perspective – ‘To satisfy our shareholders and customers, what business processesmust we excel at?’

4 Future – the innovation and learning perspective. ‘To achieve our vision, how will we sustain

our ability to change and improve?’For each perspective, a number of objectives, appropriate measures and target levels ofperformance together with initiatives for their achievement, should be defined. Thus the measureschosen under each perspective would reflect the strategic imperatives under which the organisationoperates at the time.

For Pizzatime, based on the stated objectives of our PCCS approach, I would recommend thefollowing measures within a Balanced Scorecard framework:

Financial perspective:• Revenue growth• Number of new franchises• % revenue from healthy eating products



• % revenue coming from new rather than repeat customers• % increase in EPS growth• % increase in Dividends• Asset turnover (use of resources)•

ROCE/ROICustomer perspective

• Customer enjoyment; feedback ratings from user-generated online ratings• Speed of service: number of minutes between order taken and meal served.• Activity level per employee using pedometer• Customer loyalty : % turnover due to repeat business

Internal perspective• Product quality: Increase / decrease in conformance costs•

Product quality: Increase / decrease in quality costs (Int. Failure Costs)• Product quality: Increase / decrease in quality costs (Ext. Failure Costs)• Cleanliness ratings• Speed of service : average time order placed / delivery to customer• Net number of restaurant openings

Innovation and learning perspective• Investing in people certifications• Caring for the environment• Community engagement• R&D spend• Staff training spend as a % of turnover• Marketing spend as a % of turnover

Out of the above, the most important measures when considering expansion into C-land are asfollows:

• Customer enjoyment. It is vital that we increase our reputation for quality food if we are togain market share. However, simply relying on feedback from user-generated online ratingsmay not give us enough data, so asking customers to complete feedback forms in newrestaurants should also be investigated.

• Speed of service: average time order placed / delivery to customer. Linked to the above,growth is based on customer satisfaction so we need to ensure that customers do not go awaydisappointed over something that is east to rectify

• % revenue from healthy eating products. To enable growth it is critical that we understandpotentially different customer needs in C-land, requiring careful monitoring over which rangesof food are proving more popular.

• Finally the ROI of individual restaurants needs to be monitored to ensure that the right

locations have been selected. If it turns out that particular areas do not generate the requiredreturns then we may need to consider closing them.




EXERCISE 2 – RISK MANAGEMENT

To: Monica LallDate: December 2015Subject: Risk Management

Risk management should be a proactive process that is an integral part of strategic management.CIMA’s risk management cycle go as follows:

1. Identify potential business risks:

The first stage would be to identify potential risks that the business may face. This could be doneusing external analysis tools such as PESTEL and Five Forces Analysis. Alternatively, we could usethe SWOT analysis produced by the senior management team.

We in Pizzatime are faced with a number of business risks, which could ultimately translate into aloss of market share (to other pizza chains, independent restaurants, other fast food chains,

delivery-only pizza chains) and could be listed as follows:

Strategic risk : This is the risk of failure of our business strategies of :

a. Acquisitions of failing restaurants. Growth by acquisition is likely to be much more high riskthan organic growth, although the potential returns might also be much higher. An exampleof such risk could be failure to integrate the information systems of restaurants acquired.

b. Franchising – for example, due to poor quality control and cleanliness by franchisees.

c. Healthy pizza product launches – for example, by launching in restaurants when thecustomer demographic is less concerned with healthy eating.

d. Expansion into C-land – for example, by failing to identify differences in consumer tastecompared with I-land

Strategic risks should be identified and assessed at senior management and board of directorlevel.

Product risk : is the risk of failure of new product launches, or the loss of interest in existingproducts, and indeed ‘maturing product offerings’ has been identified as a threat we face.

Commodity price risk is the risk of a rise in food/ingredient prices. Businesses might be exposedto risks from unexpected increases in the price of a key ingredient. Businesses providing us withcommodities, such as local farmers, are directly affected by price changes. Equally, companiesthat rely on the use of commodities could be exposed to risks from price changes. For example,we are exposed to the risk of increases in wheat prices affecting flour and dough costs andvegetable prices affecting the cost of toppings. Automatic increases in meal prices are notpossible because of the competitive environment.

Product reputation risk : we in Pizzatime rely heavily on brand image and product reputation, soan adverse event such as a food quality failure or poor customer experiences in our restaurantscould put our reputation (and so future sales) at risk. Risk to a product’s reputation could arise

from adverse public attitudes to a product or from adverse publicity: this was evident in Europe





with widespread hostility to genetically modified (GM) foods. There could also be a risk fromchanges in customer perceptions about the quality of our pizzas.

An operational risk , i.e. the risk that business operations may be inefficient or that businessprocesses may fail. For us, it could be poor recruitment procedures; poorly trained staff causingcustomer injury; Customer loss due to poor service, a central processing plant failure, supplierselection problems, problems with ovens or refrigerating units, etc.

Understand and assess scale of riskAt this stage of the process it is important to attempt to assess the likelihood of the risk occurringand the potential impact, both financial and non-financial on the business. This is when the TARAmatrix comes in: it identifies whether a risk will have a significant impact on the organisation andlinks that into the likelihood of the risk occurring. A risk map immediately indicates which risksshould be given the highest priority. Risks with a significant impact and a high likelihood of

occurrence need more urgent attention than risks with a low impact and low likelihood ofoccurrence.

We will discuss these at the next Board meeting but for us, risks with a high impact and highlikelihood include :

• Being tied into underperforming restaurants. Given the activities of competitors it is likelythat some restaurants will underperform. However, existing long leases increase exit costsmaking it more likely that underperforming restaurants will not be closed. The impactwould be high due to potential losses involved.

Low likelihood high impact :

• Failure of acquisition strategy. This has a low likelihood, because of our experience inacquiring failing restaurant businesses but high impact due to the size of potential lossesshould the strategy fail.

• Failure of franchising. This has a low likelihood, because of our thorough selection process,but potentially high impact due to the reputational damage that could result.

High likelihood low impact :

• Commodity prices inflation. The likelihood of price changes is high due to uncertainty oversupply of agricultural products. However, the potential impact is low due to the possibilityof multi-sourcing and switching suppliers.

Low likelihood low impact :

• Problems with ovens / refrigerating units. Modern ovens and fridges are very reliable so thelikelihood of problems is low. Furthermore, the impact is low as it is straightforward, forexample, to order more dough if required.





Development of risk response strategyThe next stage is to consider how to mitigate the risk and take action to either reduce or transferthe risk, using the TARA framework:

Transference . In some circumstances, high impact-low probability risk can be transferred whollyor in part to a third party, so that if an adverse event occurs, the third party suffers all or most ofthe loss. For us, a common example of risk transfer is franchising, or insurance. Businessesarrange a wide range of insurance policies for protection against possible losses. This strategy isalso sometimes referred to as ‘sharing’. An example might be to change the terms of franchisingagreements so franchisees take more of the risk.

Avoidance . We might choose to avoid the high impact-high probability risk altogether. Theseshould be given the highest priority for management, whether by monitoring or by taking steps to

mitigate the risk. However, since risks are unavoidable in business ventures, they can be avoidedonly by not investing (or withdrawing from the business area completely). For us, this would meannot gambling on the success of healthy pizzas, or ignoring the possibility of poor service if webelieve that current selection and training procedures are sufficient.

Reduction/mitigation. A third strategy is to reduce the risk, either by limiting exposure in aparticular area or attempting to decrease the adverse effects should that risk actually crystallise.An example for us is the financial impact of ingredient cost increases. This needs furtherdiscussion, but an approach could be to agree forward contracts with suppliers to hedge againstunplanned price increases.

Acceptance. The final strategy is to simply accept that low probability, low impact risks may occurand decide to deal with the consequences in that particular situation. The strategy is appropriatenormally where the adverse effect is minimal. For example, acquiring more outlets in C-Land mayturn into a strategic failure – but one that, at a group level, can only have a minimal impact.

In extreme circumstances, it may even be decided to avoid the risk altogether by not carrying outthat activity.

Implement strategy and allocate responsibilitiesOnce the risk management strategy has been decided, it would need to be communicated to the

people who will be responsible for implementing the action. Responsibilities should be clearlydefined so that each staff member who is involved is aware of what they are expected to do.

Implementation and monitoring of controlsFor each high-probability, high-impact risk, I recommend that further analysis should be carriedout, with a view to estimating the probability of an adverse (or favourable) outcome moreaccurately, and assessing the impact on the organisation of an adverse outcome. This is an area inwhich I should be able to contribute by providing suitable and relevant financial information.

Financial Manager





EXERCISE 3 – INVESTMENT APPRAISAL


From: Financial Manager

Date: December 2015

Subject: Investment Appraisal

Interpretation of the investment appraisal analysis

Payback period

Option 1 has achieved a payback period of 2.75 years, which is within the 3 year target. Whereasoption 2 is expected to payback the investment within 3.67 years and therefore does not achievethis target. Based on the payback period calculation, option 1 would be favourable.

The payback calculation is favoured in situations where there are cash flow concerns, as it wouldresult in the selection of the option which repays its initial investment the quickest. With thelimited amount of cash available at Pizzatime, this may be preferable.Choosing the option which repays its investment the quickest is also considered to be less risky asthere are usually more risks associated with cash flows received later in the investment.However, choosing the option with the shortest payback period does not maximise shareholderwealth as it ignores cash flows received after the payback period and does not consider the timevalue of money.

Net present value

The investment appraisal technique that maximises shareholder wealth is the net present valuecalculation. Based on this technique option 2 would be chose as it makes more money for theshareholders over the five years, after discounting the cash flows to take into account the timevalue of money.

This should translate into a greater impact on share price and shareholder value, which could beargued to be the company’s primary financial objective.

Internal rate of return

Option 2 has an internal rate of return of 14%. Therefore, if the actual cost of capital is above 14%then option 2 would actual result in a negative net present value and reduce shareholders wealth.

The internal rate of return of option 1 is 16%. This is higher than the internal rate of return ofoption 2, and although both options are above the target of 10%, option 1 would still be viable ifdiscount rates turn out to be greater than 14%. Option 1 is less sensitive to changes in discountrate and hence could be considered less risky.

Conclusion

In order to maximise shareholders wealth the preferred investment appraisal technique would bethe net present value calculation. On this basis, option 2 would appear to be the most financialbeneficial.





Other issues to consider

Forecast revenue

There is a risk that the additional revenue which has been forecasted for option 2 does notmaterialise as simply having capacity does not guarantee sales. If additional marketing is plannedto support this growth, then the additional costs should be incorporated into the calculations

Flexibility

Following on from the above point, option 2 gives greater production capacity, which could beutilised in developing other new products. Demand estimates for option 1 are much more likely tobe realised, being lower, so giving less opportunity for other plans.

Cost of capital used.

A cost of capital of 10% has been used for both options. However, this may be incorrect as the riskexposure is different – for example, the second option has greater upside potential in terms ofhigher sales. Using a higher cost of capital for option 2 would reduce its NPV and, hence,attractiveness. Sensitivity analysis on discount rates could be performed to see how high the ratefor option 2 could be before option 1 becomes the preferred choice.

Impact on financial statements

While option 2 has the greater impact on shareholder value, it is likely to result in lower profits inearlier years. It is thus vital that plans are communicated effectively to shareholders so they don’treact adversely to this.

Non-financial factorsThe analysis performed only considers financial factors. Key non-financial aspects could includeenergy usage (newer ovens may have a lower carbon footprint) and safety.





CHAPTER NINEEXERCISE 1 – COMPETITIVE ENVIRONMENT

To: Finance DirectorFrom: Financial ManagerDate: TodaySubject: Assessing competitive industry environment

The “five forces” technique is a useful framework that the new business development team coulduse to help it assess the competitive forces at work in the pizza restaurant industry in country K. Itcan be used to help the senior management team decide whether the industry is an attractiveone to enter.

Porter's model brings together the following five competitive forces:

• Threat of new entrants/barriers to entry

• Bargaining power of suppliers

• Bargaining power of buyers

• Threat of substitute products/services

• Competitive rivalry

The model assesses the market attractiveness of the industry and the collective strength of these

forces that will determine the profit potential in Country K for pizza restaurants. Essentially, itwould only be a sensible strategic decision for Pizzatime to enter Country K if the forces arerelatively weak and the potential returns are high. The information from the analysis would alsohelp in identifying the factors driving profitability and could be used to establish the competitivestrategy needed should Pizzatine decide to go ahead with its expansion plans.

Taking each force in turn:

Pizzatime will be a new entrant so it needs to assess the potential barriers to entering the industryin Country K. These might include issues associated with gaining access to appropriate locations

for its restaurants, given its existing policy if setting up in areas where there is lots of passingtrade.

Another possible barrier to entry is product differentiation. If there are already established firmsin Country K with strong brands in the market it may be hard for a new entrant to rival these.Pizzatime will also have to assess government policy in Country K to determine whether there areany legal or bureaucratic factors to deter foreign businesses entering the marketplace. From thisinformation, the business development team should be able to assess whether entry barriers arehigh, moderate or low.

Bargaining power of suppliers is primarily related to the power of suppliers to raise their prices tothe industry. Power will increase where the supply is dominated by a few firms, or suppliers have





propriety product differences. It is unlikely that the supply of raw materials and resources neededfor the production of pizzas will be concentrated in the hands of a few suppliers. . In addition ashead office control the approval of suppliers therefore supplier power is likely to be moderate to

low

The bargaining power of buyers is gained through their ability to either gain products/services atlower prices or get improved product quality. It also depends on the size and number of buyers.Power will be greater when buyer power is concentrated in a few hands and when products areundifferentiated.

Pizzatime will need to determine who its buyers are but assuming these are the end consumers,as individual buyers they will have relatively little bargaining power but are likely to have a hugechoice of alternative restaurants. Buyer power is increased when there are low switching costs, in

other words where moving to a different supplier involves little risk. This would be the case interms of buying pizzas, from the perspective of the end consumer, because they are relatively lowvalue purchases. In addition, we also need to be aware of the other factors associated with theconsumers’ choice, namely quality of food, cleanliness and speed of service. Whilst we have asignificant reputation for excellent quality and fast and friendly service, these standards will needto be maintained to limit the effect of choice and arguably create a significant switching cost forconsumers in the longer term.

Pressure from substitutes is where there are other products that satisfy the same need. In thecase of pizzas, it is probable that there will be a high threat of substitutes in the industry since

there are many alternatives such as burgers, speciality cuisine from other countries and of coursedelivery only pizza chains. It will be important to fully research the market in Country K toestablish a good understanding of these potential competitors. In addition the move toward ahealthier life style and healthy eating may also be considered in this context and should also beresearched to determine the influence of light food snacks, fruit and other healthier productoptions which are available in most markets.

In the pizza restaurant industry, the rivalry amongst existing competitors will be influenced by thenumber of firms operating in the industry, and industry growth rates. If there are numerousorganisations, particularly with strong brand images already operating in Country K, and there is

low industry growth then this will not be an attractive market for Pizzatime. If however, incontrast, the rivals are relatively small, privately owned pizza outlets with a poor brand image, themarket could prove to be attractive and, via our policy if consistent branding across allrestaurants, Pizzatime could establish a significant reputation in a relatively short space of time.

I hope that this briefing note is of use. Please do not hesitate to contact me if I can be of furtherassistance.

Financial Manager





EXERCISE 2 – WEBSITE PROJECT

To: Financial DirectorFrom: Financial Manager

Date: TodaySubject: New website project

Areas that the Operations Director should address with the project manager are time, cost andquality. The successful accomplishment of the project objective is usually constrained by thesefactors.

Time and cost tend to be positively correlated in projects (i.e. when time increases so does cost)as taking longer to complete a project generally means that human resources are needed forlonger.

Project decisions on the strategies to implement are difficult as they will often require a trade-offof cost, time and quality. For example getting the project back on time may require extraresources and therefore additional costs or a compromise on the original scope. Reducing excessexpenditure may mean using fewer or lower quality resources which may again affect the overallscope and performance of the final project.

Time

If there is a degree of urgency in a project it may be possible to reduce the timescale to

completion by adding additional resources. The timescale can also be reduced by schedulingovertime working. Both of these situations will increase cost while reducing time.

Resources could also be asked to work smarter, eliminating any distractions and focusing time onreal output producing activities. The team should focus on activities that add real value to thewebsite project for example the website functionality and eliminate any non-value addingactivities.

Increasing the amount of resource will have an impact on profitability. The addition of resourceswill reduce the profit margin and indeed, in the extreme, may make the project itself unprofitable.

Although the deadline date is important to Pizzatime, due to the revenues that might begenerated by the website, it is unlikely to be crucial given our dominant position in I-Land and theincreasingly well established presence in P-Land. It is unlikely that the customers will know thatthe website is being re-designed so will have no expectation of when the new site is due to comeon-line. The deadline is not crucial in the wider scheme of things and there is no statutoryrequirement to deliver on time.

Quality

Project quality is usually about customer specification and requirement. Quality in terms of

computer systems can be measured in terms of the number of errors, response times and fit-for-purpose, i.e. matches the business process it is intended to support.





For Pizzatime, success is linked to quality, customer enjoyment and speed of service. It will beimportant that the website is easy to use and navigate. A customer will want quick responsetimes, a guarantee of secure transactions and accuracy of menu availability and booking.

“Fit for purpose” is an important concept for a customer facing process. It is important thatPizzatime has a clear understanding of the customer specification and requirements and that theproject plan ensures that sufficient testing is included to ensure that quality requirements arefully met.

Costs

In order to manage the issue of costs, the website may have to have a slightly reduced scope interms of its functionality. Any reduced scope might have an impact on how many customers usethe site in the future. The importance of the customer perception has already been discussed. Any

reduction in scope is likely to have a detrimental impact on the revenues generated by thewebsite

Financial Manager





EXERCISE 3 – INTERNAL CAPABILITY

To: Finance DirectorFrom: Finance Manager

Date: TodaySubject: Internal capability

Briefing note:

Further to your request for information please see detailed below my note as requested.

Pizzatime’s future success is heavily dependent on our ability to develop new products, maintainour excellence in providing quality food and an enjoyable customer experience. To assess ourinternal capability to achieve this we need to consider our resources and competencies.

We could carry out a resources audit, in which we would consider our existing resources underfour key heading as follows:

Operational resources – the central processing plant and transport logistics and their respectiveabilities to manufacture and deliver the dough for our pizzas.

Human resources – it is important that we retain and train our staff, particularly those who arecustomer facing as they are crucial to the delivery of our service.

Financial resources – our gearing is relatively high when compared with Pizza2Go and it may

prove difficult to arrange further debt finance to invest in new expansion. We do have positivecash balances however this diminished over the past twelve months.

Intangible resources – our brand name and reputation are incredibly important to our overallsuccess given the nature of the industry.

The resources can then be analysed into one of two categories, basic and unique. Basic resourcesare those available to both us and our competitors. It is our unique resources that will help us toremain competitive and certainly in the past our brand name has been one of the keys to oursuccess and domination of the market in I-Land for example.

We could also consider the various activities within Pizzatime to assess their importance increating value.

Pizzatime’s inbound logistics are critical to the creation of value as Scent relies on its suppliers notonly for the ingredients but also for its packaging. These have an important role to play inmaintaining our reputation for quality and its strong brand names.

Pizzatime’s operations however are a potential weak area given the feedback that the ChiefExecutive has received from regional managers regarding transport logistics. If we decided toexpand globally, our potential lack of capacity and efficiency in this area may undermine our

reputation and brand.





Our marketing and sales are a significant source of value. We currently however seem to havelimited information being feedback from our restaurants which is potentially resulting in a lowinvestment in research and development. We need to be aware that there may be a need to

invest in more sophisticated IT systems so that we can capture more useful information oncustomer preferences.

Advantages of outsourcing

The independent logistics business will have the specialist expertise to have state of the artdelivery vehicles and on board GPS to ensure that delays in delivery are eradicated.

Outsourcing the production of dough can also offer greater flexibility over production volumes. Itis likely that the manufacturer who specialises in producing these materials will have theadditional capacity to cope with increases in sales volume. If the production activity remains in-house then the capacity available could be restricted without significant cost of investment.

The cost of the transportation and production would remain a variable cost as Pizzatime would becharged for each item produced and then delivered. If the activity remains internal then it is likelythat a significant proportion of the costs would be fixed. For example, staff employed to make thedough would be likely to be on pre-determined salaries regardless of production volumes.

The external manufacturers are also likely to benefit from economies of scale, which may meanthat they can produce the dough cheaper. Depending on the mark up that they apply whencharging Pizzatime, there is a possibility that they may still charge less than it would cost for us to

produce the dough ourselves.

Disadvantages of outsourcing

One typical risk would be a lack of direct control over the production processes. This is currently aconcern of the Operations Director who has been frustrated by quality problems.

Because of this issue, a huge reliance is placed on ensuring that the correct outsourcer is chosen.It would be strongly recommended that a thorough vetting procedure should be carried out ofpotential outsourcers with service level agreements discussed and agreed before contracts aresigned. These agreements should include provision for Pizzatime representatives to inspectoutsourcers’ premises and monitor quality procedures

For production of dough lead times are always going to be a concern when outsourcing such acritical activity to a third party. As the activity is currently in-house then these concerns aresignificantly reduced and much easier to predict as Pizzatime has full control over productionscheduling. If the production is outsourced, there would need to be investment in linking systemsand training of personnel involved to be sure that restaurant replenishment requests and henceproduction scheduling are in sync.

Financial Manager





CHAPTER TEN

EXERCISE ONE (REFURBISHMENT AND TRAINING COSTS)

E-mailTo: Helga Schmidt, Dennis ChanSubject: Refurbishment & training costs

Dear Helga & Dennis,

Thank you for your email. Please find below my response to your queries.

Firstly, I will respond to Dennis’ query of why he can see a budget for refurbishmentcosts in the management accounts but not in the financial statements.

Management accounts are prepared for use internally by the management of acompany. Consequently there are no requirements to follow any generally acceptedprinciples. As long as the management accounts are suitable for the needs of theinternal management, any accounting treatments deemed suitable can be adopted.

As part of budgeting and cash flow forecasting therefore, it is reasonable to ensurethat future refurbishment costs are accrued for and that funds are effectively setaside to cover these future costs.

However, because financial statements are prepared for external users it is importantthat standard practices are followed to promote comparability.

In particular, financial statements must be prepared in accordance with accountingstandards – in our case, International Financial Reporting Standards.

An item such as future refurbishment costs would fall under the requirements of IAS37 Provisions.

Provisions can only be recognised when the following criteria are met: A present obligation as a result of a past event A probably transfer of economic benefits A reliable estimate

The nature of the obligation can be either legal or constructive. A constructiveobligation arises when past practice or published policy has created a validexpectation that the costs will be incurred.

It might be though that the past practice of Pizzatime refurbishing restaurants createsa valid expectation that such costs will be incurred in the future. However, there isno obligation for Pizzatime to incur these costs as a result of a past event.

The event that creates the obligation to pay for the costs is the actual refurbishmentitself. Therefore until the refurbishment takes place there is no obligation to incurthese costs and so no provision can be made.

The reason that refurbishment costs are capitalised is because they meet thedefinition of an asset. The refurbishment results in a resource – a newly decoratedrestaurant - that is controlled by the entity that will generate future economicbenefits – in the form of future sales of food/drink to customers.





The costs are then charged to profits via depreciation over 4 years to ensure that thecosts match the related benefits. In other words the refurbishment costs arematched against the revenue generated by the restaurant over the next 4 years.

Unfortunately training costs cannot be capitalised.

Firstly in relation to your point about the limit under which all costs are expensedrather than capitalised – it is normal for businesses to have such a limit. The purposeof this boundary is so that small amounts of expenditure do not have to becapitalised and then written off over several years which is a more complicatedprocess than simply expensing the costs immediately. The limit is set such that anyamounts below the limit are not material. In other words, there is no significant errorin the accounts by adopting the simplified treatments.

However, the converse that any amounts above this limit should be capitalised is nottrue.

Training costs cannot be capitalised because they do not meet the definition of anasset. In particular there are issues surrounding the ability to control.

Pizzatime’s employees are free to resign and transfer their skills elsewhere.Therefore Pizzatime cannot control the skills/knowledge that is generated as a resultof the training courses. There are no guarantees that increased expenditure ontraining will result in staff being retained for longer.

I hope that the above addresses all your queries. If you have any further questions,please do not hesitate to contact me.

Financial Manager





EXERCISE TWO (ACCOUNTING FOR PREMISES AND IMPACT OF LEASES)

FOR THE ATTENTION OF THE REGIONAL MANAGER C-LAND

Further to your request for information, please find noted below a summary of my findings:

The leases will need to accounted for in accordance with the requirements of IAS 17: Leases. Thisstandard requires that leases are classified as either finance or operating leases. Theclassification reflects the commercial substance of the transactions.

A finance lease is a lease where the significant risks and rewards of ownership transfer to thelessee at the start of the agreement. An operating lease is any lease that is not a finance lease.

Premises A

This lease will be classified as a finance lease. The lease term of 25 years will be a significantproportion of the buildings life. Additionally, they can extend the lease at a nominal rent – anoption which would be considered likely to be exercised. Thus Pizzatime will receive the majorityof the rewards of the building.

Furthermore, Pizzatime will incur penalty charges to cancel the lease which is a risk of ownership.

Pizzatime bear the risks of ownership as they are responsible for buildings insurance and othermaintenance costs.

Pizzatime will recognise both a non-current asset and a corresponding finance lease obligation asa liability. This reflects the substance that Pizzatime are acquiring the building but are financingthe purchase with a loan.

The property will be depreciated over the lease term of 25 years, although it may be deemedappropriate to depreciate it over a longer period if the lease is likely to be extended.

The finance lease obligation will give rise to a finance cost within profits.

Lease payments will reduce the finance lease obligation.

The redecoration costs will most likely be expensed to profits if they are relatively immaterial.However, if they are more significant it would be acceptable to capitalise them as a separateasset and then depreciate them over their useful life i.e. the period of time until the premises arenext refurbished.

Any furniture or kitchen equipment that is purchased will be capitalised as property, plant andequipment (non-current asset) and will be depreciated over their useful lives.

Premises B

This lease will be classed as an operating lease. The lease term is relatively short at 5 years,compared to the life of a property and so Pizzatime will not receive the majority of the rewardsfrom using the asset. Pizzatime also bears no risks as they are not responsible for buildingsinsurance and nor will they incur maintenance costs.

IAS 17 requires operating lease rentals to be charged to profits on a straight line basis over thelength of the lease.





Since Pizzatime pays a lump sum at the start of the lease, this payment will be treated as aprepaid expense i.e. an asset in the statement of financial position which is then expensed toprofits over the 5 year term along with the smaller annual payments.

The building works that will be required to modify the building should be capitalised as a separateitem of PPE. They are costs that will generate future benefits in the form of being able to use thebuilding as a restaurant. They will then be depreciated to profits over the 5 years.

Since the costs are being depreciated over 5 years, but 100% capital allowances are granted whenthey are incurred, the carrying value of the asset will exceed its tax base. As a consequence adeferred tax liability will arise.

The dismantling costs are an obligation as a result of a past event – entering the lease. It isprobably that an outflow of economic benefits will be required to dismantle the building works asit will cost Pizzatime funds to do this. A reliable estimate would be capable of being made.Therefore the dismantling costs should be provided for in accordance with IAS 37 Provisions.

The provision would be measured by estimating the future dismantling costs and thendiscounting to present value. The discounting will need to be unwound each year and thesubsequent increase will be charged to profits as a finance cost.

As the costs relate to being able to have the premises as a restaurant for the next 5 years, theprovision should be capitalised as part of the premises cost within PPE. It will then bedepreciated over 5 years.

Impact on ratiosAn operating lease will increase the return on capital employed compared to a finance lease (orpurchasing asset outright). This is because the item is not reflected as an asset and so is notincluded within capital employed from the statement of financial position. However, the assetdoes physically exist for the entity and so helps to contribute to the profits of the entity. HenceROCE increases.

A finance lease will increase the gearing ratio compared to an operating lease. This is because thefinance lease results in finance lease obligations being recognised in the statement of financialposition. This will constitute debt finance and so will increase gearing.

I hope that this answers your queries, please do not hesitate to contact me if I can be of furtherassistance.

Financial Manager





EXERCISE THREE (SEGMENTAL REPORTING ANALYSIS)

To: Finance DirectorFrom: Financial ManagerDate: TodaySubject: Segmental report analysis

The segmental report provided is based on a geographical split between I-land, C-land and P-land.

I-land is very much the largest of the 3 segments. Pizzatime originated in I-land and is now thedominant chain in this market place with 900 branches, compared to 69 branches in P-land and just one branch in C-land.

Despite GDP growth in I-land being approximately only 2% per annum, Pizzatime have managedto achieve growth in revenue of 6%. This may be because Pizzatime is the dominant chain in themarket and as customers are gaining confidence following the economic downturn they are morelikely to be eating out again compared to having take-aways at home.

The change in profit however is not as good as the rest of Pizzatime which demonstrates thatperhaps costs such as advertising have had to be increased in order to attract customers.

The profit margin in I-land is in line with the group average and has only marginally improved onlast year. Pizzatime are experiencing increasingly stiff competition in I-land and are probablyunable to increase prices in order to compete.

It is likely that I-land is becoming a saturated market for Pizzatime and in order to maintain resultsin this market we will need to look at new products such as healthy eating pizza’s and newinnovations such as self-ordering via a tablet.

In P-land, revenue has fallen by a substantial 11%. This should be investigated further as theremay be a specific reason to explain this, such as certain branches being shut during the year.

However, operating profit has actually increased on last year. Profit margins have also improvedsubstantially.

As it is a less developed country it may be that labour is much cheaper in P-land compared to I-land.

The return on net assets in P-land is not as high as the other segments and the reasons behindthis should be examined. Perhaps more efficient use of floor space could be obtained.

Growth in GDP is forecast to be approximately 4% for the short-medium term future. Pizzatimeshould focus on continuing to increasing their presence in this market.

Currently Pizzatime only have 1 restaurant open in C-land. This restaurant only opened in 2014and so last years results are unlikely to have risen from a full year of activity. This explains whythere is so much growth in the revenue and profits compared to last year.

C-land is one of the world’s fastest growing economies and although their growth in GDP hasslowed slightly compared to 2012, it is still in the region of 8-9% and is showing little sign ofslowing down. This is therefore a key market for Pizzatime to target and establish a presence in.

We will need to consider strategies that can compete with Pizza2Go as they already have a strongpresence in C-land. Differentiation may be the key here as Pizzatime offer an eat-in experience

whereas Pizza2Go only offers take-away/delivery services.




There is a strong demand in C-land currently for I-land food. This could be used to Pizzatime’sadvantage. This may also provide an opportunity for crossover in terms of Pizzatime introducingC-land style food into I-land as a new product line.

Profit margins are currently higher in C-land than any of the other segments. Perhaps Pizzatimeare able to charge higher prices due to the demand for I-land style food.

The return on net assets has also improved this year which is likely to be due to the restaurantbeing fully operational in 2015.

I hope that this is sufficient information for your meetin, please do not hesitate to contact me if Ican be of further assistance.

Financial Manager

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