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Management case study exam – March 2015 Pre-seen materials

©CIMA 2014. No reproduction without prior consent. 1

March 2015 Management case study examination

Pre-seen materials

Contents

Page

1. Company and background information 1

2. Extracts from financial statements 10

3. Accounting policies 14

4. Principal risks 15

5. Extract from Chairman’s statement 16

6. Extract from financial statements – Constructmore 17

7. Summary Management Report for Bild Board 20

8. Construction News Article 22

9. News article from Economics Today 23



Background

Bild is the third largest construction company in its home country of Ceeland. Constructmore is its biggest competitor.

Bild’s activities can be categorised as civil engineering, development and investment, each of which is undertaken by a separate subsidiary.

Civil engineering

Bild’s principal business activity is undertaking

civil engineering projects for clients, building

offices, roads and other infrastructure

developments. This is a highly competitive

market, but Bild is well established and has a

good reputation.

Clients generally invite construction companies to bid for construction contracts on a competitive basis. Some contracts require Bild to construct a project according

to a client’s specification while others require Bild to assist the client with the design work prior to construction. Bild has its own professional surveyors and civil engineers and also has good contacts with outside professionals such as firms of architects, who can be brought in whenever required.

Development

Bild has some speculative ventures of its own. It buys land as an investment. Sometimes it builds projects such as office blocks with a view to finding a buyer once the building is completed.

Investment

Bild has a separate subsidiary that owns buildings that Bild retains for investment purposes. These buildings are usually rented out to third parties. Whenever Bild’s development subsidiary cannot find a buyer for one of its completed buildings it will transfer that building to the investment subsidiary. The investment subsidiary generates rental income from these buildings, with a view to selling them at a profit whenever market conditions are favourable.



A typical civil engineering project

Firstly, the client specifies the project. Sometimes the client commissions the design work from its own architects and civil engineers or from independent firms offering those services. Sometimes the design work will be part of the construction project that is awarded to the construction company. A major project can take several years from initial design to final completion.

The client will normally invite several civil engineering companies to bid for the construction contract. Bid documentation will include building specification, timescales for construction work and cost forecasts. Bild has

to decide whether or not it wishes to bid for a contract. It takes a great deal of time to prepare a bid and if Bild is already heavily committed to other projects, or if the project appears unlikely to generate a profit, then Bild may decline to bid. A typical project undertaken by Bild Civil Engineering will take between two and five years to complete.

If Bild is awarded a contract then a project management team is appointed. Bild’s project manager will be in overall command of the project. Depending on the nature and complexity of the project, the project manager may be assisted by engineers and architects as and when required. The actual construction work is usually undertaken by subcontractors. Subcontractors generally specialise in specific areas such as laying roads or brickwork. Bild is responsible for employing any subcontractors and for paying them. Bild is also responsible for the quality of the subcontractors’ work and for the prompt completion of any tasks assigned to them.

Bild must also purchase whatever materials are required and meet any other costs associated with the project.

Construction equipment is generally hired for a particular project or the subcontractors may use their own equipment. Generally, the client pays for the land and all other costs are the responsibility of the construction company.

The client will normally have the right to have the work inspected periodically by its own experts.

The contract with the client is normally divided into a sequence of stages and the client will pay for the work as each agreed stage is completed. These “progress payments” will require the client’s agreement that the work has been completed and is of an acceptable quality.



Once the project is completed it is handed over to the client and Bild issues a final invoice for the balance of the contract price. Typically, the contract will allow the client to withhold a small percentage of the total price (usually 3%-5%) for an agreed period, (e.g. a year) after completion. This “retention money” will be paid at the end of the agreed period provided Bild deals with any problems that arise after the work is completed. It is common for small defects to appear because the new building settles and so it is necessary for the construction company to carry out remedial work.

Ceeland

Bild is based in the country of Ceeland.

Ceeland’s currency is the dollar ($).

Ceeland has adopted International Financial Reporting Standards.

Ceeland is a prosperous country. It is an island but has good international trading links.

Ceeland’s capital city (Capital City) is located in the South East of the country. Most of the country’s heavy industry and manufacturing is located in the North. The South West region is rural and mostly agricultural.

Ceeland’s climate is temperate with a rainy season from November to February.

Job description

You are the senior management accountant of Bild. Your role in the organisation is to provide information to the Finance Director to enable the company’s performance to be measured and for decision making purposes.



Organisation and structure

Bild has three subsidiary companies: Bild Civil Engineering, Bild Development and Bild Investment. Bild Civil Engineering has four regional subsidiaries, each responsible for its own geographical area.

Each subsidiary has its own board of directors. The CEO of each subsidiary is also a director of Bild.

Bild

Bild Civil

Engineering

Bild

Investment

Bild

Development

Bild South

West

Bild South

EastBild Central Bild North

Bild’s head office is in Capital City. Bild Civil Engineering, Bild Development and Bild Investment also operate out of the head office building.

Bild Civil Engineering’s four regional subsidiaries have their own separate offices, each located in its respective region.

Each contract has a team of site agents who work out of temporary offices on the site. Their job is to supervise the subcontractors who undertake most of the actual physical work in terms of labour and providing construction equipment. The site agents also raise purchase orders for building materials. The materials are shipped directly to the site. The site agents are supported by architects, civil engineers, quantity surveyors and support staff at the subsidiary company’s office.

The regional subsidiaries operate independently of each other. Each reports to Bild Civil Engineering on a half-yearly basis. Bild Civil Engineering consolidates the reports into a summary for Bild’s main board to consider.

Bild’s main board receives high-level reports summarising the key results of Bild Civil Engineering, Bild Development and Bild Investment.



Budget reports

The following is a typical budget report submitted by a regional subsidiary. Actual results are reported against budget for key performance targets. The regional CEO provides a brief commentary explaining why variances have arisen. Bild South West has historically been the most profitable regional subsidiary with results consistently in line with budgets.

Management report – Bild South West

Six months to 31 March 2015

$m

Budget

$m

Actual

New work bid for 2,200 1,850

Contracts won 765 530

Progress payments invoiced 760 730

Retention monies released 89 52

Cost of work scheduled (CWS) 831 963

Cost of work performed (CWP) 721 748

Schedule variance (CWP – CWS) 110A

Cost variance (CWP – CWP) 27A

Commentary by Bild South West CEO

Results for the six months have been disappointing. In particular, we have had fewer opportunities to tender for work than we had originally anticipated. We also won just over 30% less work than budgeted. This will leave us with excess capacity for the next three months. We were successful at bidding for smaller contracts but Constructmore outbid us for two large projects, which was particularly disappointing because we have undertaken work for these clients in the past and they have been happy with the quality of our work. It appears that Constructmore undercut our bids for these contracts.



Stock market and corporate governance

Bild’s share price has remained reasonably stable over the last three years, despite stiff competition. The share price is, however, currently at its lowest price in the company’s history. The company has struggled to achieve the growth it hoped for.

Market data

Bild’s historical beta is 1.8

The equity market premium is 6%

The risk free rate is 5%



Bild’s Board of Directors

Executive directors

Andrew Mitchell, Chief Executive Officer (aged 53)

Andrew Mitchell is a qualified civil engineer. He was formerly the Managing Director of Bild Civil Engineering. He joined Bild in 1994 and has led many successful construction projects.

Felicity Bunyan, Group Finance Director (aged 62)

Felicity Bunyan is a qualified accountant with extensive knowledge of the construction sector. She has worked for a variety of organisations including an engineering company based in Australia.

Mark Grassington, Managing Director Bild Civil Engineering (aged 47)

Mark Grassington joined Bild from a major competitor Constructmore in 2010. After working for the South East subsidiary, he successfully led a new “quality matters” initiative through all four regional subsidiaries before being promoted to Managing Director in 2013.

Nigel Fanshaw, Managing Director Bild Development (aged 49)

Nigel Fanshaw is a qualified chartered surveyor. He came to Bild from Chuffingtons, a major firm of surveyors which has provided professional advice for Bild.

Amanda Hessilman, Managing Director Bild Investment (aged 55)

Amanda came to Bild from George Hope and Co, a major merchant bank. She is qualified as both an accountant and a Chartered Surveyor.



Melissa Woods, Company Secretary (aged 46)

Melissa Woods is a qualified lawyer. She also heads up the HR department, addressing the staffing implications of Bild’s business strategy.

Non-executive directors

Daniel Craggie, Non-Executive Chairman (aged 68)

Daniel Craggie came to Bild as a Non-Executive Director in 2010 and was appointed Chairman in 2012. He was previously Finance Director for another major company in the construction industry. He has had an illustrious career in the construction industry.

Jessie Hardbotham, Senior Independent Director (aged 65)

Jessie Hardbotham is also chair of the audit committee. She is a trustee of a major national charity following a successful career as an academic.

Nimrod Ekserdjian, Independent Non-Executive Director (aged 61)

Nimrod Ekserdjian is a member of the audit and remuneration committees. He has enjoyed a distinguished career in the public sector and is a former senior town planner.

Haofeng Liu, Independent Non-Executive Director (aged 58)

Haofeng Liu has held directorships for several international construction companies and is a specialist in sustainable development and environmentally friendly construction methodologies. He is chair of the remuneration committee.

Hugo Hunter, Independent Non-Executive Director (aged 47)

Hugo Hunter is Chairman of Hunter and Waddell, a prestigious property investment company. He is a member of the remuneration committee.



Reference material 2:

Extracts from financial statements – Bild

Bild GroupConsolidated statements of profit or loss

For the year ended 30 September 2014

Notes 2014 2013 $M $M Revenue 1 7,631 7,084 Cost of sales -6,926 -6,382 Gross profit 705 702 Other net operating expense -367 -312 Investment income 27 29 Finance expense -54 -52 Profit before tax 311 367 Tax 4 -132 -129 Profit for the year 179 238



Bild Group – Consolidated statement of financial position as at 30 September 2014 Notes 2014 2013 $m $m Non-current assets Intangible assets 240 240 Property plant and equipment 2 ____790 _____721 1,030 961 Current assets Inventory 298 287 Due from construction clients 432 336 Trade receivables 23 15 Cash 19 67 Assets held for sale _____43 ______62 ____815 _____767 __1,845 ____1,728 Equity Share capital 3 240 240 Share premium 32 32 Revaluation reserve 165 165 Retained earnings ____428 ____370 865 807 Non-current liabilities Provisions 128 112 Borrowings 426 414 Deferred tax 18 16 Retirement liabilities ____137 ____135 709 677 Current liabilities Trade payables 21 41 Borrowings 235 190 Tax liability ____15 _____13 ____271 ____244 __1,845 _1,728



Notes to the accounts

Bild Group - Consolidated statement of changes in equity for the year ended 30 September 2014

Share capital

Share premium

Revaluation reserve

Retained earnings

Total equity

$m $m $m $m $m

Balance as at 1 October 2013 240 32 165 370 807

Profit for the year

179 179

Dividend paid 121 121

Balance as at 30 September 2014 240 32 165 428 865

1. Revenue 2014 2013 $m $m Revenue from construction services 6,872 6,488 Proceeds from sale of developments ___759 ____596 __7,631 ___7,084

2. Property plant and equipment $m Cost or valuation At 1 October 2013 981 Additions 158 Disposals 105 Impairment _____0 At 30 September 2014 __1,034 Accumulated depreciation At 1 October 2013 260 Charge for the year 23 Disposals _____39 At 30 September 2014 ____244 Carrying amount 790



The directors carried out a review of the values of property plant and equipment and did not find any evidence of impairment.

3. Share Capital

Bild has issued share capital of 240million shares of $1.

At 31 September 2014 the share price was $3.50

4. Taxation

The corporation tax rate in Ceeland is 35%




Accounting policies

Bild complies with IFRS.

Property plant and equipment

Property, plant and equipment comprises properties held for investment purposes, a land bank intended for future development and Bild’s head office.

Property plant and equipment is held under the revaluation model in accordance with IAS 16. Items of property plant and equipment are carried at a revalued amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation. Reviews are carried out by the directors on an annual basis to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. Every five years an independent valuation is carried out by a firm of professional surveyors and valuers. The next such review is due in 2017.

Leases

Leases on plant and equipment are classed as operating leases. Lease payments are recognised within cost of sales in the income statement.




Principal risks

Risk and impact Mitigation

Failing to win contracts in existing and new target markets, leading to failure to achieve targets for revenue growth and profits.

Listening to our customers to ensure that we understand and meet their needs. Implementing cost reduction programmes to ensure that we remain competitive.

Problems with operational delivery, cost overruns, time overruns and design faults.

Work on site is checked by in house professionals and reports prepared so that any necessary corrective action can be taken. The Board is responsible for overall quality issues and reviewing best practice.

The success of the business is dependent upon sufficient financial facilities.

Cash forecasts are prepared regularly providing accurate information. Borrowing facilities have been successfully renegotiated and extended.

Bild’s activities require the continuous monitoring of the management of health and safety risks. Failure to manage these risks could lead to injury to employees and subcontractors and could also expose Bild to legal liability and reputational damage.

We have detailed health and safety policies and procedures in place. These are reviewed and monitored by management.

The business depends on a flexible, skilled and well-motivated workforce. If we are not able to attract and retain skilled people then business growth may not be possible.

Staff turnover is monitored and pay and conditions are regularly reviewed against benchmarks to ensure that Bild remains competitive. Bild has a performance review process designed to assist the career development of staff.

Future construction orders depend on the economic climate and the availability of credit for private sector expenditure.

The Board carries out quarterly reviews of workload. Bild has a network of regional offices throughout Ceeland providing strong integration with our client base.




Extract from Chairman’s statement

I am happy to report a very positive set of results for Bild for the year ended 30 September 2014.

Our core business of construction has remained profitable, despite erosion of margins. That profit has been supplemented by contributions from our property development subsidiary, including the successful sale of our major office development in Capital City. Bild Investment has also continued to provide positive returns.

In addition to valuable contributions to group revenue and profits, our investment and development activities also provide a solid asset base on which to secure borrowings. Our land bank and investment properties have shown steady growth in value. Our asset base, combined with our positive relationship with lenders, has enabled Bild to sustain gearing levels well in excess of our main competitors.

We are looking ahead to substantial opportunities in the marketplace, where we have already demonstrated we have the skills, experience and financial resources to compete and succeed. We have been successful in securing a number of new contracts and have also been able to extend some existing contracts. Our order book is almost at the same level as at September 2013, despite challenging economic conditions.

Daniel Craggie

Chairman




Extract from financial statements – Constructmore

Consolidated income statements For the year ended 30 September 2014

2014 2013

$m $m

Revenue 9,743 9,898

Cost of Sales ____-9,066 ___-9,212

Gross profit 677 686

Other net operating expenses -253 -269

Investment income 0 0

Finance expense _______-23 ______-19

Profit before tax 401 398

Tax ______-165 ____-172

Profit for the year ______236 _____226



Constructmore - Consolidated statement of financial position

as at 30 September 2014

2014 2013

$m $m

Non-current assets Intangible assets 730 798

Property, plant and equipment 125 109

855 907

Current assets Inventory 220 189

Due from construction clients 480 413

Trade receivables 376 329

Cash 390 470

1,466 1,401

2,321 2,308

Equity Share capital 700 700

Share premium 160 160

Retained earnings 123 152

983 1,012

Non-current liabilities Provisions 323 298

Borrowings 23 23

Deferred tax 74 62

Retirement liabilities 370 330

790 713

Current liabilities Trade payables 278 219

Borrowings 123 190

Tax 147 174

548 583

2,321 2,308



Key ratios

2014 2013

Bild Gross profit % 9.2 9.9

Profit for year as a % of revenue 2.4 3.4

ROCE % 21.5 26.3

Gearing (D/D+E) 45 45.6

Constructmore Gross profit % 7.0 7.0

Profit for year as a % of revenue 2.4 2.3

ROCE % 23.9 24.2

Gearing (D/D+E) 44.5 41.3




Summary Management Report for Bild Board

For six months to 31 March 2015

Results to date – revenue and profit

Actual against budget for six months to 31 March 2015

$million Civil engineering Development Investment budget actual budget actual budget actual Revenue 3,500 3,374 420 115 38 37 Gross profit 332 301 53 12 36 35 Net profit 36 33 39 8 34 33

0

500

1000

1500

2000

2500

3000

3500

Civil Engineering

Development Investment

Revenue

Revenue - budget

Revenue - actual

0

5

10

15

20

25

30

35

40

Civil Engineering

Development Investment

Net profit

Net profit - budget

Net profit - actual



Key performance indicators and CEO commentary

Budget Actual

Civil Engineering

Repeat business% 25 23

Client satisfaction% 95 83

Committed forward workload 2,700 1,560

CEO commentary on Civil Engineering results to date

Despite difficult economic conditions both revenue and profit are only just lower than an ambitious budget set for the first half of the year. We are delighted that the percentage of repeat business is holding up so well and only just below budget. 83% client satisfaction is a very high percentage. Client satisfaction rating would have been much closer to budget without the ongoing problem with defective windows at the Seaview Retail Park. We hope this issue will be resolved shortly and will not arise in future as we have found a new supplier.

Forward workload remains a serious concern. We have a number of bids awaiting decisions at the moment and are hopeful that the situation will improve in the near future. We are proposing that the board should request all regional subsidiaries to report bids made and work won on a weekly basis.

Budget Actual

Development

Expected completed value

$ million 1,278 1,180

CEO commentary on Development results to date

Sales of industrial units are progressing well and on target. The disappointing shortfall in revenue and profit is due entirely to the delay in the sale of our major office, retail and leisure centre in Capital City. I would emphasise that this is a delay only. We had aimed to have the sale completed before 31 March but the buyer has still to resolve funding issues. The sale remains agreed and we have taken advice from our legal team who consider it likely that the sale will be completed within the next few weeks.

Budget Actual

Investment

Overall occupancy rate % 95 92

Average rent per sq meter $ 250 247

CEO commentary on Investment results to date

The investment subsidiary continues to make steady and reliable returns on investment. Our occupancy rate, while below budget, is above that of similar investment companies, due largely to our high quality portfolio. Average rents are also holding up well and while in the current economic climate we have not always been able to negotiate increased rental levels when reviews are due, we have not been forced to reduce rents or to offer excessive rent free periods. Overall the performance to date has been good and this should continue for the rest of this financial year.


Reference material: 8

What does 2015 hold for the construction industry in Ceeland?

A report by our economics editor

4 January 2015

The construction industry in

Ceeland is notoriously cyclical; activity is high when the

economy is prosperous and low during downturns. So how does the economy look in 2015?

Construction companies range from very small owner run

building firms to major contractors. For this article we have focussed on those with a

turnover in excess of $100m per annum. This gave us a sample

of 63 companies, five fewer than last year’s survey because one company has since gone

into receivership and another four have had their revenues decline below $100m.

Although construction output increased, there are worrying signs that the rate of

growth is slowing down. This may not be too damaging as there is also evidence of capacity constraints, with subcontractor availability falling sharply and steep increases in the demand for construction materials.

It will always be a struggle to maintain activity levels because even the largest contractors find that their ongoing workload comprises a small number of very large

contracts. The successful completion of a shopping mall or motorway extension leaves a void in the order book.

Construction companies tend to have low gearing levels; the average gearing ratio

for our sample was 17%, with 12 of our companies having no net debt at all. Return on Capital Employed averaged 23%, but operating profit averaged only

1.5% of reported revenue.

Seven of our companies had a “company health score” that was low enough to cause concern that they may be financially vulnerable.

How many companies will we survey when we repeat this exercise next year? Steadily rising costs and downward pressure on prices in a highly competitive

market may mean that even the largest will struggle to maintain their forward workload.

Construction News




6 January 2015

PFI – the way forward for Ceeland?

The Private Finance Initiative (PFI) has been widely used in many countries as a procurement method to deliver public sector infrastructure projects. Recent announcements by the Ceeland Government indicate that following a successful series of pilot projects this

type of finance is now to be used in Ceeland for the provision of new schools, hospitals and roads.

PFI comes under the broader term of PPP (Public Private Partnerships.) Under PFI, a private sector developer pays for the construction of a project on behalf of a public sector client. Once built, the developer leases the resulting school, hospital or whatever on a fully-serviced basis for an agreed period spanning

the expected life of the buildings. So, the developer provides cleaning, catering and maintenance facilities while the public sector client pays the teachers or the medical staff and supplies the textbooks or the medicines. The companies offering this service claim that it provides an exciting new means of funding public sector services. Politicians are often attracted by the fact that they can improve public infrastructure without having to find the money up front.

Announcing the new initiative, a Ceeland Government spokesman stated “we hope that PFI will deliver new projects more quickly than the public sector acting alone, and at a lower risk. Although some countries have had problems with PFI initiatives, we believe that Ceeland can learn from others’ mistakes to ensure that projects represent good value for money for Ceeland’s taxpayers, while also providing high quality buildings and services.”

The Government spokesman was questioned about the recent public inquiry in neighbouring county Deeland into the PFI project to build BigCity Hospital. The project suffered from major cost overruns because the building specification was constantly changed in response to new medical technologies that became available during the design and building phases of the project. There have also been public protests about the level of cleanliness in the hospital and the standard of food provided for patients. Protesters have claimed that these problems are attributable to the developer’s incentive to minimise costs in order to maximise profits, even if doing so was at the expense of patient care.

The Ceeland Government spokesman insisted that the Government’s PFI team had visited several projects in overseas countries, including the BigCity Hospital in Deeland. “Although this project has had problems, there have been many examples of highly successful projects. We remain confident that partnerships with the private sector can deliver high quality schools and hospitals in Ceeland.”

ECONOMICS TODAY

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