BU7054

UNIVERSITY OF DUBLIN
TRINITY COLLEGE

Faculty of Arts Humanities and Social Sciences

School of Business

Master’s in Business Administration (MBA) Michaelmas Term 2018

Part Time Year 1

BU7054 Fundamentals of Accounting

TBSI 18:00 – 20:00

Mr. – External Lecturer

Mr. Hilary Hough - Lecturer

Instructions to Candidates:

This is a closed-book examination.

The examination is TWO hours in duration.
Answer each question in a separate answer book.

Question 1 carries 45 marks:

Question 2 carries 25 marks:
Question 3 carries 30 marks:

Answer all three questions.

You may not start this examination until you are instructed to do so by the invigilator

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Question 1
Attached are extracts from the accounts of Ryanair plc for the years ended 31 st March 2018 and 2017
You are required to:

(i) Analyse and comment on the performance of the business and its financial position as
evidenced in the Income Statement and Balance Sheet over the two years using appropriate
ratios. Ratios 10 (30 marks)
Period 2018 2017 Gross Profit 1.5 Others 0.5 each
Sales Growth % 7.57
Scheduled Revenue 5.46 -1.99
Ancillary Revenue 13.34 13.45
 Overall Sales Growth was relatively strong at 7.57% reflecting an increase of 5.46% in
Scheduled Revenue 0.5 and an increase in Ancillary Revenue of 13.34% 0.5 reflecting
strategy to increase ancillary income

Profitability
Gross Profit % 30.15 28.91
Operating Profit % 23.32 23.08
PreTax Profit % 22.53 22.12
Net Profit % 20.28 19.79

 Gross Profit % was up 1.24 1 giving an extra €88.67m 1 in Gross Profit. Most of the
improvement came from reduced fuel costs 1
 Operating Profit% was up 0.24 which is 1.00 1 less than the increase in GP. This was due to
a 0.9 point increase in Marketing expenditure relative to Sales. 1
 Pre-Tax Profit% was up 0.42 points 1 which is more than the increase in OP reflecting drop in
Finance Expense 1
 Net Profit% is up 0.49 points which is slightly higher than the increase in PTP% reflecting tax
charge as a %age of Revenue being slightly reduced in 2018..1
 All of the profitability in relation to sales ratios show a very impressive performance for
the airline industry.

Return on Capital Employed % 1.54 18.63 17.09

Return on Equity % 2.70 32.45 29.75
Asset Turnover 0.06 0.80 0.74

 Return on Capital Employed% was up 1.54 points at 18.63% and is a very good return for a
capital intensive business. 1 The increase is driven by the increase in Operating Profit and a
small reduction in Capital Employed arising principally because of reduction in borrowings. 1
 Return on Equity% at 32.45% is significantly higher than ROCE reflecting the benefit to
shareholders of relatively high leverage.1 It is up 2.7 points reflecting the increase in Net Profit
and a relatively modest increase in Shareholders’ Funds. 1
 Net Asset Turnover is up from 0.74 to 0.80 reflecting the growth in sales and the reduction in
Capital Employed. While low it is still reasonably impressive for a capital intensive business.1

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Liquidity/Working Capital
Current Ratio 1.23 1.56
Quick Asset Ratio 1.23 1.56
Collection Period 3 3
Inventory Period 0.27 0.24
Payments Period 18 23
Working Capital Ratio % -2.63 -3.56

 Current and Quick Asset Ratios are the same because of the very low inventory levels and
are down from1.56 to 1.23 because of reduction in Cash and Other Current Assets and
increases in most of the Current Liability items. 1
 Collection Period is very low at 3 days in both years reflecting the cash sales nature of the
business. 0.5
 Inventory Period is less than 1 day reflecting the nature of the business. It is up 0.03 points
consuming cash €0.41m 1
 Payments Period is down to 18 days from 23 days in 2017 consuming cash of €68m. 1
 Working Capital Ratio% is negative in both years reflecting the very low levels of Receivables
and Inventory and the fact that Trade Payables are higher than total of Receivables and
Inventory. It is a very attractive working capital model from a cash flow point of view. 0.5

Leverage
Overall 1.77 1.71
Bank 0.89 0.99
Long Term Debt 0.79 0.89
Profit Cover for Interest 27.74 22.83

 Overall Leverage is down from 1.71to1.77 reflecting slightly increased overall financial risk 0.5
 Bank Leverage is relatively high at 0.89 but is down from 0.99 in 2017 reflecting reductions in
both current and term debt. While high it would be considered acceptable given the strong
profitability of the business and that total cash amounts to almost 95% of total bank debt 0.5
 Long Term Bank Leverage is 0.79 which 89% of the Bank Leverage thus significantly 0.5
mitigating the financial risk. It also is down from 0.89 in 2017 reflecting reduced financial risk
 Profit Cover for Interest is very high in both years reflecting the strong Operating Profitability
and at these levels significantly reduces the financial risk. 0.5
(ii) Describe the main cash flow movements in Ryanair in the year ended 31/03/2018
(9 marks)
Cash Flow from Operations:
Profit after Tax of €1.45bn converted to Net Cash from Operations of €2.23bn. reflecting very
strong cash generation. 1 The main add backs contributing to this were 1 Depreciation
€561m., increase in Accrued Expenses of 1 €241m and Taxation (Net) of €42m. offset by
decrease in Payables €45m and increase in Other Current Assets €14m. 1
Investing Activities:
Purchase of Property, Plant & Equipment consumed €1,470m 1 and increase in Restricted
Cash consumed €23m. These were offset by reduction in Cash>3mos of €774m 1 giving net
cash used in Investing Activities of €719m.

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Financing Activities:
€829m was given to shareholders 1 presumably in dividends and share buybacks and
€459m 1 of Long Term Loans were repaid while an additional €65m came in from an increase
in LT Borrowings giving Net Cash used in Financing Activities of €1,223m
All of this resulted in an increase in Cash of €291m
(iii) Calculate the P/E and Market to Book ratios at 31/03/2018 and 2017 and comment on what
these ratios indicate about the market’s rating of Ryanair (6 marks)
Price Earnings Ratio 1 13.12 13.89
Book Value per Share 3.71 3.52
Market to Book Ratio 1 4.26 4.13
 Price Earnings Ratio is down 0.77 points reflecting a slightly reduced market perception of
Ryanair and slight reduction in market expectation of future growth in earnings 2
 Market to Book Ratio is very high at 4.26 up from 4.13 in 2017 and reflects a high market
value on the items which are not on the Balance Sheet. 2
Question 2
(i) Describe how the following investments are accounted for in Consolidated Accounts of an
investing company:
(a) Investment representing 15% of the investee company
 Shown as a Fixed Asset on the Balance Sheet at valuation and all of the dividend shown in
the Income Statement 2
(b) Investment representing 33% of the investee company
 Initially shown at cost and then increased annually by Net Profit to show 33% of the Net
Assets as ‘Investment in Associate’ in Fixed Assets in the Consolidated Balance Sheet.
 33% of the Operating Income will be shown in the Consolidated Income Statement as ‘Share
of Income of Associate’ 2
(c) Investment representing 70% of the investee company
 All of the assets and liabilities will be included in the Consolidated Balance Sheet and all of the
Revenue and Costs will be shown in the Consolidated Income Statement 2
( 6 marks)
(ii) Explain the different accounting treatment of Finance Leases and Operating Leases under
IFRS
Operating Lease
 Lease payments under an operating lease are recognised as an expense on a straight line
basis over the lease term 1
 The total of future lease payments must be disclosed in the notes to the accounts 0.5
 The leased asset will not appear on the lessee’s Balance Sheet 0.5
Finance Lease
At the commencement of the lease term lessees shall recognise finance leases as assets and
liabilities at amounts equal to the fair value of the asset 0.5 or, if lower, the present value of the
minimum lease payments 0.5
The discount rate to be used is the interest rate implicit in the lease or if that is not easily
determinable the lessee’s incremental borrowing rate 0.5
The leased asset is depreciated in the same way as owned assets 1
The lease payments must be apportioned between the finance charge in the Income Statement and
the reduction of the outstanding liability in the Balance Sheet 1
The notes to the accounts must disclose the net carrying amount for each class of leased assets 0.5

( 6 marks)
(iii) (a) Explain how Goodwill is accounted for under IFRS in consolidated accounts (2 marks)

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Goodwill is capitalized and shown as an Intangible Asset under Fixed Assets on the Balance Sheet. It
is not amortised but must be reviewed annually for ‘Impairment’ and any impairment identified must
be charged in the Income Statement in the year in which it is identified 2
(b) What will be the Goodwill, if any, and Non Controlling Interests, if any, in the case where
Company A acquires, for a consideration of €350m, 80% of Company B which has a Balance
Sheet as follows:
€millions
Fixed Assets 300
Current Assets 650
Total Assets 950
Current Liabilities 350
Term Loans 200
Share Capital 100
Retained Earnings 300
950 (6 marks)
Goodwill: 400X80% = 320. Goodwill = 350-320 = €30m 3
Non Controlling Interests: 400X20% = €80 3

(iv) Explain the item ‘Unearned revenue’ in the below note from the Ryanair financial statements

(5 marks)
This represents payment in advance by customers for flights that have not yet been taken. 3
The cash has been received and is included in cash on the Balance Sheet but the Revenue will not
be recognised in the Income Statement until the flights have been taken and it therefore appears as
Unearned Revenue in the Current Liabilities 2

Question 3
(i) Describe six fundamental accounting concepts that underlie the preparation of financial
statements
(9 marks)
Entity
 Accounts are kept for an entity as distinct from the people who own, run or do business with the
entity 1
Money Measurement
Financial accounting deals only with things that can be represented in monetary terms 1
Going Concern
Presumes that the business will continue for the foreseeable future 1
Accruals
Accounts for transactions when they happen rather than when the underlying cash transaction takes
place 1
Matches costs and revenues in the period in which they arise 1
Comparability and Consistency
Items should be treated in the same way each year so that valid comparisons can be made 1
If there is a change in treatment it should be disclosed in the Notes to the accounts 1

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Prudence
Revenue should not be recognised until it is received in cash or some other asset. 1
Likely costs and losses should be anticipated 1

(ii) Describe two areas of accounting that involve significant subjective judgment and discuss
how they can impact the reported results of a business.
( 8 marks)
Depreciation can be highly subjective as the amount charged is determined by the subjective view
on the ‘economic life of the asset’ 2
When considering depreciation it is the economic rather than the physical life that is relevant. .
Economic life reflects the current estimate of the period during which the asset will be in use taking
account of product life cycles, production capacity, quality requirements and technological change. All
of these factors involve varying degrees of subjectivity. If the economic life is extended it will reduce
the charge and thus increase reported profits. If it is reduced it will increase the charge and reduce
reported profits. Changing view on economic life will also have an impact on the fixed asset value in
Balance Sheet. Such changes will not have any impact on the cash position of the business 2
Inventory can be subjective because it has to be shown at ‘the lower of cost or net realisable value.
Net realisable value is the subjective element. The assessment of whether to use cost or net
realisable value needs to be done in relation to each item of stock. If items are not looked at
individually then there could be some very misleading netting of foreseeable losses with unrealised
gains in stock values. There is an element of judgement required in the valuation of each item of
Stock. NRV by its nature has to be an estimate. This introduces an element of subjectivity into the
process which can sometimes lead to doubts about the validity of the Stock figure in accounts.
2 and if for example the NRV falls below cost but is not recognised as such then profits would be
overstated and the Inventory figure on the Balance Sheet would also be overstated 2

(iii) ‘Describe two ways in which ‘outsourcing’ can contribute to enhanced Return on Capital
Employed
( 6 marks)
Outsourcing can reduce investment in Fixed Assets and Working Capital as the business will not
need the equipment to produce the outsourced product or process and will have a reduced need for
Inventory thus reducing Capital Employed with a resultant enhancement of ROCE 3
It can also reduce costs because of the benefits from the economies of scale and specialist skills of
the outsourced provider to give higher Operating Profit with a resultant increase in ROCE. This
benefit can be significantly enhanced by outsourcing to lower cost locations where labour and other
costs are much lower than in the home environment. 3

(iv) ( a) Describe any two pricing strategies that a business could apply in different circumstances
(4 marks)
Full Cost Pricing
Price is set at a level that will cover all its costs including allocated overheads and deliver a profit
margin
Most common approach, but not always the best approach
Makes sense for long term pricing on main stream contracts as ultimately all costs must be covered
Pricing strategies that rigidly use full cost can be dangerous from a marketing perspective as it could
price products out of the market in a highly competitive environment 2
Relevant or Marginal Pricing
This pricing strategy focuses on the minimum product price which will cover all its variable costs and
make a ‘Contribution’ to fixed costs thus reducing the amount of fixed costs to be allocated to other
products and leaving the firm in a better overall position It is most relevant for highly competitive once
off contracts, or when the product may simply end up unsold 2

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(b)Company A produces only one product (Product A) to which the following Unit Cost data
applies
Selling Price €80
Variable Costs €60
The total Fixed Costs of Co A are €40,000
Calculate
a) Profit Volume (PV) Ratio for Product A
b) Break-even Point in Sales Value
c) € Sales needed generate Profit of €20,000
( 3 marks)

PV Ratio: (80-60)=20 , 20/80= 0.25 (25%) 1

BEP in Sales Value: 40,000/25% = €160,000 1
€Sales to give Profit €20,000: (40,000+20,000)/25% = €240,000 1

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Share Price €15.80 €14.53

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© UNIVERSITY OF DUBLIN 2017

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