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SBM Open Book Notes Contents Page
Pricing ..................................................................................................................................................................................................... 4
Pricing strategies (price penetra on and price skimming) ................................................................................................................. 4
Ability to pass costs to customers ...................................................................................................................................................... 4
Tender price ....................................................................................................................................................................................... 4
Cost-plus method ............................................................................................................................................................................... 4
Revenue .................................................................................................................................................................................................. 5
Warran es ......................................................................................................................................................................................... 5
FR – revenue recogni on ................................................................................................................................................................... 5
Subscrip ons ...................................................................................................................................................................................... 6
Subscrip on – debt sold to bank without recourse ........................................................................................................................... 6
Inventory valua on FR ............................................................................................................................................................................ 7
Working Capital Management ................................................................................................................................................................ 8
Inventory ............................................................................................................................................................................................ 8
Cash ................................................................................................................................................................................................... 8
Intangible assets FR ................................................................................................................................................................................ 9
Impairment ................................................................................................................................................................................... 9
Reducing R&D costs ........................................................................................................................................................................... 9
Financial repor ng of reducing R&D costs .................................................................................................................................. 10
Evalua on of R&D spend ................................................................................................................................................................. 10
Sale of division/plant ............................................................................................................................................................................ 11
Refurbishment ................................................................................................................................................................................. 11
Investment Appraisal ............................................................................................................................................................................ 12
Risks – overseas factory ................................................................................................................................................................... 13
Non-financial factors – overseas factory .......................................................................................................................................... 14
Sta s cs ................................................................................................................................................................................................ 14
Acquisi on of smaller company – Benefits and risks ............................................................................................................................ 15
100% Acquisi on ............................................................................................................................................................................. 15
80% Acquisi on ............................................................................................................................................................................... 15
15% Acquisi on ............................................................................................................................................................................... 15
15% Acq (Financial Asset) Financial Treatment ................................................................................................................................ 15
Merger Strategic vs Opera onal ...................................................................................................................................................... 16
Transfer pricing – differences between internal and external pricing .............................................................................................. 16
JV vs Subsidiary ..................................................................................................................................................................................... 17
Set up foreign subsidiary FR ............................................................................................................................................................. 17
Financing............................................................................................................................................................................................... 18
Comparing two different financing arrangements ........................................................................................................................... 18
Zero coupon loan advantages .......................................................................................................................................................... 18
Fixed-Rate Bond - £1m, 2% Bond with 27% Premium on redemp on ............................................................................................. 19
Raising Finance overseas to mi gate risks – no experience ............................................................................................................. 20
Debt vs Equity comparison .............................................................................................................................................................. 21
“Borrowing is much cheaper than raising equity because borrowing is X% and SH return is Y%.” .................................................. 21
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Share op ons influencing on directors’ decision making ................................................................................................................. 21
Impact of borrowing/equity on share op ons ................................................................................................................................. 22
Financial Reconstruc on .................................................................................................................................................................. 22
O1: X Buy debt of Y from bank and buy shares from shareholders ............................................................................................. 22
O2: X Buy debt of Y from bank and force company into liquida on, acquire assets and then set up new company .................. 22
Loan with issue of op ons ............................................................................................................................................................... 23
Conver ble Bond Instrument........................................................................................................................................................... 24
Recommenda on between Zero coupon loan, Loan with op ons & Conver ble loan.................................................................... 24
Debt factoring Financial Treatment.................................................................................................................................................. 25
Leases – Comparing different periods.............................................................................................................................................. 26
Hedging ................................................................................................................................................................................................. 27
Swap arrangement ........................................................................................................................................................................... 27
Swap Example ............................................................................................................................................................................. 27
FR – use hedge accoun ng for foreign loan? ................................................................................................................................... 27
Whether to hedge costs ................................................................................................................................................................... 27
Price of op ons ................................................................................................................................................................................ 28
Forward contract – loss making ....................................................................................................................................................... 28
Cash Flow Hedge FR for Forward ..................................................................................................................................................... 28
Futures ............................................................................................................................................................................................. 29
Traded op on Currency Op on ....................................................................................................................................................... 30
Borrowing foreign currency, conver ng to £, deposi ng to earn interest and repaying foreign currency....................................... 31
Valua on ............................................................................................................................................................................................... 32
Hierarchy of inputs ........................................................................................................................................................................... 32
Determining Brand Valua on........................................................................................................................................................... 32
Determining digital asset valua on.................................................................................................................................................. 33
Asset Based Valua on ...................................................................................................................................................................... 34
Free Cash flow method .................................................................................................................................................................... 34
Price/Earnings Mul ple.................................................................................................................................................................... 35
Risk Register & Mi ga on ..................................................................................................................................................................... 36
Cyber incident – how to deal with ........................................................................................................................................................ 37
Integrated repor ng: systems to capture data and provide info .......................................................................................................... 37
Managing credit risk for foreign sales .............................................................................................................................................. 38
Supply chain management and distribu on ......................................................................................................................................... 39
Delivery mes factors ...................................................................................................................................................................... 39
Defec ve items factors .................................................................................................................................................................... 39
Outsourcing ..................................................................................................................................................................................... 40
Centralised Management Benefits vs Risks ...................................................................................................................................... 40
Upstream supply chain informa on system Benefits vs Risks .......................................................................................................... 41
Global produc on Benefits vs Risks ................................................................................................................................................. 41
Selling online to overseas customers (Direct Expor ng) Benefits vs Risks ....................................................................................... 42
Selling through overseas retailers (Indirect Expor ng) Benefits vs Risks ......................................................................................... 42
Keep same sole supplier Benefits vs Risks ....................................................................................................................................... 43
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Mul ple global supplier’s Benefits vs Risks ...................................................................................................................................... 43
Overseas manufacturing facility Benefits vs Risks ............................................................................................................................ 44
Addi onal overseas Warehouse distribu on centre along with UK Benefits vs Risks...................................................................... 44
Downstream supply chain .................................................................................................................................................................... 45
Produc on levelling ......................................................................................................................................................................... 45
Opera ng cycle improvements ............................................................................................................................................................. 45
Benefits of analysis sales forecasts .................................................................................................................................................. 45
Big data and marke ng ......................................................................................................................................................................... 46
Brands and digital marke ng ........................................................................................................................................................... 46
Benefits of digital marke ng ....................................................................................................................................................... 46
Due diligence ........................................................................................................................................................................................ 48
Why DD is important for brand acquisi on...................................................................................................................................... 49
Assurance procedures for assurance report .................................................................................................................................... 53
Assurance provided to bank through assurance report ................................................................................................................... 55
Risk assurance – Treasury department controls .............................................................................................................................. 56
Agreed-upon procedures (AUP) engagement .................................................................................................................................. 56
Corporate Governance.......................................................................................................................................................................... 57
Under 25% Shareholding ................................................................................................................................................................. 57
Going concern disclosures .................................................................................................................................................................... 58
Indicators of not Going concern ....................................................................................................................................................... 58
Responsibility for behaviour of suppliers .............................................................................................................................................. 58
Ethics .................................................................................................................................................................................................... 59
Ethics Template ................................................................................................................................................................................ 59
Scenario: Advisory work firm asked for Assurance engagement and favourable assurance opinion. .............................................. 60
Aggressive comments by CEO asking for a favourable assurance report ......................................................................................... 60
Scenario: ICAEW accountants giving advice– minor fault in programming but item s ll sent a er a month ago ........................... 61
Scenario: Company shares op ons dilu ng ownership, want to make redundancies before ves ng period .................................. 62
Scenario: Some products recalled due to supplier component; CEO says only recall products where fault known. ....................... 63
Sustainability......................................................................................................................................................................................... 64
Benefits for environmental and sustainability audit ........................................................................................................................ 64
ESG Risks .......................................................................................................................................................................................... 65
Legal requirements for Listed company ........................................................................................................................................... 65
Relevance of sustainability to non-listed company .......................................................................................................................... 65
Measuring impact on natural capital ............................................................................................................................................... 66
KPIs & assurance procedures for sustainability condi ons .............................................................................................................. 67
Iden fy and jus fy KPIs.................................................................................................................................................................... 68
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Pricing
Pricing strategies (price penetra on and price skimming)
Important for brand to gain a foothold in the market in terms of recogni on and reputa on.
Pricing policies used: price penetra on and price skimming are two extremes.
Price penetra on can help to gain market share by se ng a low price ini ally to enter the market and get the
brand name known amongst customers. This may also help in obtaining economies of scale, which would
help with long-term strategy.
Price penetra on is a temporary policy, as prices need to be increased later to generate profit if sales are
being made at full cost price. May be difficult to increase price once this lower price has been set.
Low ini al prices may damage the brand name making it difficult to establish a quality brand image later.
Price skimming is where the ini al price is set high for new products launched into a market and a smaller
market share is normally gained but at a greater margin.
Price skimming policy will involve a company charging high prices when a product is first launched; then
spend heavily on adver sing and sales promo on to win customers. The company may later lower its prices
to a ract more price-elas c segments of the market; however, these price reduc ons will be gradual.
A more sustainable pricing model would be based on market research including what similar products are
selling for in that specific market and what the target market group is willing to pay.
Ability to pass costs to customers
Depends on market compe veness and the prices charged by rival companies.
Rivals may be suffering cost increases too – causing pressure across whole industry to pay increased prices –
so can collec vely increase prices.
Increased regula on for compliance across industry
Discuss a future sustainability policy with customers to help achieve their own sustainability objec ves
Tender price
In se ng a tender price there are two issues:
maximising the expected probability of winning the contract
maximising the profit on those contracts awarded
There is clearly uncertainty as the price tendered by rival companies is unknown at the me of the bid.
Nevertheless, prior experience of successes and failures in tenders against rivals and ex post info on winning
tenders would build managerial experience of the range of tender prices likely to be successful.
There remain uncertain es, as every case is unique, and rivals may change their behaviour or engage in
'game playing' to impact the future expecta ons and judgements of compe tors' management.
Cost-plus method
Advantages Disadvantages
Clear objec ve and formalised Cost plus pricing doesn’t guarantee a profit- excessive pricing means
approach- reduces risk of poor failure to win bids and so standardised development costs, and other
judgement and selec ve bias. indirect costs cannot be recovered.
Cost plus pricing is par cularly weak in a compe ve market as it is rigid
and therefore rivals may become able to predict X tender bids and
undercut them. It also fails to consider the varying compe ve condi ons
from contract to contract.
Clearly such costs must be covered in the long-term but rival companies
will have similar cost structures and will also be making bids to cover
indirect costs.
Any cost overruns included in the cost-plus tender calcula on will cause
tender price to be inflated and uncompe ve
Ignores other factors besides profit per contract e.g. a greater number of
contracts with a lower profit per contract may result in higher overall
profit.
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Revenue
Warran es
Warranty is likely to a ract more customers
The cost of repairs under the warranty of £X
Need to es mate PV of addi onal sales to calculate overall impact of proposal. If PV of addi onal sales is
greater than should proceed with warranty
GPM on products will reduce because addi onal cost without addi onal revenue
Market research is needed to determine whether the extended warranty will increase sales volumes
significantly and/or improve customer loyalty.
There will be a CF benefit because addi onal sales received now but warran es claimed in 2025
Costs will however be recognised in the P&L. Also, addi onal costs such as admin and management me
needs to be factored.
FR – revenue recogni on
Under IFRS15, transac on price is allocated to each dis nct PO and revenue is recognised when PO
sa sfied.
Warran es which provide an addi onal dis nct service (such as free repairs over a specific period) are a
separate PO.
Therefore, X is supplying goods and service warranty.
Iden fy each component as separate performance obliga on in accordance with IFRS 15.
Transac on price needs to be allocated to goods and service based on standalone prices.
Each component should be measured and recognised separately.
To get standalone price for warranty, could iden fy market value/FV for the addi onal warranty.
Revenue for goods recognised once delivered because this is when control passed to buyer.
Revenue for services recognised when service provided. Therefore, this element of revenue recognised
when addi onal warranty is provided.
Items 1500
Price 25
Total 37500
PV(8%,3,0,37500) -£29,769
8%
BF Int Paid CF
Y1 £29,769 £2,381 0 £32,150
Y2 £32,150 £2,572 0 £34,722
Y3 £34,722 £2,778 0 £37,500
Y1 DR P&L, CR Provision 32150
Y2 DR P&L, CR Provision 2381
Y3 DR P&L, CR Provision 2778
End DR Provision, CR Cash X
End DR Provision, CR P&L X
End costs being the warranty repair costs and then releasing any unu lised provision at the end of the
agreement period
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Subscrip ons
As per IFRS 15, revenue recognised should reflect the price the consumer would have paid if they had paid cash.
Revenue recognised for each sale as the performance obliga on of delivering the device has been completed,
even though the cash has not been received.
Interest income is to be charged each year, which can be calculated using IRR/Rate and pro rated if needed.
Receivable recognised at purchase date is at end of Y3.
Interest
Income 4%
£m bf int paid cf
-
1 3,000 120 320 2,800
-
2 2,800 112 320 2,593
-
3 2,593 104 320 2,377 Receivable at purchase date
Subscrip on – debt sold to bank without recourse
Annual implicit interest rate
Selling price £3000. Bank pays £2539 per SIA device to PH today.
Bank received £319.66 per quarter from the users for three years
No. of payments = 12
Finding the quarterly interest rate using RATE
No. of payments 12
Interest payment 319.66
Market price -2539
Redemption amount 0
Quarterly implicit rate 7%
Annual implicit rate = (1+7%)^4-1 31%
Revenue £3000 recognised along with £1800 in COS. Dr Receivable, CR Revenue
Receivable is then de-recognised as an asset sale to the bank (debt factoring without recourse) for cash £2539.
DR Cash 2539, CR Receivable 2539
The difference £3000-2539= £461, then is recognised as loss on sale.
DR Loss on sale 461, CR Receivable 461
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Inventory valua on FR
A significant amount of inventory creates the risk that there is scope for material misstatement in both the
SFP & P&L.
However, it is not merely the amount of the inventory that creates the risk of misstatement. It is also the
nature of the goods and that the average inventory turnover is high, with some items likely to be held in
inventory for far longer than the average turnover period.
IAS 2, Inventories, requires that inventories should be stated at the lower of cost and NRV. There is a risk that
some goods are likely to become obsolescent, (or at least only capable of being sold at reduced prices) if held
in inventory for an extended period. This may be par cularly the case with computer equipment but may also
apply to many other electrical items.
Poor info systems, or poor managerial controls in appropriately using these systems, means that old
inventories or damaged inventories may not be readily iden fiable (e.g., from the introduc on of an ageing
analysis of inventories) to be able to make the appropriate write down.
Inventories are non-monetary assets in accordance with IAS 21, The Effects of Changes in FEX. As such, they
will be translated at the FX rate on the date of purchase and not normally retranslated therea er. The fact of
the inventories being purchased in a foreign currency is not therefore a major FS risk so long as the original
purchase price is recorded.
However, where there is an impairment, or other FV adjustment, the values of inventories are retranslated at
the current date and therefore it is necessary to have detailed and reliable con nuous inventory records to be
able to do this.
Faults in inventory
Impairment: Inventories held at YE may need to have an impairment allowance to allow for the cost of
repairing.
Provisions for repairs for future claims reported but not carried out and also for claims expected but not yet
reported. Costs to be incurred in future should be discounted in accordance with IAS 37, Provisions,
Con ngent Liabili es and Con ngent Assets. Disclosure should be made of the nature and the amount of the
provisions.
Con ngent asset – claims against the manufacturer, if credible, should be disclosed only as a con ngent asset
in accordance with IAS 37, but not recognised.
Returns of sales with major faults by customers may be an issue. Provision would need to be made if this is
the case to recognise a loss on resale
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Working Capital Management
Inventory
Manage the demand be er by building good rela onships with customers.
An cipate customer demands by contac ng regular customers and finding out their poten al orders in the
next couple of months.
Nego ate with supplier to arrange regular delivery per month
Data analy cs so ware can be used to analyse historical demand and predict future demand
Sales volumes are vola le from quarter to quarter which makes short-term demand difficult to forecast.
Demand uncertainty combines with a long lead me on the supply side, making it difficult to sa sfy changes
in short-term customer demand without holding significant levels of inventory.
However, holding high levels of inventory has a cost in tying up capital and damaging liquidity. There may also
be high storage costs and possible damage or decay of inventories.
Key factors would be analysing historic data to iden fy the ming of surges in demand or dropping off in
demand
Be er data, and be er analysis of exis ng data, can help iden fy how much inventory is needed and when it
is needed.
Be er info systems may help predict demand pa erns from customers. The use of a spreadsheet to maintain
management accoun ng records, even for a small company, is likely to be insufficient.
Minimising inventory, while s ll having enough to meet customer needs on a mely basis, can reduce
inventory costs. These may include storage costs; damage; obsolescence; insurance.
Data need to be constantly monitored, updated and analysed and compared to inventory levels which should
be measured con nually
An inventory so ware package may give be er data analysis and management info to predict demand
varia ons.
Other factors may not be captured in historic data such as an adver sing campaign, a favourable review for a
product in the press or a sudden change in weather
Management info needs to be at the correct level of each of the different products. It is of li le benefit to
forecast the correct overall weekly/monthly/quarterly demand, if the predic ons for each type of product are
not correct as the products are not likely to be subs tutable for each other.
Cash
Ask for be er credit terms from supplier
If high inventory levels need to be held to cope with demand uncertainty, then the inventory management
issues may be solved only at the expense of crea ng a cash management problem.
Arranging suitable flexible financing with bank (e.g., an overdra ) may be one way of managing cash.
There could be monthly, seasonal or annual trends around purchasing by certain customers (e.g., using
budgets at end of year, regula on requirements, monthly pa erns in demand).
Consider sales paid for in advance so the credit period is zero for these sales.
May use debt factoring to receive cash from a factor – although this may be costly
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