CASE. Company background

Transcription

1 CASE Company background Big Beauty Group Company Limited ( BBG ) is engaged in property investment and the provision of administrative services to a clinic indirectly owned by Dr. Eliza Chan, who is a reputable dermatologist in Hong Kong. Dr. Chan beneficially owns 100% of the shares in BBG via Success Story Ltd. ( SSL ), an investment holding company which holds 100% of the shares in BBG. Dr. Chan is the Chairman of the BBG and SSL Boards. BBG and SSL close their books on 31 December. Service arrangement Dr. Chan operates her clinic, which provides skincare services, in Causeway Bay under a sole-proprietorship. The clinic has entered into an administrative service arrangement with BBG. BBG would arrange for the provision of clinic premises and hiring and payment of compensation to the nurses and personnel in the clinic. BBG also handles all the daily administration work of the clinic. All the revenue generated by the Causeway Bay clinic will be paid to BBG as an administrative service fee. Monthly gross receipts reporting At the request of the landlord of the Causeway Bay clinic, BBG is required to furnish the landlord with statements of monthly gross receipts for the period from 1 January 2013 to 31 December 2013 for the purpose of determining the additional annual rental as stipulated in the tenancy agreement for the clinic premises. The additional annual rental, the turnover rent, is based on a formula with a percentage link to the annual revenue of the clinic. The BBG management would like to engage its external auditor, Sky Books CPA & Co. ( SBC ), to perform certain procedures to assist them in preparing the statements of monthly gross receipts. The management considers that this is an assurance engagement for which absolute assurance is required. Based on the preliminary discussion between the accounting manager of BBG, Bill Pao, and the audit manager of SBC, Eva Kim, the engagement should only involve straight-forward procedures and it is not necessary for SBC to express an overall conclusion. An agreed-upon procedures engagement which reports on factual findings should serve the purpose. Bill has drafted the following agreed-upon procedures: (1) Obtain from the management the statements of monthly gross receipts of the clinic. (2) Select a few months from the statements, obtained in item 1 above, for each section in the clinic. (3) Trace the monthly gross receipts of the sample month selected in item (2) above to the sales ledger. (4) Analyse the differences identified between the monthly gross receipts and the sales ledger. (5) Evaluate the clinic s internal controls in preparing the statements of the monthly gross receipts. Final Examination (December 2014 Session) Paper II 1 of 8

2 The agreed-upon procedures report is planned to be issued on 30 June Bill has drafted a management representation letter dated 25 June In the letter, it stated that This representation letter is provided in connection with your audit of the financial statements of the Big Beauty Group for the year ended 31 December 2013 for the purpose of expressing an opinion as to whether the financial statements give a true and fair view. Acquisition activities The BodyFit Group ( BodyFit ), a listed group in Hong Kong, would like to acquire the business of Dr. Chan in order to diversify its own business. A due diligence exercise for this acquisition has been planned before the finalisation of the acquisition contract terms and the completion date. It is also expected that the employment of some of the BBG administrative staff will be terminated after the acquisition by BodyFit. Meanwhile, and in view of the potential acquisition by BodyFit, Dr. Chan intends to transfer a commercial property, Property A, in Hong Kong acquired in 2005 by BBG for a consideration of HK$32 million to another company indirectly owned by her. The commercial property has been leased to an outsider not connected to Dr. Chan s clinic business. Dr. Chan intends to transfer the property from BBG to a Hong Kong private limited company, Better Investment Limited ( BIL ), at a cost of HK$100 million although the market value of this property is HK$138 million. BIL is 100% owned by SSL and is ultimately owned by Dr. Chan. The transaction is intended to be completed before the due diligence exercise. The transfer is to be settled by way of a promissory note, without any financing from an outside party. BBG owns another commercial property, Property B. The property is held by Wonderful Property Limited ( WPL ), which solely owns the commercial property and does not carry on any business or operations. Shares in WPL are 100% owned by BBG. The commercial property is also leased to an outsider not connected to the clinic business. The property management services (including security, cleaning and building maintenance services) are provided by a third party service provider and will be terminated upon change of ownership of the property. Property B will also be transferred to BIL to facilitate the due diligence through the acquisition of all the ordinary shares of WPL by BIL from BBG. BBG and BIL adopt the fair value model to account for properties and their fair values have increased since the acquisition. Dr. Chan expects that value of the properties would continue to increase in the next few years. BodyFit group of companies BodyFit Holdings Company Limited ( BFH ) is the holding company of the BodyFit Group listed on the Hong Kong Stock Exchange. Its market capitalisation is HK$8,000 million. BodyFit Subsidiary Company Limited ( Subco ) is an active subsidiary of the BodyFit Group. Subco is also a listed company on the Hong Kong Stock Exchange and is 70% owned by BFH. Both BFH and Subco were incorporated in Hong Kong. The total number of issued shares of BFH and Subco are both 1,000 million and their current share prices are HK$8 and HK$4 respectively. Final Examination (December 2014 Session) Paper II 2 of 8

3 Since the share price performance of Subco has been unsatisfactory, BFH plans to privatise Subco with a 20% premium over its current market price. In order not to dilute the shareholding of the existing shareholders, BFH has decided to raise the required funding with a rights issue of the shares in BFH. It is suggested that the rights issue shares should be issued at a discount of 40% to the current market price to make the issue attractive to the existing shareholders. Rights issue and the privatisation saga Mr. Teddy Gee, the controlling shareholder who owns 70% of BFH, is also the underwriter of the rights issue. Unfortunately, share market sentiment turned bad after the announcement of the rights issue. As a result, only 10 million rights issue shares were taken up by shareholders other than the controlling shareholder. The privatisation was effected by a voluntary general offer by BFH with the condition that the offeror receives valid acceptances for not less than 90% of the disinterested shares (as defined under the Takeovers Code), but this could be waived by the offeror. The 300 million shares of Subco not owned by BFH are all disinterested shares subject to the offer. Finally, the delisting resolution was duly passed at the relevant shareholders meeting. During the offer period, acceptances as to 210 million disinterested shares were received by the offeror. Final Examination (December 2014 Session) Paper II 3 of 8

4 SECTION A CASE QUESTIONS (Total: 75 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation and appropriate presentation of the answers. Question 1 (25 marks approximately 45 minutes) Assume you are the audit manager, Eva Kim. (a) You are going to discuss with the accounting manager, Bill Pao, again. (iii) State the matters that you should address in the discussion of the agreed-upon engagement procedures covering the level of assurance and the nature of engagement. (6 marks) Review the agreed-upon procedures drafted by Bill and propose changes to the procedures, if any. (3 marks) Identify the areas in the Letter of Representation that you need to discuss with Bill. (b) Some of the junior audit team members are very enthusiastic about the audit of the Big Beauty Group. While having lunch in a restaurant, they discussed the clinic s plan to launch a new beauty treatment package. Since this is a new package, a 10% discount will be offered to customers if the package is purchased during the promotion period. However, the package is very expensive and the team members wondered if the clinic will offer any further discount to them when purchasing the package. How should you coach your team members? (c) During your review of contracts, you discover that some of the beauty treatment packages are offered to customers at a lower price if the customers agree that the treatment is to be performed by a beauty consultant instead of a registered doctor. The company does not comply with the newly effective regulatory requirement that treatment of this kind has to be performed by a registered doctor. State the procedures that you should perform to address this finding. (6 marks) State the factors that you should consider before communicating with those charged with governance, as well as before preparing the auditor s report. Final Examination (December 2014 Session) Paper II 4 of 8

5 Question 2 (25 marks approximately 45 minutes) (a) In the rights issue exercise to fund the privatisation plan: How many BFH shares should be issued under the rights issue? (3 marks) What is the theoretical ex-rights price of one BFH share? (Note: Round your calculations to 2 decimal points.) (iii) (iv) (v) What is the theoretical value attaching to a right (nil-paid right) that is tradable on the Hong Kong Stock Exchange during the rights issue period? (1 mark) What is the impact on Mr. Teddy Gee when only 10 million rights shares were taken up? Comment also on BFH s issued shares distribution. What are the major differences between an open offer and a rights issue? (b) In the privatisation of Subco by way of a voluntary general offer: (iii) (iv) What should the offeree company do when it receives a general offer from the offeror? (3 marks) Discuss with reasons whether BFH can proceed with the privatisation. If the condition of acceptance by not less than 90% of disinterested shares is waived by BFH, what are the implications for BFH as far as the general offer and the Listing Rules are concerned? What difference would it make if the privatisation was effected by a scheme of arrangement instead of a general offer? (c) Wiley Yang, a director of BFH, owns 4 million BFH shares with a current market value of about HK$25 million. BFH is now in the blackout period for the publication of its financial results. Wiley is aware of the requirement under the Model Code for Securities Transactions by Directors of Listed Issuers ( the Model Code ) that a director must not deal in any shares during the blackout period. Unfortunately, Wiley needs to cash-in his shares badly in this instance. Suggest what Wiley could do under the Model Code to meet his financial difficulty. Final Examination (December 2014 Session) Paper II 5 of 8

6 Question 3 (25 marks approximately 45 minutes) Assuming you are the Chief Accountant of Dr. Eliza Chan, write a memo to Dr. Chan as Chairman of BBG to discuss the following accounting matters: (a) For the purposes of the financial statements of BBG for the year ended 31 December 2013, analyse and explain the accounting treatments for the following items: benefit payments for the termination of employment of some of the BBG administrative staff after the acquisition by BodyFit; and (5 marks) turnover rent. (5 marks) (b) In planning to transfer the commercial property, Property B, from BBG to BIL, analyse and explain the accounting impacts of the following matters from BIL s perspective: whether the transfer of all the ordinary shares of WPL from BBG to BIL constitutes a business combination? At the date when BIL acquires the ordinary shares of WPL, if the fair value of Property B held by WPL has increased since the end of the last financial year-end should any deferred tax be recognised at the date of acquisition and for subsequent financial periods? (Assuming: (a) the temporary difference which arises does not affect accounting profit or taxable profit (or tax loss) at the date of acquistion; (b) the current financial year-end is 31 December 2013.) (9 marks) (c) Explain the classification or accounting treatment of the promissory note for acquiring the ordinary shares of WPL from BBG in BIL s financial statements. * * * * * * * * Final Examination (December 2014 Session) Paper II 6 of 8

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8 SECTION B ESSAY QUESTIONS (Total: 25 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation and appropriate presentation of the answers. Refer to the Case information. Question 4 (10 marks approximately 18 minutes) You are working on a tax due diligence exercise conducted by BodyFit. Advise whether and how the clinic administrative service arrangement with BBG, if any, will be challenged by the IRD under the Inland Revenue Ordinance ( IRO ) and the relevant Departmental Interpretation and Practice Notes ( DIPN ). (10 marks) Question 5 (11 marks approximately 20 minutes) (a) (b) Advise as to the Hong Kong profits tax exposures of BBG in the disposal of the commercial property, Property A, and specify the tax consequence in case the IRD considers that the gain is revenue in nature. (5 marks) Advise as to the stamp duty exposures, including Ad Valorem Stamp Duty, Special Stamp Duty and Buyer s Stamp Duty, of the transfer of property A. In case there are any ways to mitigate or reduce the tax burden, advise regarding the conditions that must be fulfilled. (6 marks) Question 6 (4 marks approximately 7 minutes) After the acquisition of BBG by BodyFit, some of the administrative staff employed by BBG will be terminated. Advise as to the Hong Kong salaries tax exposures of the payment in lieu of notice and the severance payment to be received by the relevant employees. * * * END OF EXAMINATION PAPER * * * Final Examination (December 2014 Session) Paper II 8 of 8