Case Study 1 the Etinargemop SA (ESA) produces various fruit juices in its factory near Malaga in Spain. It has just finished its financial year to 31 March 2020. It has been an excellent year for company with record order intake and sales shipped. Recent expansion has been rapid with new wholesale outlets being opened at the rate of two per quarter, resulting in a major increase in ESA's market share. In addition, ESA has invested a considerable amount of sales and advertising expenditure in developing its own special brand Revolution Red, a juice made from an unusual blend of fruits. The Board of Directors estimates that ESA has spent 345,000 on a combination of: advertising on European television special briefings at luxury hotels in the South of France for a group of industry experts launches at major trade shows in Madrid, Paris, Berlin and New York. The sales and marketing director believes that the new brand has been accepted enthusiastically by the public, with sales showing encouraging early growth, leading to optimism for a successful future for Revolution Red. The financial statements to 31 March 2020 have just been completed, prior to the visit of the company's external auditors. At a meeting of the company's Board of Directors on 13- May, the CFO revealed the draft operating results and the Balance Sheet at 31 March 2020 (together with comparative figures for 2019). Income Statement Year ended 31-Mar-20 '000 7,456 4,514 2,942 Year ended 31-Mar-19 '000 5,274 2,468 2,806 Revenue Cost of sales Gross profit Administrative costs Marketing and selling costs Distribution costs Depreciation (see note 1) Operating profit Interest payable Profit before taxation Corporate taxation on profit Profit attributable to shareholders Dividends Retained profit for financial year Balance Sheet 820 500 595 280 747 32 715 157 558 100 458 745 300 546 240 975 8 967 204 763 75 688 Year ended 31-Mar-20 '000 Year ended 31-Mar-19 '000 Non-current assets Fruit juice production equipment (see note 2) Other long-term assets 1,200 50 1,250 900 25 925 Current assets Inventory Trade debtors Cash at bank 975 1,586 550 850 250 1.650 2,561 Creditors: amounts falling dwe within one year Bank overdraft Creditors (see note 3) 45 725 770 855 855 Net current assets 1,791 795 Total assets less current liabilities 3,041 1,720 Creditors: amounts due in excess of one year Long-term loans 588 2,453 25 1,695 Capital and reserves Ordinary share capital Share premium Profit and loss account 300 500 100 1,853 2,453 1,395 1,695 Notes to the Accounts Note 1 Depreciation Year ended 31-Mar-20 '000 Fruit juice production equipment Other long-term assets 270 10 280 Note 2 Fruit juice production equipment with a net book value of 100,000 was sold during the year at no gaino loss. Note 3 Analysis of creditors Year ended 31-Mar-20 '000 Year ended 31-Mar-19 '000 Trade creditors Corporate taxation payable Dividends payable 575 50 100 725 601 204 50 855 The other directors are extremely disappointed with the annual operating profit for 2020 and are questioning whether it can be feasible that such a promising sales growth has resulted in a decline in profits. They point out that the shareholders have increased their commitment to ESA over the year, but distributable profits have failed to match 2019 levels. Concerns are also expressed about the state of the Balance Sheet at 31 March 2020, where it appears that ESA's cash reserves have disappeared despite the fact that profits were earned during the year. The personnel director has a friend who has told him that profits should generate cash and he is adamant that the company should not be experiencing a deteriorating cash position. The sales and marketing director has commented that she has heard that it is possible to improve operating results by recognising brands as an asset. Therefore, she has proposed that the company examines the major sales and marketing expenditure on the Revolution Red product to assess if any, or all of it, can be converted into an asset. The CFO has been requested to approach the auditors to seek their advice and opinion on this suggestion. Required: 1. Prepare a Cash Flow Statement for the year to 31 March 2020. Show all workings. (14 marks) 2. Comment on the major movements in cash over the year, providing an explanation for the various queries on profitability and cash raised at the Board meeting (6 marks - maximum word count 400 words) Review the sales and marketing director's proposal to capitalise the expenditure on the Revolution Red product in the context of the accounting treatment of brands and the likely response of the auditors. (5 marks maximum word count 300 words) 3. Total 25 marks