Marking Key
QUESTION - MARKING KEY
Overview
1. Necessary to define the assertion being made by associations 1
Terms requiring definition include:
2. - Aexorbitant@ e.g. would mean well above industry average .5
3. - Aprofitability@ B with examples of measures of profitability .5
4. - Asubsidization@ B includes providing assistance at cost or below cost .5
5. We will need to verify that in fact sales prices for pharmaceutical/snack businesses .5
were below market
6. Subsidization would also include assisting the businesses to generate higher sales .5
through increased traffic
7. Figures used for analysis are not audited, therefore may not be accurate .5
8. - also figures are historical; as the future is more relevant, should request forecast 1
9. - for the mean time, necessary to normalize figures to reflect future 1
10. Should request a detailed income statement for each of the new businesses 1
11. - also request detailed schedule of cost allocations to new businesses .5
12. PLA will want to show that profit from alcoholic beverages is as low as possible 1
while the association will want to show high profit
13. - we will provide support for PLA=s position, but also anticipate the PLA arguments .5
14. Report focuses on financial & economic arguments/PLA should also seek legal advice .5
AVAILABLE 9.5/MAXIMUM 9.5
Profitability of PLA=s Alcoholic Beverage Operation
15. Normalized income should exclude profits from snack and pharmaceutical businesses 1
and reflect what earnings would be if PLA only involved in alcoholic beverages
16. Candidate normalized sales by removing sales from pharmacy and snack business 1
17. - candidate added back alcoholic sales lost likely due to space allocation to snack 1
and pharmaceutical businesses
18. Candidate attempted to normalize income 1
Adjustments to normalize income:
19. - subtract gross profits from pharmacy and snack businesses .5
20. - add back gross profits relating to likely loss in sales volume of 5% in 1999 due to 2
use of space of other businesses
21. - eliminate gain on sale of real estate 1
22. - add back salaries relating to pharmacists .5
23. - add back salaries of vice presidents of new businesses .5
24. - add back start up costs .5
25. - reduce lease expense to reflect rate reduction in future .5
26. Calculation of net margin from alcoholic beverage business after normalizing 1
income/sales
27. Based on net margin, alcoholic profits are exorbitant relative to private sector liquor .5
businesses
28. Analysis is based on 1999 income; may be necessary to consider profits over period of .5
time
29. - however would likely produce similar results (with reason) .5
30. PLA may question comparing their profitability to an industry average which is 1
reflective of overall industry versus comparing for example to large chains
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Marking Key
31. - before completing analysis, require more detailed statistics for industry .5
AVAILABLE 13.5/MAXIMUM 13.5
Subsidization of Other Businesses
32. Associations will wish to prove that snack/pharmaceutical businesses are profitable 1
due to subsidization by PLA
33. - therefore need to examine whether costs of services provided by PLA were 1
appropriately charged/allocated to these businesses
34. - cost allocated should be reflective of what the respected items would have cost 1
these businesses as stand alone businesses and allocation method should be
reasonable
35. Use of square footage is reasonable for allocating rent /depreciation as cost correlates .5
with space usage
36. - however, still need to determine whether cost per square foot is similar to rate .5
which could be obtained as stand alone business
37. - allocation is more likely to reflect the true value of rent if allocation takes into account .5
location of store
38. Salaries relating to V.P.=s of pharmaceutical/snack businesses should be allocated .5
fully to these businesses
39. - other salaries (with exception of support staff) should be allocated on bases of time .5
40. - if not possible to allocate on basis of time consider allocating on bases of volume .5
41. Volume will likely not correlate with space due to different turnovers per square 1
foot for each business
42. - calculation of turnover by business (See Exhibit II) 2
43. Sales would likely be more reflective of volume .5
44. As snack bar does not require a full salesperson, they benefit from being able 1
to use a Afraction@ of a salesperson by being affiliated with the PLA
45. Snack bar may have indirectly benefitted from their affiliation with the PLA in receiving .5
the potato chip shelf incentive which might not be available to a small stand alone business
46. Admin costs relating to specific business should be allocated to that business .5
47. Allocate other admin costs on reasonable basis (e.g. sales) .5
48. - need to consider whether due to affiliation with PLA other businesses enjoy 1
lower costs (e.g. due to discounts etc.)
49. Incremental interest related to start up costs of new businesses should be charged to 1
these businesses
50. - interest which can not be traced to a particular business, should be allocated based .5
on size of each business (e.g. sales, asset base etc.)
51. Associations will argue that the new businesses are benefitting from lower rate of 1
interest being paid by the PLA (i.e. 4.2% versus normal rate of 4.9%)
52. - associations also benefit from low level of debt on PLA=s properties 1
Calculation of Adjusted Profitability for New Businesses
53. Candidate attempted to recalculate profitability of pharmacy and snack business 1
Adjustments include:
54. - elimination of potato chip company incentive ($750,000) .5
55. - reallocation of salary for pharmacy 1
56. - reallocation of salary for snack operation 1
57. - reallocation of admin and selling expenses 1
58. - recalculation of store rent to take into account 10% reduction .5
Professional Accounting Supplementary School (PASS) Page 3
Marking Key
59. - allocation of warehouse rent .5
60. - assumption or adjustment re interest expense .5
61. Based on adjusted profitability, pharmacy operation is more profitable than the average 1
pharmacy
62. Snack operation is not profitable 1
63. - therefore appears pharmacy operation is profitable without subsidization / snack 1
operation could not survive without subsidization (explicit statement whether
operations could survive without subsidization)
64. Need to consider PLA=s unfair advantage due to not paying income taxes 1
65. - associations may argue that tax free status should be repealed, for new businesses .5
66. - although PLA pays dividend to province of 15%, it is less than income tax .5
AVAILABLE 27.5/MAXIMUM 27.5
Conclusion
67. Although PLA is making exorbitant profits, this does not result in giving the 1
pharmacy operation an unfair advantage
68. For snack operations, although case can be made that subsidization is present, PLA 1
could argue that given the limited number of products carried the snack operation does
not compete head on with convenience stores
AVAILABLE 2/MAXIMUM 2
Professional Capabilities
69. Student defined terms of assertion made by Associations 1
70. Student normalized income of PLA to determine whether profits are exorbitant 1
71. Student determined profitability of snack/pharmaceutical businesses after correcting 1
cost allocations etc. to reflect true profitability of these operations
AVAILABLE 3/MAXIMUM 3
Overall, the student response:
A marginally passing student must attempt to both normalize the income of PLA and
determine the profitability of the snack/pharmaceutical businesses after correcting for
cost allocations
72. Did not meet, or barely met the marker=s expectation; overall paper was weak 0
73. Clearly met, or barely met the marker=s expectation, and overall paper was adequate 1
AVAILABLE 1/MAXIMUM 1
MAXIMUM 25
Professional Accounting Supplementary School (PASS) Page 3