(a) The Conceptual Framework for Financial Reporting identifies faithful representation as a fundamental qualitative characteristic of useful financial information.

Required:

Distinguish between fundamental and enhancing qualitative characteristics and explain why faithful representation is important. (5 marks)

b) Glory Ltd is a publicly listed company which has experienced rapid growth in recent years through the acquisition and integration of other companies. Glory Ltd is interested in acquiring Rita Ltd, a retailing company, which is one of several companies owned and managed by the same family. The summarised financial statements of Rita Ltd for the year ended 30 September 2014 are:

Statement of profit or loss

GHS000

Revenue 70,000

Cost of sales (45,000)

Gross profit 25,000

Operating costs (7,000)

Directors salaries (1,000)

Profit before tax 17,000

Income tax expense (3,000)

Profit for the year 14,000

Statement of financial position

GHS000 GHS000

Assets

Non-current assets

Property, plant and equipment 32,400

Current assets

Inventory 7,500

Bank 100

7,600

Total assets 40,000

Equity and liabilities

Equity

Equity shares of GHS1 each 1,000

Retained earnings 18,700

19,700

Non-current liabilities

Directors loan accounts (interest free) 10,000

Current liabilities

Trade payables 7,500

Current tax payable 2,800

10,300

Total equity and liabilities 40,000

From the above financial statements, Glory Ltd has calculated for Rita Ltd the ratios below for the year ended 30 September 2014. It has also obtained the equivalent ratios for the retail sector average which can be taken to represent Rita Ltds sector.

Rita Ltd Sector average

Return on equity (ROE) (including directors loan accounts) 471% 220%

Net asset turnover 236 times 167 times

Gross profit margin 357% 300%

Net profit margin 200% 120%

From enquiries made, Glory has learned the following information:

(i) Rita buys all of its trading inventory from another of the family companies at a price which is 10% less than the market price for such goods.

(ii) After the acquisition, Glory would replace the existing board of directors and need to pay remuneration of GHS25 million per annum.

(iii) The directors loan accounts would be repaid by obtaining a loan of the same amount with interest at 10% per annum.

(iv) Glory expects the purchase price of Rita to be GHS30 million.

Required:

(i) Recalculate the ratios for Rita after making appropriate adjustments to the financial statements for notes (i) to (iv) above. For this purpose, the expected purchase price of GHS30 million should be taken as Rita Ltds equity and net assets are equal to this equity plus the loan. You may assume the changes will have no effect on taxation. (6 marks)

(ii) In relation to the ratios calculated in (a) above, and the ratios for Rita Ltd given in the question, comment on the performance of Rita Lt compared to its retail sector average. (9 marks)