Strategic Business Management July 2021– Advanced level

MARK PLAN AND EXAMINER’S COMMENTARY

This report includes:

• a summary of the scenario and requirements for each question
• the technical and skills marks available for each part of the requirement
• a description of how skills should be demonstrated
• detailed points for a full answer
• examiner’s commentary on candidates’ performance

The information set out below was that used to mark the questions. Markers were encouraged to use discretion and
to award partial marks where a point was either not explained fully or made by implication.

Question 1 – Linx Plant Hire plc (LPH)

Mark Grid

Requirements Technical Skills assessed

& Skills

1.1 Analyse and evaluate the performance 16 • Analyse and assimilate the data provided in a
and financial position of LPH for the structured manner (eg a table).
year ended 30 June 2021 compared • Carry out data analysis to evaluate
with the year ended 30 June 2020. performance and position.
Suggest reasons for changes in • Critically appraise the data and the comments
performance and financial position. of the operations director.
Include an evaluation of the comments
• Demonstrate a clear understanding of key
made by the operations director. issues of performance appraisal.

1.2 12 • Analyse and assimilate the data provided in a

Explain: structured manner.
• Carry out structured and logical analysis of
(a) the three key metrics currently performance metrics.
reported to the board and evaluate the
• Demonstrate and explain the strengths and
appropriateness of these metrics to
weaknesses of the metrics.
inform board-level decisions
(Exhibit 3). Further calculations are not • Set out and explain assumptions and other
relevant factors to be considered.
required.
• Use judgement and analysis of the data to
(b) the benefits of reporting a more evaluate the limitations and risks of the
detailed analysis of monthly measures.
performance to the board. Identify and
justify additional, appropriate
performance measures.

@ICAEW 2021
Page 1 of 28
 Strategic Business Management July 2021– Advanced level

1.3 22 • Identify and explain the key financial reporting

In respect of the financing of the construction issues.
equipment (Exhibit 4): • Set out and explain the financial reporting
treatment of the leases and the loan.
• Set out and explain the financial • Use data provided to illustrate and justify the
reporting treatment for each of the differences between financing choices.
three financing choices over the • Address the key financial reporting issues
six-year asset life cycle. Ignore arising from the financing choices.
taxation. • Use judgement to identify and evaluate key
financing issues.
• Determine and justify the most • Demonstrate a clear understanding of the
appropriate method of financing nature of the risks.
from the three choices identified. • Analyse, compare and evaluate the alternative
Show supporting calculations for methods of financing.
all three financing methods, • Assimilate data and other information to
including tax effects. Explain identify key issues.
relevant financial and non-financial
factors.

Use the working assumptions in Exhibit 4 and

other available information.

1.4 Explain how the new digital 10 • Use judgement to identify and explain the key
information system can support issues for improved management information.
operational decision making to • Demonstrate a clear understanding of the key
improve: benefits and problems of asset management
• Asset management and management of revenue generation.
• Revenue generation. • Use judgement to critically appraise the key
issues.
• Analyse, compare and evaluate the benefits of
the SaaS software compared with previous
procedures.

Maximum marks 60

@ICAEW 2021
Page 2 of 28
 Strategic Business Management July 2021– Advanced level

Scenario

LPH hires out industrial equipment to business customers. The LPH board is concerned about the company’s
performance and financial position and is asking questions about the management of assets and operations.
The finance director is concerned about the metrics which should be used in future to inform board-level
decisions.

In order to improve performance, the board decided to make a major investment, in construction equipment
for hire and wants to select the most appropriate method of financing this new construction equipment. After
consultation, LPH has identified three potential types of financing to acquire the construction equipment for a
six-year cycle:
• Bank loan
• A six-year lease
• Two consecutive three-year leases.

LPH appointed a new head of digital technology to support the improvement of asset management and
revenue generation and introduced a new digital information system. The new system is functioning, but the
board is concerned that the system is not being used effectively. The board would like advice on how the
information made available by the new system can improve operational decisions by depot managers and
others.

Financial and operating data is provided.

Requirement 1.1 – Performance and position

Figures in red are given in the question (no marks awarded)

%
2021 2020 change
Revenue 355 330 7.6%
Cost of sales -162 -151 7.3%
Gross profit 193 179 7.8%
Distribution and administration costs -164 -153 7.2%
Operating profit 29 26 11.5%
Finance costs -4 -2 100.0%
Profit before tax 25 24 4.2%
Tax -5 -5 0.0%
Profit for the year 20 19 5.3%

Customers 25,200 24,100 4.6%

Depots 180 175 2.9%

EBITDA 70 62 12.9%
Depreciation 41 36 13.9%
Net debt 86 61 50.9%

ROCE 8.9% 9.5%

Utilisation 52% 56%
Net debt/EBITDA 1.23 0.98 33.7%

@ICAEW 2021
Page 3 of 28
 Strategic Business Management July 2021– Advanced level

Gross profit margin 54.4% 54.2%

Operating profit margin 8.2% 7.9%

Interest cover 7.25 13.0

Gearing D/E 41.9% 31.6%
Gearing D/E (using net debt) 37.6% 29.2%
Gearing D/(D+E) 29.5% 24.0%
Gearing D/(D+E) (using net debt) 27.3% 22.6%

CAPEX (£m) 78 45 73.3%

Revenue per customer (£) 14,087 13,693 2.9%

Operating profit per customer (£) 1,151 1,079 6.7%

Revenue per depot (£) 1,972,222 2,062,500 -4.4%

Profit per depot (£) 161,111 162,500 -0.9%

Revenue

Revenue has increased in 2021 by 7.6% compared with the previous year. Data is not provided on price changes
and changes in the volume of hires, but there are other causal factors that can be identified.

If the operations director is correct, then £5.6m of the increased revenue is due to the acquisition of specialist
assets at the beginning of the year. This leaves a more modest increase of about 2% in like-for-like growth from
existing equipment for hire.

Part of the explanation for the increase in revenue has been an expansion in the number of customers by 4.6%.
Also, the revenue per customer has risen by 2.9% which could suggest that the new customers generate more
revenue than the longer-term customers. However, this assumes that the average revenue generated by the longer-
term customers has not changed significantly from last year.

Another possible casual factor for revenue growth has been the growth in the number of depots by 12.5%
compared with last year. This is significant but has also resulted in a fall in the revenue per depot by 4.4%. Part of
the explanation may be that new depots are in new geographical areas which overlap with existing areas. These
may now serve new customers and generate new sales, but could also service existing customer needs more
effectively and at lower transport cost by being closer to markets (ie closer than existing depots to existing
customers’ locations).

Profit and costs

Both the overall gross profit margin and the overall operating profit margin have changed very little. This could be
indicative that the additional revenue has been generated with similar prices and costs to existing revenue streams.

However, this overall picture of stability of margins could hide different and compensating trends in sub-sets of the
data. Thus, for instance, the new specialist equipment may have performed poorly (as indicated by the low
utilisation rate of 40%) but profit margins on underlying like-for-like hiring revenue from other assets may have
improved. This matter is considered further below in discussing the statement of the operations director.

At £41m for 2021, depreciation is a key cost of asset ownership and use. This is largely a fixed cost and makes the
profit sensitive to changes in the level of activity through operating gearing.

@ICAEW 2021
Page 4 of 28
 Strategic Business Management July 2021– Advanced level

Return on assets

While profit has increased in absolute terms in 2021 compared with 2020, there has been increased investment in
more equipment in 2021 and therefore an expansion of the asset base available to generate revenue.

The total CAPEX in the year was £78m. While some of this amount was for replacement of assets, there was also
new investment in specialised equipment for hire of £30m and new depots of £5m.

The ROCE decreased from 9.5% to 8.9% showing that, although profit increased, it did not increase by as much as
the asset base. The % return on assets therefore fell. It may however be that this reduction is not a reasonable
measure of performance as:

• it may take time for the new business line relating to specialist equipment to gain traction and generate
profit. So, while ROCE may fall initially, it may rise again once the new business line is more established.
• Some of the assets (eg the depots) may have been purchased during the year and so have not had a full
12 months to generate profit. Nevertheless, all these assets would be fully reflected in the statement of
financial position.

ROCE is considered more in requirement 1.2.

Financial position and liquidity

A loan of £30 million was taken out in July 2020 to finance the new specialist equipment. As a consequence, non-
current liabilities increased by 45% and all measures of gearing increased. A breach of debt covenants expressed
in terms of gearing may be a risk if further borrowing is needed for expansion.

There is a significant increase in debt exposure but, due to a low interest rate on the loan at 4%, LPH’s ability to
service the debt looks to be secure. For example, in 2021 interest cover remains high at 7.25, despite decreasing
from 13 in 2020.

In terms of the asset position, there has been some debt financed expansion as already noted. However, of the total
CAPEX only £30m has been debt financed. A reduction in the cash balance (from £10m to £5m) has provided
sufficient finance for the investment in new depots. Operating cash flows and disposal proceeds have financed the
new replacement assets.

Operations director’s statement

The operations director claims that the specialised equipment generated £5.6m in the year. If they have the average
useful life of six years, then this is only £33.6m generated against a cost of £30m. At 10% pa discount rate this
revenue only generates a PV of £24.4m (£5.6m x 4.355) which is less than cost.

In addition to considering the initial outlay, the revenues attributed to the new specialist equipment are gross and do
not include variable costs from their use. It is necessary to deduct the annual variable costs of maintaining,
transporting and storing the equipment, before assessing whether the specialist equipment contributed to profit. It
then needs to be assessed whether it made an adequate return on the initial investment.

In mitigation, as already noted, it may be that this is the first year of use of the specialist equipment and new
markets may develop over the six-year life and so the revenue will increase. With a utilisation rate of only 40% there
is certainly capacity for greater use.

It may also be, as the operations director notes, that hiring revenue from other equipment may have been
generated as a result of gaining new customers.

Despite these mitigating factors there is a requirement for significant improvement before the specialist equipment
is likely to break even and earn a reasonable return on the initial outlay.

@ICAEW 2021
Page 5 of 28
 Strategic Business Management July 2021– Advanced level

Requirement 1.2 – Metrics suggested by finance director

(a) Three current metrics

(i) ROCE

ROCE is a measure of return on assets employed (total assets less current liabilities) and therefore takes into
account all sources of finance (debt and equity).

In the numerator, the profit is operating profit (ie before interest is deducted) and the therefore the amount available
as a return to all providers of finance.

For LPH, it is a measure of the return that its equipment generates from hiring to customers (net of operating costs)
relative to the cost of the investment.

This is an important measure of efficiency and performance of the assets as it emphasises not just that assets need
to generate positive cash flows but that they need to be sufficient to justify the initial investment.

This is important, not just in selecting the right type of asset, but also in acquiring the appropriate quantity of each
asset. If too many of a given type of asset are purchased then, at the margin, a low return may be made due to low
utilisation (see also utilisation below).

However, whether ROCE is an appropriate way of measuring monthly returns is questionable as this requires
monthly measurement of assets.

Moreover, if carrying amounts in the statement of financial position are used to measure assets in the denominator
of ROCE than managers might retain assets beyond their useful lives and which are almost entirely depreciated as
they have a low carrying amount and boost ROCE. This may lead to dysfunctional behaviour in managers being
measured using ROCE as they may retain older assets for longer than desirable rather than replace them with
newer, and more modern, assets.

(ii) Utilisation

Utilisation is a key measure of the efficiency with which assets are being used which is related to the return they
make in terms of ROCE.

LPH appears to measure physical utilisation of assets based on time. It could more beneficially be measured in
terms of value. ie the revenue that has been generated compared with the revenue that could have been generated.
This gives a greater weighting to the utilisation of more valuable assets.

Utilisation is however a metric that can be used not just at company level but at all levels down to each depot and
even each individual piece of equipment. As such, it is a measure of how far the business is ‘making the assets
sweat’.

It also provides key management information which is appropriate at a monthly level in a range of key management
decisions. Poor utilisation of individual assets may indicate:
• a shift in customer demand
• an inappropriate purchase
• purchase of an excessive quantity of a given asset
• the need to sell the asset
• wrongly located assets.

Conversely, very high utilisation may suggest that more of a given item of equipment needs to be purchased to
ensure it is available to satisfy customer demand.

A problem may be that utilisation may depend on a range of factors that are not easily identify (eg over/under
pricing). However, it could enable appropriate questions to be asked by the board.

@ICAEW 2021
Page 6 of 28
 Strategic Business Management July 2021– Advanced level

A measure of asset utilisation at a granular level (eg per depot or equipment type) is therefore likely to be an
appropriate metric to report to the board on a monthly basis.

(iii) Net debt to EBITDA

Net debt to EBITDA is a measure of leverage. It shows how quickly net debt can be repaid using EBITDA as a
surrogate for operating cash flows.

In essence, it measures liquidity and solvency from a measure of the ability and time period over which debt can be
repaid.

A weakness is that it does not consider the need to replace equipment and acquire new equipment through CAPEX,
without which the current level of EBITDA is unlikely to be sustained.

However, whether net debt to EBITDA is an appropriate as a monthly measure is questionable as it reflects longer
term liquidity from annual measures of EBITDA.

(b) Alternative performance measures

Measuring performance for the business as a whole may have limited use as it may struggle to identify areas of
good and bad performance to guide decision making.

Possible suggestions for measuring performance could be:

UK and Overseas

This is a geographical segmentation and if the markets are differentiated or managed differently this may be
important is assessing which area needs more investment or divestment or a different type of management. The
role of exchange rates could also be considered.

By depot

This is a localised geographical segmentation. However, it can also be used to measure and incentivise the
managerial performance of depot managers. Measurement would therefore be linked to managerial responsibility.

A problem might be in measuring common costs (eg where equipment is transferred between depots) and in
servicing larger customers with national operations.

By product type

Measuring the performance of individual assets (eg by utilisation rates; hire charges achieved relative to cost) may
provide the board with information on the most productive areas to invest in. It may also indicate the most profitable
types of customer (eg civil engineering).

The appropriate level at which to capture data is an issue (eg individual type of equipment or classes of equipment
types).

Recommendation

Assessing monthly performance depot level seems to be the most appropriate as it links to organisational structure
and operational management decision making (depot manager) and therefore metrics may not only measure and
control at board level, but also incentivise at depot level.

@ICAEW 2021
Page 7 of 28
 Strategic Business Management July 2021– Advanced level

Requirement 1.3:

Financial reporting

Choice 1 -
borrow and
buy
Asset
Acc
To 30 June COST depreciation depreciation NBV

2023 40,000,000 6,000,000 6,000,000 34,000,000

2024 40,000,000 6,000,000 12,000,000 28,000,000

2025 40,000,000 6,000,000 18,000,000 22,000,000

2026 40,000,000 6,000,000 24,000,000 16,000,000

2027 40,000,000 6,000,000 30,000,000 10,000,000

2028 40,000,000 6,000,000 36,000,000 4,000,000

Liability (all
years) 40,000,000

SoPL Depreciation Interest at 5% Total

2023 6,000,000 2,000,000 8,000,000

2024 6,000,000 2,000,000 8,000,000

2025 6,000,000 2,000,000 8,000,000

2026 6,000,000 2,000,000 8,000,000

2027 6,000,000 2,000,000 8,000,000

2028 6,000,000 2,000,000 8,000,000

36,000,000 12,000,000 48,000,000

Choice 2: six
year lease
(£8,000k x
PVFLP at 5% 42,632 (AF5yrs +1) AF % yrs = 4.329 + 1
Note: Rounding differences apply to annuity
factors. Unrounded data below.

@ICAEW 2021
Page 8 of 28
 Strategic Business Management July 2021– Advanced level

Bal
Y/e 30 June Liability b/f interest at 5% payment liability

42,635,813 8,000,000 34,635,813

2023 34,635,813 1,731,791 8,000,000 28,367,604

2024 28,367,604 1,418,380 8,000,000 21,785,984

2025 21,785,984 1,089,299 8,000,000 14,875,283

2026 14,875,283 743,764 8,000,000 7,619,048

2027 7,619,048 380,952 8,000,000 -

2028 - - - -

Tutorial note: Assumes rentals paid 30 June. Acceptable to assume paid 1 July.

SoPL
Depreciation Interest at 5% Total

2023 7,105,969 1,731,791 8,837,760

2024 7,105,969 1,418,380 8,524,349

2025 7,105,969 1,089,299 8,195,268

2026 7,105,969 743,764 7,849,733

2027 7,105,969 380,952 7,486,921

2028 7,105,969 - 7,105,969

42,635,813 5,364,187 48,000,000

Check (6 x £8000k) =
£48,000k

Choice 3: Two 3-year leases

Lease 1
(£8400k x AF % yrs
PVFLP at 5% 24,015.6 (AF2yrs +1) =1.859 + 1

Lease 2
(£9000k x AF % yrs
PVFLP at 5% 25,731.0 (AF2yrs +1) =1.859 + 1
Note: Rounding differences apply to annuity
factors. Unrounded data below.

@ICAEW 2021
Page 9 of 28
 Strategic Business Management July 2021– Advanced level

Bal
Y/e 30 June Liability b/f interest at 5% payment liability

24,019,048 8,400,000 15,619,048

2023 15,619,048 780,952 8,400,000 8,000,000

2024 8,000,000 400,000 8,400,000 -

Bal
Y/e 30 June Liability b/f interest at 5% payment liability

25,734,694 9,000,000 16,734,694

2025 16,734,694 836,735 9,000,000 8,571,429

2026 8,571,429 428,571 9,000,000 -

2027 - -
2028 - -

SoPL Depreciation Interest at 5% Total

2023 8,006,349 780,952 8,787,302

2024 8,006,349 400,000 8,406,349

2025 8,006,349 - 8,006,349

2026 8,578,231 836,735 9,414,966

2027 8,578,231 428,571 9,006,803

2028 8,578,231 - 8,578,231

49,753,741 2,446,259 52,200,000

Check (3 x £8,400k) + (3 x £9,000k) =

£52,200k

Lease-buy decision

Cost 40,000,000
After tax
borrowing rate 5%(1-T) = 4%

Disposal value 4,000,000

Tax rate 0.20

WDA 0.15

@ICAEW 2021
Page 10 of 28
 Strategic Business Management July 2021– Advanced level

Choice 1 –
Purchase
(loan)
TWDV
0 40,000,000
1 34,000,000
2 28,900,000
3 24,565,000
4 20,880,250
5 17,748,213
6 Disposal 4,000,000
Balancing
allowance 13,748,213

Value of tax Value of bal

Time Equipment relief WDA allowance DF 4% CF PV

0 (40,000,000) 1 - 40,000,000 -40000000

1 1,200,000 0.9615 1,200,000 1,153,846

2 1,020,000 0.9246 1,020,000 943,047

3 867,000 0.8890 867,000 770,760

4 736,950 0.8548 736,950 629,948

5 626,408 0.8219 626,408 514,861

6 4,000,000 2,749,643 0.7903 6,749,643 5,334,341

NPV of
4,450,358 purchase - 28,800,000 - 30,653,197

@ICAEW 2021
Page 11 of 28
 Strategic Business Management July 2021– Advanced level

Choice 2: one
six year lease

Lease rental
pa 8,000,000

Value of tax
Time Lease rental relief DF 4% PV
-
0 8,000,000 1 - 8,000,000 - 8,000,000
-
1 8,000,000 1,600,000 0.9615 - 6,400,000 - 6,153,846
-
2 8,000,000 1,600,000 0.9246 - 6,400,000 - 5,917,160
-
3 8,000,000 1,600,000 0.8890 - 6,400,000 - 5,689,577
-
4 8,000,000 1,600,000 0.8548 - 6,400,000 - 5,470,747
-
5 8,000,000 1,600,000 0.8219 - 6,400,000 - 5,260,333

6 1,600,000 - 0.7903 1,600,000 1,264,503

NPV of 6-year lease - 38,400,000 -35,227,160

or use
annuity

@ICAEW 2021
Page 12 of 28
 Strategic Business Management July 2021– Advanced level

Choice 3: two
3-year leases

1. Lease rental
pa 8,400,000
2. lease rental
pa 9,000,000

value of tax
Time Lease rental relief DF 4% PV
-
0 8,400,000 1 - 8,400,000 - 8,400,000
-
1 8,400,000 1,680,000 0.9615 - 6,720,000 - 6,461,538
-
2 8,400,000 1,680,000 0.9246 - 6,720,000 - 6,213,018
-
3 9,000,000 1,680,000 0.8890 - 7,320,000 - 6,507,453
-
4 9,000,000 1,800,000 0.8548 - 7,200,000 - 6,154,590
-
5 9,000,000 1,800,000 0.8219 - 7,200,000 - 5,917,875

6 1,800,000 - 0.7903 1,800,000 1,422,566

NPV of two
leases - 41,760,000 - 38,231,909
or use
annuity

(a) Financial reporting treatment

Purchase and borrow

The construction equipment will be recognised as PPE. The depreciable amount (£36m) is written off as
depreciation over the six-year useful life on a straight-line basis (£6m pa) if periods benefit equally from the assets’
use.

The loan of £40m is recognised as a non-current liability for 5 years, then as a current liability for one year until
settled as a bullet repayment on 30 June 2028.

Interest at 5% is recognised each year on the loan (£2m) in profit or loss as a finance charge.

Six-year lease

Initial recognition of the asset (the right of use of the construction equipment) and the lease liability in accordance
with IFRS 16 is the present value of the future lease payments (PVFLP).

The assets are recognised as PPE and the PVFLP is written off as depreciation over shorter of the lease term (six-
years) and the useful life (also six-years) on a straight-line basis (£7,105,969 pa) if periods benefit equally from the
assets’ use.

The liability is amortised using the interest rate implicit in the lease or the incremental borrow rate. LPH has chosen
the latter (at 5% pa) as its accounting policy. IFRS 16 requires the total finance charge to be allocated to each
accounting period to give a constant periodic rate of charge.

@ICAEW 2021
Page 13 of 28
 Strategic Business Management July 2021– Advanced level

The lease liability reduces each year by the difference between the lease rental payment and the finance charge.

The SPL is charged with the depreciation on the asset and the finance charge on the liability. Overall, the amount
recognised through profit or loss is the same as the sum of the lease rentals of £48m

Two, 3-year leases

Each of the leases is treated separately.

The treatment is as for the six-year lease in accordance with IFRS 16 but as the lease terms are shorter than for the
six year lease arrangement, the lease liability (PVFLP) is smaller at the inception of the lease and, until the final
year, at the end of each accounting period (see calculations above).

(b) Method of financing

The discount rate is the net of tax borrowing rate of 4% (ie 5%(1-T)). This is because lease rentals are low risk like
servicing debt. However, it could be argued that a higher discount rate should apply to the second tranche of 3-year
lease rentals as they are uncertain, unless they have been contractually fixed at the beginning of the project.

The proposed expansion of £40m is significant and there could be elements of the investment where LPH borrows
and buys the equipment and other elements where it leases the equipment. A range of local commercial factors
should be considered in individual investments.

Borrow and buy

Owing the equipment is more flexible than leasing. If the useful life is eventually longer than expected, LPH can
retain the asset beyond the (say) six years. Alternatively, if customer demand changes, or technology changes and
utilisation is low then LPH can sell the asset without the early termination penalties likely to be in a lease contract.
LPH therefore has more discretion with the timing of the end date when it is buying rather than leasing. This can be
important in hiring equipment as the business is cyclical and seasonal so utilisation can vary over the term of
expected use.

There may also be more flexibility in using the asset. For example, there may be a restriction on taking some
equipment out of the UK to use in LPH’s European operations if they are leased. There may also be restrictions on
the extent of use in a lease (eg a maximum number of miles travelled in a vehicle being hired out).

Owning assumes the ability to borrow sufficient funds to purchase the asset. There may be limited debt capacity.
Gearing is high for LPH but, more importantly, it is close to the debt covenant threshold.

Leasing

Leasing will reduce the need to find the initial £40m cash in July 2022. The cash cost will be spread, enabling the
new equipment have time to generate revenue for hiring to customers to help pay the lease rentals. With leasing,
the timing of costs is therefore more closely matched with cash inflows from revenue streams, which aids liquidity.

The implicit rate of interest in the lease may be lower than a bank loan, although this needs to be ascertained.

Similarly, there may be a difference in the tax treatment of a lease, but this may be a benefit or a cost according to
the tax jurisdiction.

Lease rentals need to be capitalised in accordance with IFRS 16. However, the amount of the capitalised lease
liability is likely to be lower than the borrowing required to purchase the equipment. This is particularly true for
shorter leases. This may be an advantage in avoiding a breach of the debt covenant based on gearing.

@ICAEW 2021
Page 14 of 28
 Strategic Business Management July 2021– Advanced level

The lease contract may include maintenance costs or require the lessee to maintain the asset. If maintenance costs
are incurred by the lessor, then the lease rentals will be higher, but it avoids uncertainty. With LPH’s mechanical
equipment, this may be an advantage.

A key assumption is that the LPH board has already decided to acquire the construction equipment. It is therefore
presumably confident that the construction equipment will make a profit irrespective of the method of finance. The
viability of the acquisition of the construction equipment is not therefore in question. The issue is therefore which of
the three methods of financing the construction equipment is preferable.

Using the net of tax borrowing interest rate as the discount rate, this shows the following present values of financing
cash flows.

Purchase and borrow £30,653,197

A six-year lease £35,227,160
Two, 3-year leases £38,231,909

In pure financial terms, using the working assumptions, the purchase and borrow decision gives the lowest after tax
PV and is therefore preferred if assessed on this basis alone.

However, other factors need to be considered. If the asset is still serviceable and its condition acceptable to
customers after six years, the ownership of the asset can be extended. Extensions of the lease term may or may
not be negotiated with the lessor with the leasing options, but this is uncertain and is likely to have greater cost than
extending ownership.

Comparing the 6-year lease with the two 3-year leases, while the 6-year lease has a lower PV cost there are three
advantages to the two 3-year leases:
• There is an exit route after three years (unless there is a prior contractual commitment), so if the
construction equipment is not hiring out as successfully as expected, then the second lease need not be
entered into.
• The second lease is for brand new construction equipment which may be technologically or aesthetically
superior to the construction equipment used in the first three years and in the six-year lease.
• As the two leases are shorter than the six-year lease, the lease liability recognised in the financial
statements is lower and so gearing is lower. This may be important for complying with the loan covenant.

1.4 New digital information system

T-Soft is offering SaaS (software as a service) to LPH. SaaS solutions employ internet technology and remote
servers, enabling users to access software online from anywhere, using a device with an internet connection. The
software does not need to be installed on hardware in the company's offices.

The RFID tracking device enables the assets over £3,000 to be located and their movements recorded providing
useful management information to LPH and its customers.

Asset management

Asset management is the process of making best use of an organisation’s assets to promote their efficient use and
increase the returns generated from the asset.

The tracking of assets enables equipment meeting customers’ specification to be identified and located as soon as
a customer order is made. The software and tracking improves logistics, enabling the most appropriate asset, in the
closest location to be delivered to the customer to reduce lead times and transport costs.

Once delivered to the customer, the use and movement of the asset can be traced recording valuable management
information about how and where the asset is being used by the customer.

There is also a benefit to the asset management of the customer who can trace the LPH asset during the hire
period to make best use it.

@ICAEW 2021
Page 15 of 28
 Strategic Business Management July 2021– Advanced level

Upon completion of the hire period, information about the location of the asset and possibly the next customer to
use the asset can be accessed. This can help determine which depot to return the asset to for storage or whether to
transfer it directly to the next customer.

Operating efficiencies can therefore be achieved, such as speeding up drop-off and pick-up (ie turnaround times)
which may reduce the associated operating costs and improve customer experience.

Inventories of assets and their locations can also be maintained to ensure there is geographical balance of each
type of asset to most efficiently meet future customer demands.

There may also be a more general improvement in customer experience in using real time data to enable
customers to track hired equipment and reduce the likelihood of equipment being lost or wrongly located.

Tracking asset usage may also enable maintenance to be carried out by LPH at the time of lowest demand so the
impact on utilisation is minimised.

The life-cycle history of each asset can also be ascertained and the decision to replace early or extend useful lives
can be informed by evidence.

Revenue generation

For LPH, the use of equipment in terms of utilisation is directly linked to revenue generation. Hire revenues are
generated by ensuring the assets are available for customers’ use at the right time and location.

Management information about the location and use of equipment will facilitate awareness of the patterns of
availability and use of each type of asset. This will identify under and over stocking of each type of equipment and
help optimise the equipment portfolio to meet customer needs. For example, the number of instances when
customer orders cannot be satisfied due to lack of availability of appropriate assets can be minimised.

Having assets in the best locations due to tracking may also shorten lead times to meet urgent customer demands
and increase customer satisfaction. Ensuring that assets are in the possession of customers means hiring revenues
are being generated.

Cross depot communication may also be improved. Depot managers may have knowledge of local customer needs
but may be unaware of revenue generating opportunities outside their geographical region. Asset availability at the
company level can be enhanced by co-operation between depots through sharing information via use of the
dashboard. The centralised availability of the same real time and historic data enables better internal
communications and better and more consistent communications with customers.

Administration of revenue is also facilitated by tracking assets’ use and location to support invoicing and provide
evidence of the cut-off on the asset return date if there is a dispute.

A centralised sales database can be accumulated over time for customer relationship management (CRM) and
marketing, based on knowledge of past customer use.

Examiner’s comments

1.1 Performance and financial position

Candidates generally performed very well on this requirement.

Most candidates calculated all or most of the appropriate relevant ratios. However, lower scoring answers tended
to calculate only a few meaningful ratios. Candidates received no credit for reproducing ratios provided in the
question.

In terms of discussion, there was some good analysis, for example suggesting causal factors and making linkages
between ratios. Many discussed the impact on performance of the investment in specialist equipment. Weaker
answers provided a limited assessment of financial position and largely focused on profitability.

@ICAEW 2021
Page 16 of 28
 Strategic Business Management July 2021– Advanced level

It was surprising that some candidates at this level still just stated that ratios had increased or decreased without
offering suggestions or insights into why these changes had occurred by referring to linked data and the
circumstances in the scenario.

Surprisingly, some weaker candidates did not address the comments of the operations director, which was a
specific instruction in the requirement. There were also some very brief answers, which merely dismissed the
operations director’s comments with very limited justification.

1.2 Three key metrics

Most candidates generally performed well on this requirement.

Comments by weaker candidates on the three key metrics tended to be generic. Many candidates merely
described the three metrics in general terms and stated how they were calculated. There was sometimes little
application to the scenario. However, the better answers focused on the metrics for LPH and identified their
relevance for management decisions, referring to the numbers in the question.

The section of the requirement addressing the benefits of more detailed analysis and alternative measures, also
generated some generic answers by weaker candidates. Some candidates merely restated a few of the ratios
calculated in the first requirement, such as operating profit margin and gearing. A large minority of candidates did
not discuss whether monthly reporting is appropriate. Better candidates produced answers which highlighted
specific, meaningful information for the LPH board such as analysing monthly performance on a geographical or
depot basis, as opposed to company-wide information only.

1.3 Financing – lease v buy

There was significant variation in candidate performance on this requirement.

Two general weaknesses were:

• Addressing the financial reporting section in detail, but making a very limited attempt at the NPV lease-buy
decision section (or vice versa)
• Describing in narrative terms how to do the calculations (for both FR and NPV sections) but not actually
making any meaningful attempt at the calculations themselves.

Specific weaknesses on the financial reporting section were:

• For the buy and borrow choice:

o this was a straight vanilla loan, with easy marks, but many candidates over-complicated the calculation
by discounting, using a variety of interest rates, to obtain a fair value
o depreciating cost, rather than the depreciable amount
o addressing the asset, but not the liability
o addressing the liability, but not the asset
o limited explanations.

• For the two leasing choices:

o including tax when this was excluded in the requirement
o using unadjusted calculations from the NPV lease-buy decision section for FR purposes
o calculating the implicit interest rate in the leases when the question had said not to use this rate and to
use the borrowing rate instead
o treating the leases as operating leases
o initial recognition at cost, rather than PVFLP.

Specific weaknesses on the NPV lease-buy decision section were:

• using the FR calculations for the lease-buy decision with no new calculations
• ignoring tax and capital allowances, when tax was specifically required in the question for the NPV lease-buy
decision

@ICAEW 2021
Page 17 of 28
 Strategic Business Management July 2021– Advanced level

• interest payments were included as cash flows

• depreciation was included as a cash flow
• use of 6-year annuity factor as an ordinary annuity, rather than 5 years plus one for an advance annuity
(annuity due)
• a wide variety of discounts rates used without justification
• limited explanations.

1.4 Digital information system

Many candidates wasted time at the beginning of their answers repeating descriptions given in the question on
how SAAS and the RFID tracking devices operated.

Most candidates dealt well with asset management well by explaining how the tracking of assets would benefit
LPH’s operational decision making in terms of the tracking process, location, customer experience and
maintenance.

However, many candidates were far more limited in their coverage of revenue generation and either left this part
out altogether or produced quite brief answers repeating what they had said on asset management. Where
candidates made no reference to revenue generation, they lost all the marks that were on offer.

Weaker candidates merged the two requirements on asset management and revenue generation, despite these
being identified separately in the requirement in separate bullet points for candidates to address. This is a weak
approach in not clearly answering the two sub-requirements separately by explaining how the digital information
system could improve each of asset management and revenue generation.

Some very weak candidates went down the wrong avenue for this requirement and provided a full discussion of
change management issues.

@ICAEW 2021
Page 18 of 28
 Strategic Business Management July 2021– Advanced level

Question 2 – Tallam

Mark Grid

Requirements Technical & Skills assessed

Skills

2.1 Evaluate and interpret the data 12 • Use judgement to identify key information in
provided by the data analytics team the data distributions.
(Exhibit 2). Explain the relative risks • Demonstrate an understanding of the purpose
arising from the net operating cash of the types of data analysis required.
flows for each division and the • Evaluate the impact of volatility.
resulting risks for the company as a • Structure information.
whole. • Demonstrate an understanding of the
application of data analytics.
• Distinguish volatility risk in local currencies
from currency risk.
• Distinguish divisional risk and company-wide
risk.

2.2 Calculate the settlements in £ of 8 • Perform calculations using multilateral

interdivisional currency balances at 30 netting-off procedures.
June 2021 by applying multilateral netting-
• Identify and explain issues relating to foreign
off procedures to the illustrative data
currency risks, including implications for
provided (Exhibit 2).
Explain: operating cash flows.
• Demonstrate an understanding of the nature of
• how multilateral netting-off
procedures may be of benefit to a centralised treasury department.
Tallam • Use judgement to assess the appropriateness
• the extent to which multilateral of multilateral netting-off.
netting-off procedures may have • Understand and assimilate the data provided
been facilitated by introducing a in a structured manner.
centralised treasury department.

2.3 In respect of the concerns raised by 12 • Demonstrate an understanding of the causes

the internal audit department (Exhibit 3), and risks relevant to each issue.
prepare a report for the audit committee • Use judgement to determine actions and
which sets out and explains: procedures which are appropriate to the
• appropriate procedures for Tallam circumstances.
to manage credit risk on foreign • Use judgement to evaluate the issues.
sales contracts (Concern 1); and • Distinguish credit risk from currency risk.
• the financial reporting and business
issues arising from the differences
between internal and external
pricing arrangements (Concern 2).

@ICAEW 2021
Page 19 of 28
 Strategic Business Management July 2021– Advanced level

2.4 Identify and explain the ethical issues 8 • Use ethical language and principles.
for the Tallam board and members of the • Identify key ethical issues presenting a
treasury department arising from the balanced approach to interpreting the facts
matters described in the anonymous letter
and incentives
(Exhibit 4).
• Identify issues for each party separately
Evaluate, with supporting calculations, the • Set out the actions to be taken by the
claims made in the anonymous letter relevant parties.
regarding the forward contract. Set out any
ethical and business implications.

Explain the actions that should be taken by

the Tallam board in response to the receipt
of the anonymous letter and the ethical
issues identified.

Maximum marks 40

Scenario

Tallam plc is a global manufacturing company with three subsidiaries. It produces semiconductor devices
(semiconductors) and integrated microelectronic circuits (IMCs).

The majority of Tallam’s semiconductors are sold to external customers. However, some semiconductors are
transferred internally to be used as components in Tallam’s manufacture of IMCs.

The board is concerned about Tallam’s cash management and treasury activities, particularly in respect of its
multiple currency operations. The board is also concerned about foreign currency risks arising from its operating
activities.

Each division produces IMCs which are specific to one industry:

• UK division – Aerospace industry
• German division – Digital communications industry
• Malaysian division – Computing industry

Each division sells its IMCs to global external customers operating in the related industry.

The company’s data analytics team carried out an analysis of net operating cash flows for Tallam’s four major
currencies. The team’s data shows the average amounts (mean) and variability (standard deviation) of monthly net
operating cash inflows during the year.

An ethical matter has arisen when the finance director received an anonymous letter from a treasury staff member
making a complaint about the group treasurer.

@ICAEW 2021
Page 20 of 28
 Strategic Business Management July 2021– Advanced level

Requirement 2.1 – Relative risks from net operating cash flows

Table 1 – Total net operating cash flows in £s

£’000
Division Amount XR per month £’000 pa
UK 40,000 1.0 40,000 480,000
Euro 27,500 1.1 25,000 300,000
Malaysia 75,000 5.0 15,000 180,000
US 26,000 1.3 20,000 240,000

Total 168,500 100,000 1,200,000

Table 1 above translates the net operating cash inflows provided in the four currencies into £ sterling using the
year-end exchange rates provided to bring them to a common currency basis. The year-end exchange rate is not
ideal as the transactions occurred over the year, but it provides a reasonable approximation for management
information purposes.

The key issue is that the company generates a significant amount of net operating cash flows at £1,200 million pa.
This is a ratio of 0.20 (operating cash flows divided by revenue) on the revenue of £6,000 million. There are a
number of payments to be made from these operating net cash inflows including: investment cash flows (CAPEX);
financing cash flows (interest and repayment of debt), tax, dividends. Nevertheless, there is a substantial surplus for
the year. The cash and cash equivalents balance of £87 million reflects the fact that significant net cash inflows are
being generated, but there are substantial outflows.

Nevertheless, whilst there is currently strong growth in the semiconductors industry, there is an historic pattern of
variability and hence there is a need to manage variation in cash flows within years and between years.

This is not just to maintain liquidity, but also to optimise the use of surplus cash to generate returns for
shareholders.

Table 2

Net operating cash inflows

(per month)
Currency Average Standard Coefficient of
(mean) deviation variation

British pounds (£’000) 40,000 19,596 0.49

Euro (€’000) 27,500 22,000 0.80
Malaysian ringgit (MYR’000) 75,000 30,000 0.40
US dollars (US$’000) 26,000 16,444 0.63

The standard deviations (SD) shown in the table produced by the Tallam’s data analytics team gives absolute
values. They cannot therefore be directly compared with each other to give a relative assessment of risk, as the
scale of the amounts differs. Clearly, they are also in different currencies.

The coefficient of variation relates the SD to its absolute value and is therefore comparable between the divisions to
compare relative risk. Higher values of the coefficient of variation suggest a greater dispersion in the data adjusting
for absolute size.

Once this scaling is considered then Malaysian cash flows have the lowest coefficient of variation and therefore the
lowest relative dispersion.

If the four currencies are translated to £s then the absolute numbers of the means and SDs will change, but this
does not affect the coefficient of variation which shows the relative variability of each division, as it merely scales
the data. This is demonstrated below with the table translated to £s as the common currency:

@ICAEW 2021
Page 21 of 28
 Strategic Business Management July 2021– Advanced level

Net cash inflows

(per month)
Currency Average Standard Coefficient of
(mean) deviation variation

British pounds (£’000) 40,000 19,596 0.49

Euro (£’000) 25,000 20,000 0.80
Malaysian ringgit (£’000) 15,000 6,000 0.40
US dollars (£’000) 20,000 12,649 0.63
Total 100,000

It can be seen from the above tables that the euro currency cash generation has the highest relative volatility, but all
the divisions are experiencing a reasonable degree of variation in monthly net operating cash flows based on the
SD.

In terms of risk, if the cash flows of each division are approximately normally distributed, then there is a probability
of approximately 16% of them falling more than one SD below the mean in any one month.

However, the above figures are translated at constant year end exchange rates. Currency fluctuations within the
year are an additional source of cash flow uncertainty when the SD in £s equivalent may change over the year from
currency variations within the year. This adds to the variations in the original cash flows in the underlying
currencies.

The individual divisions’ cash flows show fairly high SDs. However, in considering the overall variation for the
company, the covariance between divisional flows needs to be considered. A low, or negative, covariance would
reduce overall volatility of net operating cash flows for the company as a whole.

Conversely, if the SDs are highly correlated then there is a significant risk at company-wide level as there is a high
covariance which means they will move together and not be compensated by different random movements or by
movements in opposing directions. The SDs may be highly correlated if there are common factors affecting all
divisions, such as a global recession or a technological change in the semiconductor industry.

For the company as a whole, it is unlikely that the SDs are highly correlated if the movements are random and
independent between divisions and over time.

However, applying professional scepticism to the data, it should be questioned whether the SD of the past is likely
to continue in future. It may be asked, is the data persistent to extrapolate the past to the future? For example, what
is the probability of an event shifting the distribution of all divisions through a common causal factor, such as a
recession or technological change.

Irrespective of the nature of the distributions, high volatility, measured by a high SD, is not necessarily a major risk.
In terms of managing the risk, unexpected volatility is the key problem. If the volatility is expected, then plans can be
put in place (eg, extend the overdraft facility) to manage the liquidity risks.

Despite the high SD, the mean cash flows are all positive, so the company is expected to be cash generative. This
does not mean cash management is not important as surplus cash flows need to be used favourably (eg invested)
and liquidity needs to be managed in case there are random shocks to cash inflows from revenues.

Overall, with centralised cash management, the central treasury department effectively acts as the bank for the
group. The central treasury has the job of managing the volatility and ensuring that individual operating units have
all the funds they need at the right time. For example, a centralised pool of funds can be maintained for
precautionary purposes avoiding the need for separate management of pools at divisional level.

@ICAEW 2021
Page 22 of 28
 Strategic Business Management July 2021– Advanced level

Requirement 2.2 – Interdivisional currency settlements

The multilateral netting off process involves establishing a ‘base’ currency to record all intra-group transactions. For
Tallam, this has been determined to be in £s.

In terms of the data provided, multilateral netting off would take place as follows.

Convert to £:

Payables divisions

In £s UK Germany Malaysia Total Total Net receipt/

receipts payments (payment)
£ £ £
Receivables
divisions
UK - £24,000 £18,000 £42,000 £(12,000) £30,000
Germany £5,000 - £10,000 £15,000 £(34,000) £(19,000)
Malaysia £7,000 £10,000 - £17,000 £(28,000) £(11,000)
Total = zero

All transactions are handled in £. Therefore:

The German division should pay £19m to the UK division.
The Malaysia division should pay £11m to the UK division.

• Benefits

This procedure has the advantage for Tallam of reducing the number of settlement transactions and thus
transaction costs, including foreign exchange purchase costs and money transmission costs. There will also be less
loss of interest through having money in transit. However, it requires strict control procedures from the central
treasury. There may also be other legal and tax issues to consider.

• Central treasury function

Multilateral netting off occurs when each of the three divisions of Tallam interact with the central treasury
department to net off the outstanding balances arising from internal transactions.

The arrangement is normally most effectively carried out as an internal procedure being co-ordinated by the
centralised treasury as it has access to internal transactions and balances and avoids external transaction costs.
However, the arrangements could alternatively have been operated by Tallam’s relationship bank had the treasury
functions remained at division level.

The group treasurer’s claim that “centralisation of the treasury department has made this possible” is not therefore
valid. However, for the reasons above, it would be valid to state that the process has been significantly facilitated at
lower cost by having a central treasury operation.

@ICAEW 2021
Page 23 of 28
 Strategic Business Management July 2021– Advanced level

Requirement 2.3 – Internal audit

Issue 1 – Credit risk for foreign sales

Credit risk for Tallam is the risk that credit customers may not pay in full or on time in accordance with the sale
agreement.

While LaserTeck has paid in the past, there is now a clear credit risk that it will not pay some or all of the £12 million
outstanding.

As this was a foreign sale, the credit risk is potentially increased by a lower level of direct contact with, and
knowledge of, the customer’s business environment. Moreover, the legal framework cuts across two jurisdictions,
which may make the exercise of legal rights for Tallam to recover the debt a more difficult.

In this case, the long credit term of 90 days may have meant that the creditworthiness of LaserTeck has
deteriorated in this period. The subsequent delay in settlement beyond 90 days may have caused further
deterioration.

Tallam’s procedures for granting credit need to be reviewed. There is normally less risk for existing customers, like
LaserTeck, than for new customers. Nevertheless, Tallam should not be blind to changes in creditworthiness,
particularly on a substantial contract for £12 million, that was far larger than previous contracts with this customer.
Bank references, trade references and reference to credit agencies could have been considered.

Alternatively, if competitive conditions permit, some advance payment or periodic progress payments procedures
could be considered on such a large contract.

For the future, the following procedures could be considered to manage the credit risk of foreign sales (ie, exports):

Forfaiting is medium-term export finance. Forfaiting would enable Tallam as an exporter to receive immediate cash
by selling their medium and long-term receivables at a discount through an intermediary. This is achieved by the
purchase of financial instruments such as bills of exchange and letters of credit on a non-recourse basis by a
forfeiter. Given Tallam’s bad debt experience, the discount may however be significant.

Documentary credits This is a risk-free method of obtaining payment, also a method of obtaining short-term finance
from a bank, for working capital, as a bank might agree to discount or negotiate a letter of credit.

Export credit insurance (ie, trade credit insurance). This is insurance against the risk of non-payment by foreign
customers for export debts. Export credit insurance is offered by private insurance companies and by government
agencies, often referred to as export credit agencies (ECAs). However, export credit insurance comes at a cost
which Tallam must weigh against its credit experience. If credit experience has been poor, as indicated by internal
audit, then premiums will also be poor.

Acceptance credits. Short-term finance by a bank agreeing to accept bills of exchange drawn on itself.

Issue 2 - Transfer prices

• Financial reporting issues

Some semiconductors manufactured in one division are transferred to Tallam’s other two divisions at an average of
full cost plus 10%. This inter-divisional trading means the value of inventory may contain some unrealised profit in
the consolidated financial statements.

It is important for divisions to ensure that all inter-divisional trading is separately analysed so that any unrealised
profit can be identified. As 10% is an average, not universal mark-up, the mark-up on individual internal transfers
still in inventory will need to be identified.

Exchange rate movements may alter the impact of the transfer prices. The 10% may apply in the originating
currency but the impact would vary with the recipient company. However, under IAS 21, inventory is a non-

@ICAEW 2021
Page 24 of 28
 Strategic Business Management July 2021– Advanced level

monetary item so normally there is no adjustment between the date of the transaction and the end of the reporting
period.

The interdivisional receivables/payables balances are monetary items in the individual company financial statement
of the subsidiaries. They therefore need to be retranslated at the year end in accordance with IAS 21. These intra
group balances need to be cancelled in the consolidated financial statements so common exchange rates need to
be used.

As the divisions are subsidiaries, they are related parties of each other. Appropriate disclosures of the related
parties should be made in accordance with IAS 24.

Also, there may be challenge by tax authorities if transfer pricing regulations in a jurisdiction require that, for tax
purposes, transactions between related parties be priced on a basis that would be comparable to an arm’s length
transaction between unrelated parties. Provision for any tax payable based on such a challenge should be made in
the financial statements.

• Business issues

The practice of adding an average of only 10% onto the cost price may cause other divisions to underprice these
products, damaging the gross profit margin of the company as a whole.

More generally, if internally transferred goods are not being recognised at their market value then this may lead to
dysfunctional behaviour in not only pricing decisions but performance measurement and performance management.

In particular, divisional performance measures will be distorted by transfer prices that are not market values.
Moreover, the policy of centrally set transfer prices is contrary to the general policy of autonomy of divisions and this
may have behavioural consequences for managers and by head office towards managers.

Requirement 2.4 – Ethics

There are a number of ethical issues

Confidentiality – opening the group treasurer’s desk

Forcing open the group treasurer’s desk in her absence could be viewed by the board as a breach of confidentiality
committed by the members of the treasury department. This applies in terms of her personal confidentiality
(personal possessions) and corporate confidentiality in terms of accessing potentially sensitive business
information. The board has ultimate responsibility, although not culpability, for this breach of the treasurer’s
confidentiality.

While the desk and any business contents are the property of Tallam, the decision to force it open should not have
been made at the level of treasury staff. Given the group treasurer is a senior employee it would be appropriate for
the board to authorise forced access and inspection of the documents contained therein if this was deemed legal
and necessary. These documents could then be distributed to appropriate treasury staff.

Depending on the health condition of the group treasurer, permission could have been obtained from her, or at least
notification given, to aid transparency of the actions.

Intimidation

There is a possible suggestion in the anonymous letter of an element of intimidation towards the treasury team by
the group treasurer in her senior management role. However, this is an accusation, rather than being established,
and needs to be ascertained by the board. The board is responsible for governance and the behaviour of its senior
management and, if it ignores the possibility of intimidation by the treasurer, it could be regarded as complicit.

The fact that the whistleblower wrote anonymously may suggest possible intimidation, but there may be alternative
explanations such as fear of legal action or disciplinary action for an invalid claim or a claim with malicious intent.

@ICAEW 2021
Page 25 of 28
 Strategic Business Management July 2021– Advanced level

Hedging transactions with Mooton Bank

The ethical issue with the placing of the forward contract with the bank where the group treasurer’s brother works
may imply conflict between personal family interests and the corporate interests of Tallam, particularly the group
treasurer’s duty in respect of those interests.

In particular, the group treasurer’s brother was directly responsible for issuing forward contracts at the bank. By
processing transactions for Tallam, this may have meant a bonus or at least a better appraisal for the group
treasurer’s brother.

Regarding the ‘evidence’ presented that the group treasurer had deliberately chosen a less favourable contract with
her brother’s bank Mooton than was available by other banks, the calculations are set out below:

• Mooton Bank
£/$
Three months’ forward rates 1.3032 - 1.3072

The net payment in three months is: US$4.8m/1.3032 = £3,683,241

• Kimmel Bank
£/$
Three months’ forward rates 1.3030 - 1.3071

The net payment in three months is: US$4.8m/1.3030 = £3,683,807

From the above it is clear that the Mooton Bank forward contract is actually slightly more favourable to Tallam than
the alternative suggested by the whistleblower, as the sterling cost locked-in by the forward is lower.

Also, the bid-offer spread is greater on the contract with Kimmel Bank suggested by the whistleblower. Kimmel is
therefore pricing its risk higher, which is to the disadvantage of Tallam compared with the Mooton Bank contract.

The difference in quoted forward rates between Mooton and Kimmel may be due to timing. Although they are both
on the same day, they may not be at the same time of the same day, so intra-day exchange rate movements may
account for the difference.

There are also non-financial factors to consider as to which bank offers the better deal. For example, it may include
the counterparty risk involved if one of the banks is operating under stressed conditions.

There is however a question of motives and competence in whether the group treasurer should be entering into a
US$ forward contract for settlement of a payment at all. Tallam generates significant revenues in US$ and there
could be matching and a natural off-set against these. Some justification may be required from the group treasurer
on her return to work as to why a hedging contract was needed in these circumstances. Entering into the contract
may have been a genuine commercial misjudgement but, alternatively, it questions her motives in entering into an
unnecessary transaction with a related party.

Overall, there appears to be a lack of transparency and accountability for the group treasurer’s actions. A number of
quotes should have been obtained and a record made of which quote was selected with a justification of why this
quote was preferred over the others. Authorisation should have been obtained (eg, from the finance director).

Actions

• Take legal advice on the actions the board should take with response to whistleblowing and ensure the board’s
actions responding to the letter comply with legal advice.
• The anonymous letter should be discussed at board level.
• The whistleblower’s claims of intimidation and the culture of staff working in treasury feeling threatened needs
to be investigated.

@ICAEW 2021
Page 26 of 28
 Strategic Business Management July 2021– Advanced level

• Discussions should be held with the group treasurer and explanations obtained when she returns to work. This
should include the results of investigations if evidence of intimidation is discovered.
• It is not appropriate to discover who sent the letter. This may be illegal and it may open the person up to the
intimidation feared and may discourage other whistleblowers to come forward in the future.
• An investigation of the circumstances in which it was decided to force open the group treasurer’s desk, and how
this was done, needs to be carried out. Possible disciplinary action may result.
• Internal controls need to be set up over the group treasurer’s ability to enter into hedging transactions on her
own. An approval process needs to be set up (eg, with approvals by the finance director) establishing
procedures to obtain multiple quotes for hedging and other finance transactions. This should be for all hedges
which can impact material risks or have material costs.
• On her return to work, the group treasurer needs to explain why she used Mooton Bank and address the
concerns, if true, that her brother, as a related party, is processing transactions for the bank without any
disclosure of this relationship.
• Establish procedures for disclosure where there may be potential conflicts of interest to facilitate transparency.

Examiner’s comments

2.1 Data Analytics – Mean and Standard Deviation

The average performance on this requirement was poor.

Many candidates failed to grasp the nature of a standard deviation (SD) and did not address the relative risk of the
divisions. Many candidates did not distinguish between the operating risk of each division, expressed in their local
currencies as measured by SD, and currency risk.

Better candidates, who addressed each requirement in a logical manner, referencing the background information
provided, performed well. These candidates were able to use the statistical data by translating the currencies into
a common currency and placing the standard deviation into context by producing a relative measure to the mean,
the coefficient of variation. They also tended to use a one standard deviation measure to show the extent to which
cash flows are like to vary from mean in either direction. The better candidates provided explanations that were
linked to their findings and evaluated the risks in relation to each of the relevant factors.

Weaker candidates made few calculations, if any. They typically provided some very general answers relating to
currency risk only, which described transaction, translation and economic risk, but with little application to the
question. There tended to be little or no discussion of variability in cash flows from an operational perspective.

As this is a relatively new area of the syllabus, candidates should have been better prepared and should have
expected to do some applied analysis and calculations which are available in the Learning Materials.

2.2 Multilateral netting-off

Overall, this requirement had the highest performance by candidates in the exam.

A large majority of candidates produced a matrix the apply multilateral netting off correctly, and thereby scored full
marks on the calculation element of the requirement.

The benefits in terms of efficiency and reduction in number of transactions and costs was also dealt with well by
most candidates. Some weaker candidates failed to consider the comments in relation to the central treasury
function but, those who did, correctly identified that centralisation was not the only factor which had led to
improved efficiency.

2.3 Internal Audit – credit risks and transfer pricing

The credit risk section of this requirement produced a mixed performance.

There were some excellent answers showing an in-depth knowledge of the various aspects of managing credit risk
including the forfaiting process, the advantage of taking out credit insurance and obtaining documentary credits.

@ICAEW 2021
Page 27 of 28
 Strategic Business Management July 2021– Advanced level

Weaker candidates produced generic answers about managing default risk. They often failed to specifically
address credit management on foreign sales contracts, with answers that could have applied to UK sales. Other
weaker candidates focused on currency risk rather than credit risk.

The transfer pricing aspects of the question tended to be weak. Whilst most candidates acknowledged that there
needed to be a market value adjustment, the financial reporting aspects in terms of exchange rate movements
impacting transfer pricing was noticeably absent. Whilst transfer pricing being challenged for tax purposes was
also a relevant point, some candidates wasted time discussing, at great length, tax avoidance and evasion and
some of the penalties which may be applied.

Some candidates merged their response to FR issues and business issues. In general, the treatment of business
issues was poor, with many missing the point of dysfunctional decision making.

2.4 Ethics

There was a mix of responses to this requirement.

A significant number of candidates still adopt the transparency, effect and fairness approach to questions, without
considering any other ethical principles relevant to the scenario. The better answers identified that there were
confidentiality and intimidation issues from the treasurer’s desk being forced open. They also identified that there
were potential self-interest and related party issues, given the group treasurer’s unauthorised transactions through
her brother on behalf of the company.

The weaker answers did not adopt a balanced approach and often suspected that the group treasurer had stolen
from the company and that money laundering had been committed.

It was encouraging to note in this question that a high number of candidates used the data from the question to
identify whether there had in fact been any loss to the company through the transaction with her brother. The
majority of the candidates were able to calculate the numbers correctly.

In this new ‘technical-ethical’ style of question, there was data given in the scenario where candidates were able to
make FOREX calculations to establish the facts for themselves and then apply professional scepticism to the
assertions of the characters in the scenario.

The actions to deal with the issue were reasonable, with candidates identifying the internal control weaknesses
and the inappropriateness of how the information had initially been obtained.

@ICAEW 2021
Page 28 of 28