Public Sector Accounting and Finance · November 2022

a. i. Home-Use Limited Statement of profit or loss (extracts) for the years ended December 31, 2017, 2018,2019 and 2020 N’000 1/01/2017 Lease rental 8,000 31/12/2017 Depreciation expense 6,000 31/12/2017 Interest expense 2,000 1/01/2018 Lease rental 8,000 31/12/2018 Depreciation expense 6,000 31/12/2018 Interest expense 1,400 1/01/2019 Lease rental 8,000 31/12/2019 Depreciation expense 6,000 31/12/2019 Interest expense 740 96 1/01/2020 Lease rental 8,000 31/12/2020 Depreciation expense 6,000 31/12/2020 Interest expense 140 Home-Use Limited Statement of financial position (extracts) as at December 31, 2017, 2018, 2019 & 2020 N’000 2017 Non-current assets Carrying value of LPG Station (28,000-6,000) 22,000 Non-current liabilities Lease obligation (28,000 – 8,000) 20,000 2018 Non-current assets Carrying value of LPG Station (28,000-12,000) 16,000 Non-current liabilities Lease obligation (22,000 – 8,000) 14,000 2019 Non-current assets Carrying value of LPG Station (28,000-18,000) 10,000 Non-current liabilities Lease obligation (15,400 – 8,000) 7,400 2020 Non-current assets Carrying value of LPG Station (28,000-24,000) 4,000 Non-current liabilities Lease obligation (8,140 - 8,000 + 14) 154

Workings: Year Capital b/f Rental payment Capital outstanding Interest at 10% Capital c/f N’000 N’000 N’000 N’000 N’000 2017 28,000 (8,000) 20,000 2,000 22,000 2018 22,000 (8,000) 14,000 1,400 15,400 2019 15,400 (8,000) 7,400 740 8,140 2020 8,140 8,000 140 14 154

ii. Features of operating lease are:

• Ownership is not transferrable;

• Risks and rewards incidental to ownership resides with the lessor;

• Lease contains no bargain option;

• Lease term does not cover the major part of the asset’s economic life; 97

• Present value of minimum lease payment does not cover substantially the assets value;

• It is not specialised nature;

• The assets is easily replaceable;

• Lessee does not bear the lessor’s cancellation loss;

• No option to extend rental at lower than market value; and

• Gains or losses from the fluctuations in the fair value of the residual value does not accrue to the lessee Features of finance lease are:

• Ownership is transferrable to the lessee;

• Risks and rewards incidental to ownership resides with the lessee;

• It carries the option to purchase the asset at a lower value than the fair value;

• The lease term is for the major part of the economic life of the assets even if ownership is not transferred;

• At the inception of the lease, the present value of the minimum lease payments cover substantially at least the fair value of the leased assets;

• The leased assets are of specialised nature that only the lessee can use without major modifications;

• Other assets cannot easily replace the leased assets;

• If the lessee can cancel the lease, the losses associated with the cancellation are born by the lessee;

• The lessee has the ability to continue the lease for a secondary period at a rent substantially lower than the market rent; and

• Gains or losses from the fluctuations in the fair value of the residual accrue to the lessee. b.i. Examples of investment property are:

• Land held by a government hospital for capital appreciation, which may be sold at a beneficial time in future;

• Land held for a currently undetermined future use;

• A building owned by the reporting entity (or held by the reporting entity under a finance lease);

• A building that is vacant but is held to be leased out to less than one or more operating leases on a commercial basis to external parties; and

• Property that is being constructed or developed for future use as investment property.

ii. Disclosures that should be made when an investment property is stated at a revalued amount are:

• The effective date of their valuation;

• Whether an independent valuer was involved;

• The methods and significant assumptions applied in estimating the assets’ fair values;

• The extent to which the assets’ fair values were determined directly by reference to observable prices in an active market or recent market 98 transactions at arm’s length terms, or were estimated using other valuation techniques;

• The revaluation surplus, indicating the change for the period;

• The sum of all revaluation surpluses for individual items of investment property within that class; and

• The sum of all revaluation deficits for individual items of investment property within that class.

Examiner’s report Part (a i) of the question tests candidates’ knowledge on how lease will be treated in the financial statements (extract) of the lessee while part (a ii) requires the candidates to identify the features of operating lease and finance lease. Part (c) of the question also tests candidates’ knowledge on the examples and disclosure requirements of investment property (IPSAS 13). As a compulsory question, all the candidates attempted the question and their performance was average. The common pitfalls were the inability of the candidates to calculate the amount of the lease rentals that will be treated in the financial statements (extract) of the lessee and state the features of operating and finance leases. Also candidates were unable to state examples and disclosure requirements of investment property. Candidates are advised to have adequate knowledge of the relevant provisions of International Public Sector Accounting Standards (IPSAS) and to make use of Pathfinder and Study text of the Institute for better performance in the Institute’s future examinations.

Marking guide Marks Marks a..i. Statement of profit or loss (extracts) Title ½ Calculation of lease rental, depreciation expense and interest expense of 2017 1½ Calculation of lease rental, depreciation expense and interest expense of 2018 1½ Calculation of lease rental, depreciation expense and interest expense of 2019 1½ Calculation of lease rental, depreciation expense and interest expense of 2020 1½ Statement of financial position (extracts) as at 31 December Title ½ Calculation of carrying value of non-current assets for 2017, 2018, 2019 and 2020 1 99 Calculation of lease obligation under non-current liabilities for 2017, 2018, 2019 and 2020 1 Workings 5 14 ii Features of operating lease and finance lease Three features of operating lease 3 Five features of finance lease 5 8 b. Four examples of investment property 4 Four disclosure requirements when an investment property is stated at revalued amount 4 8 Total 30

SECTION B

(a) The IPSASB adopts a due process for the development of IPSASs that provides the opportunity for comment by interested parties including IFAC member bodies. Auditors, preparers (including finance ministries), standards setters and individual are priorities. The IPSASB’s due process for projects normally, but not necessarily takes the following stages:

i. Study of national accounting requirements and practice and exchange of views about the issues with national standard-setters; ii. Consideration of pronouncement issued by:

• The International Accounting Standard Board (IASB);

• National standard setters, regulatory authority and other authoritative bodies;

• Professional accounting bodies; and

• Other organisations interested in financial reporting in the public sector. iii. Formation of Steering Committees (SC). Projects Advisory Panels (PAPs) or sub-committees to provide input to the IPSASB on a project; iv. Publication of an exposure draft for public comment usually for at least four (4) months. This provides an opportunity to those affected by the IPSASB’s pronouncements for comments before they are finalised and approved by the IPSASB. The exposure draft will include a basis for conclusion; v. Consideration of all comments received within the comment period on discussion documents and exposure drafts, to make modifications to the proposed standards as considered appropriate in the light of the IPSASB’s; and vi. Publication of an IPSAS which includes a basis for conclusion that explains the steps in the IPSASB’s due process and how the IPSASB reached its conclusions. 100

(b) Some observations on government accounting system in developing countries by United Nations manual The general features of government accounting system as published by the United Nations are as follows:

i. Unlike the advanced countries, where research work has been documented and published, the records of general practice in the developing countries are difficult to obtain; ii. Relatively, little effort has been given to social government accounting and budgetary control system; iii. Accounting procedures in government departments, which reflect complicated systems of checks and balances, tend to impair the efficacy and timeliness of the accounting information and statistics produced; iv. Government accounting is seen mainly as an accountability device for public receipts and expenditure. Efficiency, effectiveness and economy of the operations tend to be neglected; v. Bookkeeping or administrative legal compliance procedures are more common than modern accounting approaches; vi. Accounting tends to be identified with expenditure control. The fact is that expenditure is subject to multiple checks; vii. The amount of paper work is much, but no efficiency, accountability or financial control is achieved; viii. The accounting data upon which government budgets and plans are based are frequently inaccurate and incomplete; and ix. Financial reports are delayed and generally in arrears. They consequently become obsolete at the point of implementation. Characteristics of a good system of public sector accounting as published by the United Nations (UN). The characteristics are as follows:

i. Comply with constitutional, statutory and other legal requirements of the relevant country; ii. It must be related to budget classifications. Budgetary and financial management must be closely integrated; iii. It must be maintained in a manner that will clearly identify the objects and purposes for which funds have been received and expended and the executive authorities who are responsible for custody and use of funds in programme/budget implementation; iv. Maintain records in a way that will facilitate audit by external review authorities and readily furnish the information needed for effective audit; v. Be developed in a manner that will permit administrative control of funds; vi. It must be developed so that it effectively discloses the economic and financial results of programme operations, including the sources of revenue, identification of costs and determination of the 101 operating results of government programmes and organisation; and vii. It must be maintained in a manner that will provide financial data useful for economic analysis and identification of governmental transactions and also assist in the development of the country’s accounts.

(c) Benefits of the ATRRS Accounting software are:

i. Familiarise the workforce with the use of IT equipment at an early stage of Government Integrated Financial Management Information System (GIFMIS) implementation, which would enable a smoother transition to the GIFMIS software; ii. Potentially reduce training period and requirement for GIFMIS; iii. Potentially reduce GIFMIS implementation cost; iv. Shorten business process re-engineering period (i.e. it is faster to transit from a semi-automated process than a manual process; v. Facilitates ease of reconciliation of the various bank accounts; and vi. Ensure that clean and accurate data will be available for migration to GIFMIS.

Examiner’s report Part (a) of the question tests the candidates’ knowledge of the five stages of IPSASB due process for development of standards. Part (b) tests the candidates’ knowledge of the United Nations’ observations and recommendation on features of good system of public sector accounting in the developing countries, as contained in the United Nations Manual on Government Accounting. Part (c) tests the candidates’ knowledge on the benefits of Automated Accounting Transactions Recording and Reporting System (ATRRS). Few of the candidates attempted the question and performance was below average. The common pitfalls were the inability of the candidates to differentiate between developing countries and advanced countries. Most of the observations provided by the candidates are for advanced counties as against of developing countries. Also the candidates were unable to identify some benefits of the ATRRS accounting software Candidates are advised to make use of the Pathfinder and Study Text of the Institute for better performance in the Institute’s future examinations. 102

Marking guide Marks Marks a. Five stages of IPSASB adoption of the due process 5 b. Five observations on government accounting system in developing countries 5 Characteristics of a good system of public sector accounting as contained in a United Nations manual on government accounting 5 10

c. Five benefits of the ATRRS accounting software 5 Total 20

(a) i. The MTEF contains the following information:

• A macro-economic framework setting out the three financial years, the underlying assumptions, and an evaluation and analysis of the macro- economic projection for the preceding three financial years;

• Fiscal strategy document setting out: - Federal government’s medium-term financial objectives; and - The policies of the federal government for the medium term relating to taxation, recurrent expenditure borrowings, lending and investment and other liabilities;

• The strategies, economic, social and developmental priorities of government for the next three financial years;

• An explanation of the finance objectives, strategic, economic, social and developmental priorities and fiscal measures;

• An expenditure and revenue framework, which will set out: - Estimates of aggregate revenue for the federation for each financial year, based on the pre-determined commodity reference price adopted and tax revenue projections; - Aggregate expenditure for each of the next three financial years; - Minimum capital expenditure projection for the federation for each of the next three financial years; and - Aggregate tax expenditure projection for the federation for each of the next three financial years;

• A consolidated debt statement indicating and describing the fiscal significance of the debt liability and measures to reduce the liability; and

• A statement on the nature and fiscal significance of contingent liabilities and quasi-fiscal activities and measures to offset the crystallisation of such liabilities.

ii. Requirements of the Fiscal Responsibility Act as it affect time lag for preparation of MTEF and notifying the National Assembly are:

• A copy of the underlying revenue and expenditure profile for the next two years; 103

• A report setting out actual and budgeted revenue and expenditure with a detailed analysis of the performance of the budget for the 18 months up to June of the preceding financial year;

• A fiscal target broken down into monthly collection targets;

• Measures of cost, cost control and evaluation of result of programmes financed with budgetary resources;

• A fiscal target document derived from the underlying medium–term expenditure framework, setting out the following relevant targets such as inflation rate, fiscal account balances and any other development deemed appropriate; and

• A fiscal risk document evaluating the fiscal and other related risks to the annual budget and specifying measures to be taken to offset the occurrence of such risks.

iii. Documents that should accompany the estimates of revenue and expenditure of the Nigeria’s annual budget are:

• A macro-economic framework;

• A fiscal strategy paper;

• An expenditure and revenue framework;

• A consolidated debt statement; and

• A statement on contingent liabilities.

b. i. Fiscal transparency This is the aspect of accountability, which requires government to carry out all aspects of budgeting responsibilities with openness, trust, basic values and ethical standards without hiding anything from the public. Where a government has something to hide, public reporting is more likely to be infrequent, unreliable and less comprehensive in order to hide material facts.

ii. IMF code of good practices and transparency

• Clarity of roles and responsibilities: The government sector should be separated from the rest of the public sector and from the rest of the economy. Also, policy and management roles within the public sector should be clearly stated and publicly disclosed;

• Open budget process: There should be clear procedures for budget execution, monitoring and reporting. The budget preparation should be guided by well-designed macroeconomic and fiscal policy objectives;

• Public availability of information: The public should be provided with comprehensive information on past, current and projected fiscal activity on major fiscal risks. The central government should publish information on the level and composition of its debts and financial assets, significant non-debt liabilities and natural resource assets. Fiscal information should be presented in a way that facilitates policy analysis and promotes accountability; and

• Assurances of integrity: These should include that: 104 ➢ Fiscal data should meet accepted data quality standards and budget forecasts and updates should reflect recent revenue and expenditure trends, underline macroeconomic development; ➢ Data in fiscal reports should be internally consistent and reconciled with relevant data from other sources. Major revisions to historical fiscal data and any changes to data classification should be explained; ➢ Ethical standards of behaviour for public servants should be clear and made public; ➢ Purchases and sales of public assets should be internally audited and audit procedures should be open to review; ➢ Fiscal information should be independently scrutinised. All public finances and policies should be subject to scrutiny by national audit body or an equivalent organisation that is independent of the executive; and ➢ The national audit body or equivalent organisation should submit all reports, including its annual report to the legislature and publish them.

Examiner’s report Part (a) of the question requires candidates to identify the key information to be contained in the Medium – Term Expenditure Framework (MTEF). Part (b) requires candidates to identify requirements of Fiscal Responsibility Act as it affects time lag for preparation of MTEF, notifying the National Assembly and to outline the documents that should accompany the estimates of revenue and expenditure of the annual budget. Part (c) of the question requires the candidates to discuss the term ’fiscal transparency’ and also to identify and explain codes of good practices and transparency in line with IMF code of good practices as related to the Nigerian government. Few candidates attempted the question and performance was below average. The common pitfalls were the inability of the candidates to identify the key information to be contained in MTEF, requirements of Fiscal Responsibility Act as it affects time lag for preparation of MTEF, discuss the term ’fiscal transparency’ and explain codes of good practices and transparency in line with IMF code of good practices as related to the Nigerian government. Candidates are advised to read widely and ensure they have adequate knowledge of relevant provisions of MTEF and other international provisions on codes of good practices and transparency. Pathfinder and Study Text of the Institute are relevant learning materials on this aspect of the syllabus for better performance in future examinations. 105

Marking guide Marks Marks a. Identification of five key information to be contained in an MTEF 5 b. i. Identification of five requirements of Fiscal Responsibility Act as it affects time lag for preparation of MTEF and notifying the National Assembly 5 ii. Three documents that should accompany the estimates of revenue and expenditure of the annual budget 3 8 c. i. Explanation of ’fiscal transparency’ 4

ii. Identification any three codes of good practices 1½ Explanation any three codes identified 1½ 7 Total 20

a. i. Nun Local Council Development Area, Bayelsa State Revenue budget for the year ended December 31, 2021 Revenue Note N N Revenue generated from tax: 1 Adult men: 7,019,585,280 Adult women: 2,495,852,544 Total taxable income 9,515,437,824 Rent LCDA property: 2 Warehouses 16,000,000 Lock-up shops 36,000,000 Sheds 12,300,000 Total rent from LCDA property 64,300,000 Fees from market hawkers: 3 Regular hawkers 1,032,000,000 Other hawkers 134,640,000 Total fees from market hawkers 1,166,640,000 Tenement rate: Tenement rates collected on houses 2,411,000 Total revenue budget 10.748,788,824

ii. Nun Local Council Development Area, Bayelsa State Overhead cost budget for the year ended December 31, 2021

Note N Motor vehicle maintenance 5 675,000 Drainage cleaning 231,250 Transport and travelling 175,000 Office maintenance 160,000 Office accommodation 278,750 Utility services 250,000 Others 300,000 Total overhead cost budget 2,070,000 106

Workings 1 Population Current population with 6% growth (1.06 X 1,548,412) 1,641,317 Less: 1% Rural-urban migration (.01 X 1,641,317) 16,413 Total population of Nun LCDA 1,624,904 Revenue generated from tax N Adult men: (50% of 1,624,904 X .9 X 800 X 12) 7,019,585,280 Adult women: (20% of 1,624,904 X .8 X 800 X 12) 2,495,852,544 Total taxable income 9,515,437,824 2 Rent on local government property N Warehouses (2 x 8,000,000) 16,000,000 Lock-up shops (300 x 120,000) 36,000,000 Sheds (150 x 82,000) 12,300,000 Total rent from LCDA property 64,300,000 3 Fees from market hawkers: N Regular hawkers (17,200 x 200 x 25 X 12) 1,032,000,000 Other hawkers (18,700 x 200 x 3 X 12) 134,640,000 Totalfees from market hawkers 1,166,640,000 4 Tenement rates N Tenement charges collected on houses (2,411 x 1,000) 2,411,000 5 Overhead cost N Motor vehicle maintenance (540,000 X 1.25) 675,000 Drainage cleaning 185,000 X 1.25) 231,250 Transport and travelling (140,000 X 1.25) 175,000 Office maintenance (128,000 X 1.25) 160,000 Office accommodation (223,000 1.25) 278,750 Utility services (200,000 X 1.25) 250,000 Others (240,000 X 1.25) 300,000 Total overhead cost 2,070,000

b. The functions of the Ministry of Finance, Budget and Planning are as follows:

i. Developing reasoned economic assumptions and forecasts; ii. Issuing budget guidelines to the ministries and extra-ministerial departments; iii. Acting as the liaison between the presidency, ministries and extra- ministerial departments during the budget preparation; iv. Compiling total revenue and expenditure estimates;

v. Drafting the budget speech; vi. Supervising and controlling the implementation of the budget; vii. Monitoring and evaluating the performance of programmes funded through the government budget; viii. Assessing the impact of the budget on the economy; 107

ix. Developing formats of returns aimed at ensuring cost effectiveness in the use of government resources; and x. Carrying out research on budget utilisation and the attainment of national or state objectives.

Examiner’s report Part (a) of the question tests candidates’ knowledge of the preparation of revenue and overhead cost budgets. Part (b) tests the functions of the Ministry of Finance, Budget and Planning. Majority of the candidates attempted the question and performance was average The common pitfalls were the inability of the candidates to prepare revenue and overhead cost budgets and identify the functions of the Ministry of Finance, Budget and Planning. Candidates are advised that they should ensure they have adequate knowledge of the relevant provisions on the preparation of revenue and overhead cost budgets and other regulations relating to public sector account for better performance in the Institute’s future examinations. The Pathfinder and Study Text of the Institute are relevant learning materials on this aspect of the syllabus.

Marking guide Marks Marks a. Preparation of revenue budget Title 1¼ Calculation of components of total revenue budget 2¾ Calculation of total revenue budget ½ Workings 3½ Preparation of overhead budget Title 1 Calculation of components of total overhead budget 4 Workings 2 15 b. Functions of the Ministry of Finance, Budget and Planning Five functions 5 Total 20

a. Crowding-in effect: If public expenditure has positive or stimulating influence on private consumption, that is, personal consumption and investments, then we have crowding - in effects, which include:

i. Fiscal policy may crowd-in private investment, resulting in positive externalities in some cases. For example, if an increase in public investment is so effective in making people to believe that a boom may 108 come soon, many firms are likely to invest more. Consequently, other firms will increase their investments. This is a desirable outcome of the crowding-in effect, which comes from the positive effect on people’s attitude regarding future economic conditions;

ii. It is important for the efficacy of fiscal policy that public spending, especially public investment, produces a profitable outcome for private agents. If a public investment project makes private firms more productive, then crowding-in effect occurs; and

iii. In such situation, government may only stimulate a small number of private firms and/or industries. However, because of the crowding-in effect, this policy may produce more investment in the whole economy. Crowding-out effect: Public expenditure can have positive and negative effect or influence on private sector, if the public expenditure has negative or restrictive influence on private consumption especially on investments, we have crowding - out effect which include:

i. When governments borrow to pay for a stimulus, this drives up borrowing costs for households and firms, reducing the amount of consumption and investment;

ii. Crowding-out effect reduces the effectiveness of expansionary policies aimed at increasing the total demand for a nation's output;

iii. An increase in the interest rate depresses investment and hence income. This offsetting effect is called the crowding-out effect in the sense that an increase in public spending crowds out private investment; and

iv. A situation when increased interest rates lead to a reduction in private investment spending, it dampens the initial increase of total investment.

b. Ratios that can be used for measuring debt sustainability of a country and their shortcomings are:

i. External debt service to export ratio The debt-to-exports ratio is defined as the ratio of total outstanding debts at the end of the year to the economy’s exports of goods and services for any one-year. This ratio can be used as a measure of sustainability because an increasing debt-to-exports ratio over time, for a given interest rate, implies that total debt is growing faster than the economy’s basic source of external income, indicating that the country may have problems meeting its debt obligations in the future. 109 Shortcomings

• Countries that use external borrowing for productive investment with long gestation periods are more likely to exhibit high debt-to-exports ratios. But as the investments begin to produce goods that can be exported, the country’s debt-to-exports ratio may start to decline. So, for these countries, the debt-to-exports ratio may not be too high from an inter-temporal perspective, though in any given year it may be perceived as large.

• Some countries may benefit from highly concessional debt terms, while others may pay high interest rates. For such countries to better capture the implied debt burden in terms of the opportunity cost of capital, it is useful to report it and analyse the average interest rate on debt. We may also need to the present value of debt by discounting the projected stream of future amortisation payments including interest, with a risk-neutral commercial reference rate.

ii. Debt to GDP ratio The debt-to-GDP ratio is defined as the ratio of the total outstanding external debt at the end of the year to annual GDP. By using GDP as a denominator, the ratio may provide some indication of the potential to service external debt by switching resources from production of domestic goods to the production of exports. Indeed, a country might have a large debt-to- exports ratio but a low debt-to-GDP ratio, if exports comprise a very small proportion of GDP. Shortcomings

• While the debt-to-GDP ratio is immune to export-related criticisms that mainly focus on the differing degree of value added in exports and price volatility of exports, it may be less reliable in the presence of over-or under- valuations of the real exchange rate, which could significantly distort the GDP denominator.

• Also, as with the debt-to-exports ratio, it is important to take account of the country’s stage of development and the mix of concessional and non-concessional debt.

iii. Ratio of present value of debt to fiscal revenue This is defined as the ratio of future projected debt-service payments discounted by market-based interest rates (a risk- neutral commercial reference rate) to annual fiscal revenue. This ratio can be used as a measure of sustainability in those countries with a relatively open economy facing a heavy fiscal burden of external debt. In such circumstances, the government’s ability to mobilise domestic revenue is relevant and will not be measured by the debt-to-exports or debt-to-GDP 110 ratios. An increase in this indicator over time indicates that the country may have budgetary problems in servicing its debts Shortcomings

• Fiscal policy can be swayed by politics and placating voters, which can lead to poor decisions that are not informed by data or economic theory.

• If monetary policy is not coordinated with fiscal policy enacted by governments, it can undermine efforts as well

iv. Ratio of debt service to exports This ratio is defined as the ratio of external debt-service payments of principal and interest on long-term and short-term debt to exports of goods and services for any one-year. The debt-service-to-exports ratio is a possible indicator of debt sustainability because it indicates how much of a country’s export revenue will be used up in servicing its debt and thus, also, how vulnerable the payment of debt service obligations is to an unexpected fall in export proceeds. This ratio tends to highlight countries with significant short-term external debt. A sustainable level is determined by the debt-to-exports ratio and interest rates, as well as by the term structure of debt obligations. The latter may affect credit worthiness because the higher the share of short-term credit is in overall debt; the larger and more vulnerable is the annual flow of debt-service obligations. Shortcomings

• The amortisation payments on short-term debt are typically excluded from debt service and the coverage of private sector data can often be limited, either because the indicator is intentionally focused on the public sector or because data on private debt service are not available.

• A debt-service-to-export ratio not corrected for the import intensity of exports is biased downward for economies with a higher propensity to export.

v. Ratio of international reserves to short-term debt This ratio is a pure liquidity indicator that is defined as the ratio of the stock of international reserves available to the monetary authorities to the short-term debt stock on a remaining-maturity basis. This could be a particularly useful indicator of reserve adequacy, especially for countries with significant, but not fully certain, access to international capital markets. 111 The ratio indicates whether international reserves exceed scheduled amortisation of short-term, medium-term, and long- term external debt during the following year; that is, the extent to which the economy has the ability to meet all its scheduled amortisations to non-residents for the coming year, using its own international reserves. It provides a measure of how quickly a country would be forced to adjust if it were cut off from external borrowing, for example, because of adverse developments in international capital markets. Shortcomings

• A large stock of short-term debt relative to international reserves does not necessarily lead to a crisis as being portrayed by the ratio. Many advanced economies have higher ratios of short-term debt to reserves than many emerging economies, which have shown vulnerability to financial crisis.

• The ratio assumes that measured international reserves are indeed available and can be used to meet external obligations; this has not always been true historically.

Examiner’s report Part (a) of the question tests candidates’ knowledge on the difference between the crowding – in effect and crowding – out effect of fiscal policy while part (b) tests candidates’ knowledge on the ratios that can be used for measuring debt sustainability of a country and one shortcoming of each ratio. Few of the candidates attempted the question and performance was below average. The common pitfalls were the inability of the candidates to differentiate between the crowding – in effect and crowding – out effect of fiscal policy. Also, the candidates were unable to explain the ratios that can be used for measuring debt sustainability of a country and one shortcoming of each ratio, Candidates are advised to make use of Pathfinder and Study Text of the Institute for better performance in the Institute’s future examinations. 112

Marking guide Marks Marks a. Discussion of crowding-in effect Definition 11/2 Explanation of any two of the effects 1 Discussion of crowding-out effect Definition 11/2 Explanation of any two of the effects 1 5

b. Ratios that can be used for measuring debt sustainability of a country and one shortcoming of each ratio Identification of any four ratios 2 Explanation of the four identified ratios 4 Identification of any one shortcoming of the identified ratios 4 10 Total 15 113

Otunba Local Government (a) Calculation of Net Present Value (NPV) for each project Project A Project B Project C Project D Project E Project F Year DF (12%) CF DCF CF DCF CF DCF CF DCF CF DCF CF DCF N’000 N’000 N’000 N’000 N’000 N’000 N’000 N’000 N’000 N’000 N’000 N’000 0 1 -2,460 -2,460 -1,800 -1,800

- 1,750 -1,750 -1,800 -1,800 -1,800 -1,800 -1,500 -1,500 1 0.893 700 625.1 750 669.75 480 428.64 620 553.66 400 357.2 350 312.55 2 0.797 700 557.9 870 693.39 480 382.56 620 494.14 500 398.5 820 653.54 3 0.712 700 498.4 640 455.68 630 448.56 620 441.44 600 427.2 820 583.84 4 0.636 700 445.2 0 0 730 464.28 620 394.32 700 445.2 0 0 5 0.567 700 396.9 0 0 0 0 0 400 226.8 0 0 NPV 63.5 18.82 -25.96 83.56 54.9 49.93 Ranking 2 5 6 1 3 4 114

(b) Profitability Index (PI) Project A B C D E F N’000 N’000 N’000 N’000 N’000 N’000 Outlay 2,460 1,800 1,750 1,800 1,800 1,500 NPV 63.5 18.82 (25.96 83.56 54.90 49.93 PI = NPV Outlay 0.0258 0.0105 (0.0148) 0.0464 0.0305 0.0333 Ranking 4 5 6 1 3 2 Project to be invested based on Profitability Index Project Initial Investment NPV N’000 N’000 D 1,800 83.56 F 1,500 49.93 E 1,800 54.90 Sub-Total 5,100 188.39 B (Note) 1,100 11.50 Total 6,200 199.89 NB Project A, which is the 4th Project in ranking will not be selected because it is mutually exclusive with project E that is already selected. We will now select the next project in ranking, which is project B. Only N1,100,000 is left for investment in project B. Project B requires a total investment of N1,800.000. However, since the projects are said to be divisible, the available amount of N1,100,000 will be invested in project B and the NPV will be a proportion of total NPV for project B. Thus, 1,100,000/1,800,000 X 18.82 = N11,500,000.

(c) The rankings differ from (a) because NPV is an absolute measure whereas the profitability index is a relative measure that takes into account the different investment cost of each project. Also, the main difference between NPV and profitability index is that the PI is represented as a ratio, so it does not indicate the cash flow size.

Examiner’s report Part (a) of the question tests candidates’ knowledge of the calculation of net present value of projects and their ranking while part (b) asks the candidates to calculate the Profitability Index (PI) and rank the projects to determine how the fund available would be best invested. Pat (c) requires the candidates to state why the rankings in (b) differ from that in (a). Majority of the candidates attempted the question and their performance was above average. The commonest pitfalls were the inability of the candidates to calculate Profitability Index (PI) and rank the projects accordingly. Also, candidates could not state the reason why rankings under Net Present Value (NPV) and Profitability Index (PI) differ. 117 Candidates are advised to make use of the Pathfinder and Study Text of the Institute for better performance in the future’s examinations.

Marking guide Marks Marks a. Calculation of net present value of projects A – F 61/2 Ranking 11/2 8 b. Calculation of profitability index for projects A – F 11/2 Ranking based profitability index 11/2 Decision on the projects to invest using profitability index 11/2 Decision on the mutual exclusive projects to invest on 1/2 Determination of how the balance of the total outlay should be invested 1 6

c. Explanation on the reason why ranking between NPV and PI approach to project appraisal differs. 1 Total 15

a) Current Position Particulars Pre-booked Standard Premium Family Sales Price per ticket ₦580 ₦780 ₦3,700 No of ticket 1,500 8,000 675 Monthly sales in quantity 30 x 1500 =45,000 240,000 20,250 Monthly Fixed Costs N130,000,000 Determination of Optimal price of Premium family: P = a + bx Where a = Maximum Price at which no Premium Ticket will be sold: b = Changes in P = Price Elasticity Changes in X Marginal cost = Variable Cost = N2050 x 0.92 = N1886 =b

- 100 25 -= 4 89 Therefore: bxap = + xaP =

- 4 700,3 =a- 6754 ( ) = a- 2700 a = 3700 + 2700 a= .400,6 Therefore P = 4400,6 - x Converting to Total Revenue TR=P x Q ( 4400,6 - xx ) = 400,6 xx - 24 MR = ∂ ∂TR x= 8400,6- x MC = VC = 1886 Pr isofitmax imized where MR =MC 886,18400,6 -x= - 400,6886,18 x = - - 514,48 x = - x=

- 8/514,4 - x= 564 units Contribution: Pre-booked Ticket Premium Price 580 780 6,400 Variable Cost (1,886) (1,886) (1,886) (1,306) (1,106) 4.514 Tickets sold per month 45,000 240,000 16,920 (58,770,000) (265,440,000) (76,376,880) Total Quantity for the month 1500 x 30=45,000; 8,000 x 30=240,000; 564 x 30=16,920 Total Contribution Prebooked Ticket (58,770,000) Standard Ticket (265,440,000) Premium Ticket 76,376,880 (247,833,120) Decision: No financial benefit unless it is undertaken for corporate social responsibility 90 Standard Ticket

b. Sensitivity Analysis Variable Cost Savings from Standard Ticket [(2,050 – 1,886) x 8,000 x 30] = 39,360,000 Hiring Cost of equipment = (5,000,000) 34,360,000

Examiner’s report The question tests candidates’ ability to provide solutions on optimal pricing, marginal cost and sensitivity implication on hire of ticketing equipment. The question was well attempted. The Performance was above average. The major pitfall observed was the candidates’ inability to decipher the method to be used to compute the marginal revenue as well as determine the sensitivity components of hire of the ticketing equipment. It is hereby advised that candidates should use ICAN study manual on Performance Management when preparing for future Institute’s examination.

Marking guide a Financial benefit and Premium Price Charged (22 ticks @½ mark) 11 b Sensitivity Analysis (4 ticks @1 mark) 4 15

a. There are four major ratios or indicators commonly used to determine the extent of indebtedness of any country. These ratios are explained briefly below:

i. External debt service to export ratio: This relates total external debt service to export of goods and services. It reflects the level of export earnings committed to servicing external debts. Since external debts are denominated in foreign currency, then servicing and repayment must be in foreign currency, which can only be procured through export earnings; ii. External debt stock to export ratio: The ratio relates to the availability of foreign exchange earnings in the economy. It is an important indicator since foreign exchange is needed to pay off foreign debts. It reflects the extent to which total exports of goods and services can be used to liquidate external debt outstanding. The movement in this ratio is an indicator of the nation’s debt service capacity; iii. External debt stock to nominal gross domestic product ratio: This ratio measures the extent to which total domestic output can be deployed to wipe out total outstanding external debt obligations. The higher this ratio the greater the degree of external debt burden; and iv. External debt service to nominal gross domestic product ratio. This ratio relates to the proportion of total domestic output set aside for servicing external debt. The ratio will be rising where total domestic output is falling. The higher these ratios the greater are the debt burden. However, it is important to emphasise that debt service ratios should be interpreted with 118 caution because the ratio will be relatively low if the country continues to default in debt service payment.

b. General reasons for borrowing The following are some of the reasons that have been advanced to justify the need for a country to borrow: i. Huge and persistent budget deficit: The government borrows when its expenditure is greater than its revenue (budget deficit), especially after its taxing capacity has been stressed to the limit; ii. Balance of payments disequilibrium: Excessive reliance on foreign resources to sustain domestic production processes, and on foreign goods and services beyond the nation’s foreign exchange earning capacity may lead government into contracting debt obligations; iii. Rapidly increasing population: In most developing countries, population is growing faster than the level of national output. The need arises for government borrowing to expand public enterprises and public utilities to cater for the welfare of the people; iv. Implementation of development programmes: To promote economic development usually require provision of new and upgrading of existing social and economic infrastructural facilities, like roads, railways, electricity, schools and hospitals. The tax revenue of government may be insufficient to execute such projects, hence the resort to government borrowing; v. Economic instability: A stable economy naturally provides an enabling environment for economic growth and development. Public debt of the internal type may be contracted to control inflation, while both internal and external borrowing may be used to stimulate economic activities during economic depression; vi. Natural disasters: Government has the responsibility to provide relief to the victims of earthquake, flood, fire disasters, famines, sectarian violence and other natural calamities. Government borrowing may be justified because such occurrences are never expected or budgeted for. vii. Fluctuations in government revenue: Most countries operate mono product economies, depending on only one (or very few) export product for foreign exchange earnings. A sudden poor performance of such product in the international market would reduce income considerably and adversely affect budget implementation. Any country that finds itself in such a situation may have no option than to borrow to bridge the financial resource gap; viii. War-time borrowing: Financial resources needed to prosecute wars are usually beyond the capacity of the government. Hence, the need to borrow arises to avoid devastating consequences of defeat; and ix. Debt servicing: New debt with favourable terms and conditions may be undertaken to service old debts thereby reducing the burden of debt on the economy. 119

Examiner’s report Part (a) of the question tests candidates’ knowledge of the ratios or indicators commonly used to determine the extent of indebtedness in a country while part (b) asks the candidates to identify and explain reasons for borrowing. Few candidates attempted the question and their performance was average. The common pitfalls were the inability of the candidates to identify and explain any three ratios or indicators commonly used to determine the extent of indebtedness in a country. Also, the candidates were unable to identify and explain the reasons for borrowing. Candidates are advised to make use of the Pathfinder and Study Text of the Institute for better performance in the Institute’s future examinations.

Marking guide Marks Marks a. Ratios commonly used to determine the extent of indebtedness of a country Identification of the three ratios 3 Explanation of any three ratios identified 3 6

b. Reasons for borrowing Identification of the six reasons for borrowing 3 Explanation of six reasons identified for borrowing 6 9 Total 15 ICAN/222/Q/B6 Examination No......................... THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA SKILLS LEVEL EXAMINATION – NOVEMBER 2022 CORPORATE STRATEGIC MANAGEMENT & ETHICS EXAMINATION INSTRUCTIONS PLEASE READ THESE INSTRUCTIONS BEFORE THE COMMENCEMENT OF THE PAPER

1. Check your pockets, purse, mathematical set, etc. to ensure that you do not have prohibited items such as telephone handset, electronic storage device, programmable devices, wristwatches or any form of written material on you in the examination hall. You will be stopped from continuing with the examination and liable to further disciplinary actions including cancellation of examination result if caught.

2. Write your EXAMINATION NUMBER in the space provided above.

3. Do NOT write anything on your question paper EXCEPT your examination number.

4. Do NOT write anything on your docket.

5. Read all instructions in each section of the question paper carefully before answering the questions.

6. Do NOT answer more than the number of questions required in each section, otherwise, you will be penalised.

7. All solutions should be written in BLUE or BLACK INK. Any solution written in PENCIL or RED INK will not be marked. THURSDAY, NOVEMBER 17, 2022

Examiner’s report The question test’s candidates’ ability to provide solutions on investment appraisal decision with sensitivity components. The question was well attempted. The Performance was above average. The major pitfall observed was the candidates’ inability to decipher the sensitivity issues that bother on factors that affect the cash inflows for both Projects A and B. It is hereby advised that candidates should use ICAN study manual on Performance Management when preparing for future Institute’s examination.

Marking guide

a. Expected Net Present Value

• Joint Probability (9 ticks @1/6 marks) 1½

• Impact on cashflow (9 ticks @1/6 marks) 1½

• (7 ticks @1 mark) 7 10 b. The more profitable project (10 ticks @½ mark) 5 15 Working Notes

• The contract time for the 400 units is calculated using the learning curve technique. The company has already produced 200 units and now needs to produce another 400, i.e. 600 in total.

• The learning rate is computed as follows: Cumulative Cumulative Cumulative Average Quantity Hours Hours per unit 50 1,800 36 100 3,000 30 The learning rate is therefore 30/36 = 831/3%

• The contract time can now be determined using the learning curve formula: Y = axb 91 Where: Y = Cumulative average time for the cumulative output of 600 units A = the average time for the first batch i.e. 36 hours x = Output level desired Number of units in the 1st bacth = 600 50 = 12 b = Log of .83333 Log of 2 = −0.263 :. Y = 36(12)-0.263 = 18.73 hours Total hours for the 600 units= 600 x 18.73 = 11,238 hours Less: Total hours for the first 200 units already produced 5,000 hours Hours now required 6,238 hours

• Contribution per labour hour. This is necessary because labour is in short supply. Any labour hour used on the special order entails opportunity cost. From the budget statement. N’000 N’000 Sales 18,000 Materials 1,800 Labour 7,560 VOH 2,520 11,880 Contribution 6,120 Budgeted labour hours 42,000 Contribution/hour = 6,120,000 ÷ 42,000 = ₦145.71 Calculation of minimum price ₦ Materials 1,000kg x N1,800,000 = 120,000 15,000 Labour 6,238 x 7,560,000 = 1,122,840 42,000 VOH 6,238 x 2,520,000 = 374,280 42,000 Direct fixed costs = 180,000 Opportunity cost of labour 6,238 x ₦145.71 908,939 Minimum price N2,706,059 92

Examiner’s report This question tests candidates’ ability to use relevant costing approach to determine the minimum price to quote for special security padlock considering the learning effect on labour hours. The question was fairly attempted. However, the performance was average. The major pitfall observed was candidate inability to take note of the implication of learning effect on labour and variable overhead cost. It is hereby recommended that candidates should use ICAN study manual on Performance Management when preparing for future Institutes’ examination.

Marking guide The Minimum Price (15 ticks @1 mark) 15 93 ICAN/231/Q/B5 Examination No.................... THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA