Subject CB1 Revision Notes For the 2021 exams Company structure, governance and taxation Booklet 1 covering Chapter1 Key principles of finance and corporate governance Chapter2 Business ownership Chapter3 Taxation The Actuarial Education CompanyPAST EXAM QUESTIONS This section contains all the past Subject CT2 and Subject CB1 exam questions from 2010 to April 2020 that are related to the topics covered in this booklet. The questions are divided into two sections: multiple-choice questions and other questions. Solutions are given later in this booklet. For multiple-choice questions, we provide only the answer. Other solutions give enough information for you to check your answer, including working, and also show you what an adequate examination answer should look like. Further information may be available in the Examiners’ Report, ASET or the Course Notes. We first provide you with a list of exam questions in chapter order. You can use this, if you wish, to select the questions that relate just to those aspects that you may be particularly interested in reviewing. Alternatively you can choose to ignore the checklist, and instead attempt the questions without having any clues as to their content. Exam question checklist Chapter Muttiple-choice Other 1 1, 2, 3, 4, 7, 9, 10, 11, 12, 1, 3, 4, 8, 10, 15, 17, 19, 20, 17, 18, 19, 20, 23, 25, 26, 21, 23, 26, 27, 32, 34, 35, 27,28 36, 37, 38 2 5, 6, 8, 13, 21, 22, 24 5, 9, 12, 13, 28, 31, 33 3 14, 15, 16 2,6, 7, 11, 14, 16, 18, 22, 24, 25, 29, 30 Questions with numbers in italics relate to more than one chapter. © IFE: 2021 Examinations Page 33Muttiple-choice questions Subject CT2 April 2010 Question 1 Which of the following statements best describes the duties of a company's board of directors? A The directors should maximise shareholder wealth and ignore externalities. B The directors should maximise shareholder wealth and respect regulatory constraints on the imposition of externalities. C_ The directors should maximise shareholder wealth and seek the greatest possible social benefit. D_ The directors should maximise social welfare. Subject CT2 October 2010 Question 1 Which of the following best describes the role of the stock market in motivating company directors to make sound decisions? ‘A Abadly managed company can be identified by comparison to other quoted companies. B_ Abadly managed company may have its stock market quotation suspended C Abadly managed company will have a low share price and it may be possible to buy a controlling interest and replace the board. D Abadly managed company will report poor profits and the shareholders will complain. Subject CT2 October 2010 Question 10 Which of the following best explains the use of maximisation of shareholder wealth as the basis for finance theory? A Allshareholders are greedy. B It provides a single, clear criterion against which success or failure can be measured. C_ The shareholders require a return for investing. D_ The shareholders require protection from the directors’ ambitions. Page 34 © IFE: 2021 Examinations4 Subject CT2 April 2011 Question 1 Which of the following best describes the concems arising from the agency relationship in companies? ® B Cc D The directors may act in their own interests at the expense of those of the shareholders. The shareholders may have different interests from one another. The directors may be unwilling to consider the company’s duties to society. The directors may put the interests of lenders before those of the shareholders. 5 Subject CT2 April 2011 Question 2 Which of the following best describes the potential exposure of a member of a limited liability partnership (LLP)? * ® Cc we Members of an LLP are not exposed to any risk of loss. The LLP itself could fail, costing each member his or her stake in the business. Each member nag or her share of the LLP’s liabilities. Each member is jointly and severally liable for the liabilities of the LLP. 6 Subject CT2 October 2011 Question 6 Ifa company has the phrase ‘Public Limited Company’ or the abbreviation ‘ple’ after its name you know. é that the company must be large. that the company must be quoted on a stock exchange. that the company must have an established track record. none of the above. © IFE: 2021 Examinations Page 35Subject CT2 October 2011 Question 10 Which of the following best explains why a declining share price is thought to. impose some discipline on weak directors? A The value of the directors’ share options will decline. B__ The shareholders will withdraw their cash from the company. C The cost of capital will be depressed. “D_ The company will be vulnerable to a takeover. Subject CT2 April 2012 Question 2 What aspect of a limited liability partnership (LLP) is ‘limited’? The liability of individual members is limited to £100,000. B_ The liability of individual members is limited to their agreed share of the partnership's liabilities. C Nomember can suffer loss due to the acts or omissions of another member. The LLP’s creditors cannot normally seek payment from the members oemanee Subject CT2 April 2013 Question 1 Which of the following best describes the possibility of an agency relationship between company directors and debenture holders? A There is no agency relationship because the debenture holders are protected by the terms of their debenture. B_ The directors could indulge in risky behaviour that threatens the value of the debenture holders’ stake in the company. The debenture holders do not appoint the directors and so the directors are not the debenture holders’ agents. D__ The debenture holders bear exactly the same agency risks as the shareholders. Page 36 © IFE: 2021 Examinations10 Subject CT2 April 2014 Question 1 "1 12 Which of the following is legally responsible for the commitment owed by a limited company to the company's lenders? the company's directors the company's external auditor the company's shareholders the company’s treasurer, who negotiated the terms of the loan with the lenders Subject CT2 April 2014 Question 2 Which of the following best explains the problems arising from information asymmetry? A B @ D Directors do not always have sufficient information with which to reach sound managerial decisions ‘Shareholders cannot process all of the information that is available to them. ‘Shareholders feel that they do not have sufficient information to evaluate the behaviour of the directors. ‘Some shareholders are better informed than others. Subject CT2 September 2014 Question 1 ‘When considering the maximisation of shareholder wealth, how is shareholder wealth expressed? A a D directors’ estimates share price share price and dividends survey of shareholders © IFE: 2021 Examinations Page 3713 14 15 Subject CT2 September 2014 Question 2 ‘A company has issued £0.25 shares at a premium of £0.20 per share. The shareholders have each paid £0.22 for each share that they hold. What is the maximum liability that each shareholder might bear with respect to each share in the event that the company cannot pay its liabilities? A £0.03 B £0.20 Cc £0.23 D £0.25 Subject CT2 September 2014 Question 3 AUK taxpayer has disposed of four assets during the year. Which of the following gains could be subject to Capital Gains Tax? A The taxpayer purchased a large sum of Euros for use on holiday, which were not spent and were worth more than had been paid for them when converted back to Sterling. ®). The taxpayer had invested in shares issued by his employer and sold them at a gain. © The taxpayer purchased a rare model of sports car, but sold it soon afterwards at a profit because he found it difficult to drive. D_ The taxpayer sold his family home, realising a profit, in order to move to a smaller property. Subject CT2 September 2014 Question 4 AUK taxpayer has eamed income in Australia and has paid tax to the Australian tax authorities equivalent to £10,000. Under UK tax law the income would have been subject to tax of £8,000. Which of the following is most likely to apply? A The taxpayer can reclaim the whole of the tax paid in Australia B_ The taxpayer can offset the £10,000 paid in Australia against the total tax liability arising in the UK. The taxpayer can offset £8,000 against the total tax liability arising in the UK. D_ The taxpayer does not have to declare the income earned in Australia to the UK tax authorities. Page 38 © IFE: 2021 Examinations16 Subject CT2 September 2014 Question 5 (updated) What is the most logical explanation for the requirement that investment income sometimes has tax deducted at source? r to discourage companies from paying dividends B to ensure that taxpayers who have insufficient income to pay tax are required to pay tax on their investment income to enable governments to tax investment income at a higher rate than med income (DF to simplify the collection of tax 17 Subject CT2 September 2015 Question 2 Which of the following best describes the relationships between the interests of major groups of stakeholders in a limited company? A. The directors will ensure that all stakeholders’ interests are satisfied B_ The stakeholders’ interests will often conflict and their relationships will be defined entirely by formal, written contracts. The stakeholders’ interests will often conflict and their relationships will be defined by a combination of contracts and implicit agreements. D_ The stakeholders will work together for their mutual benefit. 18 Subject CT2 September 2016 Question 3 Why might maximisation of profit be a less acceptable corporate objective than maximisation of shareholder wealth? Profit can be a short-term measure of performance only. Profits can lead to pressure to pay dividends. D_ The shareholders do not benefit from profit. ® It is rarely to the directors’ advantage to improve profit. 19 Subject CT2 September 2016 Question 4 Which of the following is an example of an agency problem? The directors might award themselves excessive salaries. The share price may decline because of poor sales. D Interest rates may increase the cost of borrowing er might be difficult to recruit capable directors. © IFE: 2021 Examinations Page 3921 22 23 Subject CT2 April 2018 Question 1 Which of the following best explains why the maximisation of shareholder wealth is said to be the primary objective for company directors? A _ Italigns the directors’ interests with those of the shareholders. B_Iteliminates agency problems. C_ Itmaximises profit. (©) provides a measurable basis for evaluating decisions. Subject CT2 September 2018 Question 1 Which of the following statements about limited companies is correct? A Acompany’s shareholders will never be personally liable for the company’s obligations B_ Asmall company’s shareholders must be directors. C Company directors can be shareholders. D Companies can be managed by professional managers, whereas sole traders and partnerships must be managed by their owners. Subject CT2 September 2018 Question 4 A manufacturing company has been approached by a public limited company (PLC) that wishes to apply for trade credit. Which of the following statements about the applicant's PLC status is correct? A APLC hasa stock market quotation, making it more accountable B APLC has a wide shareholding, reducing the risk of conflicting interests. C APLCisa larger entity than a private limited company. (By APLC is not necessarily more creditworthy than a private limited company. Subject CB1 April 2019 Question 2 Which of the following statements best describes the driver of the market price of a quoted company? A expectations of future revenues expectations of future dividends historical trends of reported profits D__ historical trends of dividend payments: Page 40 © IFE: 2021 Examinations24 Subject CB1 April 2019 Question 3 Martin has just been admitted to a long established business partnership. He has bought 20% of the partnership equity, although he has not paid for this yet. He will be entitled to 15% of the partnership profit. If the firm incurs any liability, what proportion of that liability will be Martin’s legal responsibility? A 0% B 15% C 20% 100% 25 Subject CB1 April 2019 Question 5 Which of the following statements describes the agency problem? Agents may feel that they cannot trust their principals. Agents may have insufficient authority to manage their principals’ affairs. A B (@ Principals may fee! that they cannot trust their agents. D__ Principals may not have the necessary expertise to manage their own businesses. 26 Subject CB1 April 2020 Question 1 Why would the directors of a quoted company spend more than necessary on their external audit? Auditors are greedy and will overcharge if they can. Company directors do not understand the pricing of audit services. Finance directors are frequently recruited from the external audit firm. Qowr To signal that the financial statements are credible in the face of agency concerns. © IFE: 2021 Examinations Page 4127 Subject CB1 April 2020 Question 2 How can the directors of quoted companies deal with the different risk preferences of the many shareholders who have invested in their companies? by aiming to maximise market capitalisation by maxi expected returns, regardless of risk C through minimising risk as much as possible D__ by seeking feedback from shareholders 28 Subject CB1 April 2020 Question 3 Which of the following would be a suitable duty for a non-executive director? participation in the selection of executive directors selection between major mutually exclusive projects D__ selection of the principal supplier for key raw materials @ development of a business plan to support application for bank funding Page 42 © IFE: 2021 ExaminationsOther questions Subject CT2 April 2010 Question 11 Information asymmetry has been identified as a serious problem for shareholders. (a) Explain what is meant by ‘information asymmetry’ in the context of limited companies. (b) Explain the role of financial reporting as a means of resolving information asymmetry for shareholders. 5] Subject CT2 October 2010 Question 12 National tax systems often have the objectives that the tax burden is fair and reasonable. Explain how these objectives are achieved. 6 Subject CT2 October 2010 Question 20 (part) Koolclean pic was founded several years ago by the inventor of an innovative consumer product. The product has been very successful in the UK and the inventor has decided to seek a quote on the Alternative Investment Market (AIM). At present 60% of Koolclean pic's shares are held by the inventor and the remaining 40% are held by a venture capitalist who is keen for the company to list in this way so that his block of shares can be sold. The company has been managed by the inventor herself, assisted by a part- time director appointed by the venture capitalist. The part-time director will ‘step down when the venture capitalist’s block of shares is sold. The inventor is keen to appoint an experienced management team and has decided to offer a remuneration package that comprises a fairly large number of share options and a relatively small salary in order to attract a particular type of manager. (ii) Explain the agency issues that are likely to arise from paying the new directors with share options rather than salaries. (8] Subject CT2 April 2011 Question 11 Comment on the suggestion that the interests of shareholders and lenders can confict. (8) © IFE: 2021 Examinations Page 43Subject CT2 April 2011 Question 12 Simon established an actuarial practice several years ago. The business has been successful. One of Simon's longest-serving actuaries has started to look for alternative employment and Simon is considering offering her a partnership in the practice. Discuss the implications for Simon of making this employee a partner. [5] Subject CT2 April 2011 Question 14 Explain why tax legislation does not permit depreciation as an expense for tax purposes but grants a capital allowance instead. 5] Subject CT2 April 2012 Question 11 (updated) Explain why, from a tax perspective, many individual shareholders prefer to eam a return from an increase in the share price rather than payment of a dividend. 6) Subject CT2 April 2012 Question 14 Four engineers have established a company to manufacture a new product that they have patented. Each of the directors owns 25% of the company’s equity. They have employed a qualified accountant to manage the company’s record-keeping and to engage with potential lenders on the company’s behalf. Describe the respective legal responsibilities of both the company's directors and its accountant in relation to record-keeping and lenders. 15] Subject CT2 October 2012 Question 11 Two actuaries are considering establishing a consultancy business and are considering incorporating as a limited company. The company will have to borrow in order to raise sufficient finance to get started. The actuaries would have to pledge personal guarantees before a bank will grant a loan to their company. Discuss the benefits of incorporating as a limited company in these circumstances. 5] Page 44 © IFE: 2021 Examinations10 1 12 13 14 Subject CT2 October 2012 Question 12 Discuss the implications of the threat of a takeover for the behaviour of a quoted company's directors. 5] Subject CT2 October 2012 Question 14 Describe the implications for companies if it is not clear whether a significant expense is permissible for tax purposes 6 Subject CT2 April 2013 Question 12 Sarah recently inherited a substantial sum of money. Her friend Tom is a successful businessman who owns a small factory. Tom is a sole trader. He has offered Sarah the opportunity to become a sleeping partner in his business. She will invest £200,000 of her inheritance in return for a partnership share of 30% of all future profits. She will not take any part in the running of the business. The business is profitable and is struggling to keep up with demand, so the expansion will probably be successful. Describe the risks that Sarah will be taking on if she enters into this arrangement with Tom. (5) Subject CT2 September 2013 Question 11 Describe the advantages of establishing a business as a limited liability partnership rather than a traditional partnership. 5) Subject CT2 September 2013 Question 14 Discuss the difficulties associated with charging tax on ‘fringe benefits’ to employees. (‘Fringe benefits’ can be thought of as non-monetary rewards — they exclude wages and salaries.) (5) © IFE: 2021 Examinations Page 4515 16 17 18 Subject CT2 September 2013 Question 19 (part) Paul has developed and patented a new product. He requires finance in order to put the product into production. A venture capital company has offered to finance Paul on the basis that Paul will incorporate his business as a limited company. The venture capitalist will provide all of the funding necessary to commence the manufacture and sale of the new product in return for 51% of the equity in this new company. The venture capitalist will appoint a board member and Paul will also be a director of the company. Paul will sign a five year employment contract with the company. Paul's role with the company will be to work on improvements to the original product and to develop new products for sale by the company. In addition to working full-time as an employee, he must patent any new ideas in the company’s name. The company will be independently valued at the end of its first five years. The venture capitalist will then offer Paul the opportunity to buy its 51% holding for that proportion of the independent valuation plus 20%. If Paul does not take that offer then the venture capital company will retain its shareholding and the question of Paul's contract will be reviewed by both sides. () Discuss the benefits of this arrangement to both Paul and the venture capitalist. [10] Subject CT2 April 2014 Question 13 Discuss the suggestion made by the owner of a small UK business that it is unfair that depreciation is not allowed as an expense for tax purposes. [5] Subject CT2 September 2014 Question 11 Explain why the market prices of shares are generally regarded as unbiased reflections of the shares’ ‘true’ value. (5) Subject CT2 April 2015 Question 11 In many countries capital gains are only taxed when the taxpayer disposes of the asset on which the gain has arisen. Describe the implications of delaying the taxation of capital gains until the asset has been sold. 5) Page 46 © IFE: 2021 Examinations19 Subject CT2 April 2015 Question 20 (part) Exesses is a family-owned company that is in the process of recovering from a major corporate scandal. Exesses is a substantial business that is not quoted. None of its shareholders owns more than 5% of the equity shares. None of the shareholders is able to take an active role in the company's, management. Exesses’ directors were all forced to step down because of the discovery that the directors had been overstating reported profits, which had the effect of inflating their profit-related bonuses. The directors also provided themselves with lavish lifestyles at the company's expense. For example, the company provided chauffeur-driven limousines to transport the directors ‘on both business and personal travel. The entire board of Exesses has resigned. The shareholders have met and have appointed a new chairman and a chief executive. Neither of these appointees have had anything to do with Exesses in the past. They have both agreed that their first priority is to appoint a new board and to structure the management arrangements so that the shareholders’ confidence is restored. The chairman has suggested that the new board should be structured as follows: * The chairman will work on a part-time basis and will be responsible for the management of the board, including chairing board meetings. The chairman will be paid a fixed annual salary that offers an appropriate rate for the time that he is expected to commit to the company. * — The chief executive will be employed on a full-time basis to manage the company itself and will receive both a substantial salary and a profit related bonus. * — Four additional full-time directors will be appointed to take charge of particular areas such as marketing and finance. Each will receive a similar package to the chief executive. * Two part-time directors will be appointed to participate in board meetings and to review corporate strategy. They will be paid a fixed salary. * The chief executive and each of the full-time directors will receive a 5% shareholding after satisfactorily completing three years on Exesses’ board. © IFE: 2021 Examinations Page 4721 22 23 * The chairman and the two part-time directors will appoint a new external audit firm. They will negotiate a contract with a much larger firm than the outgoing auditor and will pay a larger fee for the new auditor's services. (Discuss the suitability of the proposals for the appointment and remuneration of the new board of directors from the perspective of maintaining shareholder confidence. [12] Subject CT2 September 2015 Question 11 Describe the relationship between principals and agents according to agency theory. 5] Subject CT2 September 2015 Question 13 Discuss the difficulties faced by underwriters in setting an appropriate fee in respect of an offer for sale at a fixed price. (5) Subject CT2 September 2015 Question 16 Describe ways in which governments can use taxation to incentivise pensions saving. (5) Subject CT2 September 2015 Question 19 (part) Global pic is a quoted company that manufactures petrochemicals. The company has recently patented a new process that will enable it to extract oil from oil wells that had previously been regarded as uneconomic Global plc is confident that the process is fully protected by patent law, so that nobody else can use it without permission. The directors have demonstrated the process to business and oil industry journalists and to television news stations and it has generated a great deal of publicity. Global pic's directors were disappointed that there was very little evidence of an increase in the share price in response to this positive publicity. The process had been a closely guarded secret before the announcement, and nobody outside the company knew that a major project was under development (Discuss the directors’ belief that Global's share price should have increased upon the announcement of the new process. [3] Page 48 © IFE: 2021 ExaminationsSubject CT2 April 2016 Question 11 Describe the role of tax in determining whether an individual shareholder would prefer to receive a dividend or a capital gain. 5] Subject CT2 September 2016 Question 11 Describe why a country might enter into double taxation agreements with other countries. 5) Subject CT2 September 2016 Question 15 Describe the role of the capital markets in disciplining company performance. 6) Subject CT2 April 2017 Question 11 An engineering company has a rival, Bolt, that it is thinking of buying. Bolt's current market capitalisation is $800 million. Explain whether the engineering company should pay more than $800 million in order to acquire this company. 6 Subject CT2 April 2017 Question 12 Three actuaries have decided to establish their own consultancy. Describe the advantages and disadvantages to the actuaries of operating as a limited liability partnership (LLP) rather than a simple partnership. {5} Subject CT2 April 2017 Question 13 Describe why some individual taxpayers may prefer to receive investment retums in the form of capital growth rather than dividends. 6 Subject CT2 September 2017 Question 11 Describe why many countries give individuals a personal allowance which effectively means that income up to that amount is not taxed. 5] © IFE: 2021 Examinations Page 49uM 32 33 35 37 Subject CT2 September 2017 Question 15 ‘Some major accountancy firms have converted themselves from traditional partnerships to limited liability partnerships (LLP). Explain the potential advantages of doing so. (5) Subject CT2 September 2017 Question 16 Test the proposition that agency problems can be eliminated by paying company directors with a mixture of shares and salary. Subject CT2 April 2018 Question 11 Joan is an actuarial consultant who has operated as a sole trader for several years. She has decided to bring Frank, a colleague, into the business. Describe the advantages to Joan of a traditional partnership over a limited company for the business arrangement with Frank. (5) Subject CT2 September 2018 Question 11 Explain how market forces might protect the shareholders in quoted companies from agency problems. [5] Subject CB1 April 2019 Question 11 Discuss the proposition that businesses should take account of social responsibility when conducting their operations. (5) Subject CB1 September 2019 Question 11 Discuss the need for formal and transparent procedures to determine the policy for directors’ remuneration in a quoted company. (5) Subject CB1 September 2019 Question 19 (part) Roundspar, a manufacturing company, needs a new piece of equipment that will cost $70m and is looking at financing the equipment via a loan. The new loan will be secured by a floating charge. (ii) Discuss the potential agency conflicts that might arise between the interests of Roundspar’s shareholders and the providers of debt finance. (6) Page 50 © IFE: 2021 Examinations38 Subject CB1 April 2020 Question 11 Explain the role of share prices in managing the behaviour of the directors of quoted companies. © IFE: 2021 Examinations Page 51SOLUTIONS TO PAST EXAM QUESTIONS Multiple-choice questions BYR HRWNS 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 27 28 PMPFOQCOMODOGOMABMOOCONOMOFOYBOOCOOTPFTDOD Page 52 © IFE: 2021 ExaminationsOther questions Subject CT2 April 2010 Question 11 (a) Information asymmetry An information asymmetry exists in a limited company if different groups of stakeholders do not share the same insights into the company. Information asymmetry often exists between equity shareholders and the managers and directors. Shareholders may be exclusively reliant on the Published financial statements, whereas managers and directors have direct access to the company’s internal figures and communications. These two groups also differ in how easy it is for them to obtain more information. (b) Financial reporting and information asymmetry Financial statements provide shareholders with a true and fair view of the position of the company. The directors’ report and the statements must show all material facts about the position of the company. Financial statements must be produced in line with accounting standards and be audited which increases their credibility. Subject CT2 October 2010 Question 12 To ensure that the tax system is fair and reasonable, taxation systems are often designed with the following principles: * Tax cashflows so that that cash is available to finance the tax payable. * Tax in arrears so that income has been earned before it is taxed. * Tax once: In general, governments will seek to ensure that revenue fiows are taxed only once, eg imputation systems for dividends and double taxation relief which aims to prevent income being taxed twice in separate tax regimes. Other possible features include: * personal tax-free allowances that exempt some basic levels of income or wealth from tax * — higher-rate tax bands for higher earners to ensure they pay more * not levying tax on income spent on certain activities, for example contributing to a pension scheme or charity. © IFE: 2021 Examinations Page 53Subject CT2 October 2010 Question 20 (part) (i) Share options Granting share options aligns the interests of the new directors with the inventor and other shareholders. The new directors will have an incentive to perform well and improve the company’s share price, yet will also share the risk of underperformance. ‘The strike price on the options will need to be realistic. If the strike price is too high, (or the options vest too soon) it might encourage the directors to take on excessive risks or grow the company too quickly to drive up the share price. If the directors see the possibility of their options expiring with no value they may become uninterested. Alternatively they may take an ‘all or nothing’ risk as they have nothing to lose (while the inventor has everything to lose). Options are more valuable if the share price is more volatile. Again this may encourage more risk taking by the new directors than the inventor is comfortable with, Subject CT2 April 2011 Question 11 Shareholders own the residual profits of the company. Lenders want to ensure that their interest is paid and their capital is repaid at the end. Where interests are aligned with one another Both shareholders and lenders want the company to succeed and avoid bank«uptcy. If the company failed, lenders would receive neither interest nor capital repayments; and shareholders would receive no dividends and would hold worthless shares. Where interests conflict with one another Shareholders would be happy to take some risks within the company ifit is likely to generate profits, especially t the cone in Se Lenders, however, a an can pay te inlerestand borrowed capital. the company is in trouble, they would not want to take risks if this further reduces the amount that they are likely to recover from winding up the company Page 54 © IFE: 2021 ExaminationsShareholders would also be happy in certain circumstances to raise extra debt finance. If the company’s prospects are good, raising equity finance shares the profits between lots of new shareholders and may be unpopular. However, debt holders would normally prefer equity finance to be raised as it adds to the security of their loans. Subject CT2 April 2011 Question 12 The employee may be motivated by the new responsibility and potential rewards of partnership. The result of this might be: * she may stay with the business. This might be important if she is ‘tong- serving’ and has acquired useful knowledge and skills or the business has become dependent on her. * she may work harder because of the potential profits. The new partner would have to buy into the partnership with her own cash. This cash might be invested in the business and help it grow. Or it might go to Simon if he is selling her some of his existing partnership. Since, in a partnership, all partners are jointly and severally liable, any mistake by the employee, either as a partner or as an employee, could have serious implications for Simon. It may be more likely that a major mistake is made if the employee receives new responsibilities at the same time as becoming a partner. Partnerships have partnership agreements, where the rights of the partners are documented. This would need to be changed to add the employee as a partner, which would involve costs. Subject CT2 April 2011 Question 14 Depreciation can be calculated in many ways and is therefore highly subjective. For example, managers can choose to depreciate a cost over a long or short period and can choose to depreciate using the reducing balance method or on a straight-line basis. The implication is that the depreciation charge can be manipulated higher or lower, which would mean that the tax liability could be manipulated. Capital allowances are stipulated by the tax authorities and are therefore not subjective. They do not need justifying or checking © IFE: 2021 Examinations Page 55Capital allowances can also be used to encourage investment in fixed _ assets by companies If the capital allowance in the first year is a high proportion of the cost of the asset, then companies will be able to show a high capital allowance and therefore incur a low tax charge in the initial year. Paying less taxis a cashflow advantage to the company. Subject CT2 April 2012 Question 11 (updated) Income from investments may be added to other income such as salary, and be taxed at a taxpayer's highest marginal rate. In the UK this can be in excess of 40%. There may however be a tax-free allowance, ie an amount of certain types of investment income that is tax-free. Capital gains are usually taxed at a lower rate (eg in the UK since April 2016 the rate for most chargeable gains is either 10% or 20%). Income is taxed when it is received with no freedom to manage the timing of the income. Gains can be realised at a convenient point in time, for example, at the same time that an investor realises a loss. Then aggregation of gains and losses is allowed. Losses can likewise be carried forward if they are realised in a year where there are no gains for aggregation. They can then be used to aggregate a gain in a subsequent year. Investors receive an annual capital gains allowance which can be used up before gains are taxable. Again, in the UK, this allowance is higher than the allowance for income. Subject CT2 April 2012 Question 14 The directors The directors are ultimately legally responsible farallfinancialissues, including those to do with record-keeping and borrowing. TheyGannot pass this responsibilitpon to an accountant through any contract, Page 56 © IFE: 2021 ExaminationsIn practice, they can hire other professionals to carry out tasks that they are not entirely competent with, for example accounting and bookkeeping. As he ‘may not have expertise in this area. They can also expecta high standard of work from any professional they recruit, and could sue if they thought that there had been intentional fraud or incompetence. But they could not pass the legal responsibility onto the accountant. Likewise, they can ask the accountant to liaise with banks and lenders on their behalf, and to agree contracts, but the legal liability and the duty to manage the business so as to meet any covenants agreed with lenders rests gather shoudes The accountant As a memberof.a-professional body, the accountant would be judged by the standards set by that body. If his work was found to be substandard or fraudulent, he could be accountable to the profession. For example, if the accounts did not meet all accounting standards, the accountant could be disciplined by his profession. As he is employed to meet with lenders he will be responsible for drawing up loan covenants and checking that these are not breached, and this would be stated in his employment contract. Subject CT2 October 2012 Question 11 Limited liability: Incorporation as a company would limit the liability of the consultants. Future lenders would have a claim against the company's assets but not those of the individuals who own it. The exception to this is the bank loan which is backed by personal guarantees. Ease of raising capital: It would be easier for a limited company to raise capital, both now and in the future, than it would for other types of business, eg partnership. This is because potential providers of capital may be reluctant to become involved as a part owner of a partnership since they risk their entire personal wealth. With limited liability, lenders should be much more willing to provide capital. eee confidence: A company will need to satisfy minimum reporting (audited provided the business is amen certain size). This information may give investors more confidence in the company, making capital more available and possibly less costly. © IFE: 2021 Examinations Page 5710 "1 Ease of valuation: Where shares are quoted on an exchange, their value is easily determined. rtnership may have difficulties determining the ‘value’ Of a part ownership: if not quoted, the clear separation of a company from its owners means that the value of the company should be more easily determined than that of a partnefShip) This would be an advantage if the actuaries were looking to sell the consultancy in future. Subject CT2 October 2012 Question 12 The directors act on behalf of the shareholders (who elected them). If a predator wishes to take over, ie to obtain sufficient shares to have control of the company, it is likely to have to pay more than the current market price of the shares. Logically, it only makes sense for a predator to offer this higher price if it believes the company (and its shares) will be worth more after the takeover. To achieve this higher value is likely to require a change in the operations of the.company. Typically, new senior management will be brought in to implement changes. _ So, faced with the threat of a takeover, a company’s directors may encourage shareholders to reject the bid in_an effort to safequard their jobs and reputations. However, ireciors aaa oo the Boat act in interests of the shareholders and so must recommend a bid if it is considered to be the shareholders’ best option. Subject CT2 October 2012 Question 14 Ifit is not clear whether a significant expense is permissible for tax purposes, considerable uncertainty is introduced for the company over the amount of tax it will need to pay (and also over its final published financial statements). This uncertainty will introduce a need to spend time and expertise in consultation with the Revenue. This will take up management time that may be better spent on other aspects of running the company. It is also likely to incur fees, eg from tax professionals. As the expense involved is significant, the company is likely to be prepared to commit time and money to getting the expense classified as allowable for tax purposes. If the issue is also significant for the Revenue (for example, as a precedent for how other similar cases may be dealt with), then the Revenue will also be prepared to commit resources. Page 58 © IFE: 2021 Examinations12 13 The uncertainty will also restrict the ability of the company to make plans, eg being uncertain about recent and estimated future profitability, especially if similar expenses will be incurred in relation to future projects. Subject CT2 April 2013 Question 12 $ a sole trader, Sarah would be (jointly and severally) liable for all debts of the company were it to wind up. She could lose everything, including the remainder of her inheritance. Even though she is only a 30% owner, she may be Table for T00% of the debts of a failed business. ‘She will participate in any profits, but if the venture proves unprofitable, she will also participate in the losses. This is_more likely if the new capital is going to be used for significant expansion. If her-fiendship.withLom.ends, it may be difficult to maintain a working relationship with her partner in the business. As a sole trader it will be difficult to find someone to whom to sell her share in the business. Also, as a sleeping partner, she would not be able to influence the cunning of the company if she thought that the risks were becoming higher or the business was being badly run. If the £200,000 sum is a significant proportion of her overall wealth and a significant part of the inheritance, then she will have a lot tied up with Tom's business. This lack of diversification may bé@ Worry. SSS Subject CT2 September 2013 Question 11 The main advantage of an LLP is the limited liabilities of the members of the partnership. In a traditional partnership, the partners have unlimited liability. They are jointly liable for any business debts. They will also be ‘severally liable’. So, each individual is at risk of large liabilities due to the actions of others. A limited liability partnership separates the members’ business from their Personal wealth. The LLP is a separate legal entity, and this protects the members’ personal wealth being called on if the LLP’s assets are insufficient to meet its liabilities. However, even in an LLP, actions may be taken against individual members who are found to be negligent or fraudulent in their dealings. © IFE: 2021 Examinations Page 5914 15 Subject CT2 September 2013 Question 14 The definition and value of certain fringe benefits may be unclear, leading to uncertainty about what should be included and what monetary value should be taxed, Benefits that don't have an easily identifiable cost will be particularly tricky, eg the value of free or subsidised housing will be difficult to establish. This leads to practical problems such as the need for employees, employers and the revenue to keep and check records. For example, if a company car is available for private use, reliable records may be needed of the split between each employee's private and company mileage It will be difficult for the revenue to ensure consistent application of any rules relating to these matters across different employers. Taxation of fringe benefits may reduce the perceived value of these forms of reward to employees, especially if they do not fully appreciate the value of the benefit. Subject CT2 September 2013 Question 19 (part) () Benefits of the arrangement Paul benefits as the arrangement Provides the finance to enable his new Product to go into production. The venture capitalist benefits from the potential return to be made on the capital, if the new product can profitably be put into production. Incorporating as a limited company will provide both Paul and the venture capitalist with the advantages of limited liability. Paul benefits from not having to provide any of the finance and not having to try and raise it from other sources. Paul benefits from not having contractual interest payments, which a debt provider could demand even in the event of short-term cashflow problems. The venture capitalist will provide further capital in future if needed. The advantages of an equity stake to the venture capitalist include the ability to share in the upside if the venture is a success. This also benefits Paul, as the venture capitalist is more incentivised to support the business to maximise its growth. Both the venture capitalist and Paul will benefit from being able to provide board input and decision making. Page 60 © IFE: 2021 Examinations16 17 his Employment and probably salary: It benefits the venture capitalist as it, in conjunction with Paul's equity stake, provides certainty about Paul's commitment and continued involvement in the business. The five-year employment ss provides Paul with greater certainty over Paul benefits from potentially being able to bring any new products he develops over the next 5 years to market, within the existing structure, with its infrastructure, contacts and finance. The option gives Paul the opportunity to gain complete ownership and control of the company. It also gives him clear timescale for raising the necessary finance to buy the venture capitalist's stake. It also benefits the venture capitalist as it incentives Paul to maximise the success of the company, given he may ultimately be its sole owner. Subject CT2 April 2014 Question 13 Companies have a great deal of discretion in their depreciation policies, which can have a significant effect on profits. Two companies with identical assets may choose different methods, residual values or asset lives resulting in very different depreciation figures. Within unds of what is acceptable to the auditor, policies may be chosen which deliberately reduce profits. If this was the basis for company taxation, companies may be able to avoid or defer tax liabilities beyond the control of the tax authorities. Hence, (in the UK) the tax authorities disallow depreciation as a business expense. However, in its place companies may deduct a capital allowance. Capital allowances are effectively a standardised depreciation schedule. Subject CT2 September 2014 Question 11 The true value of an asset could be considered to be ‘what someone is prepared to pay for it’ The market share price is objective — a transaction at a particular price has been observed in the market. Because the market involves the interaction of a large number of investors, the share price in the market can be considered to be unbiased. The market price will be an up to date value of the share. © IFE: 2021 Examinations Page 6118 19 Market prices of shares are usually publicly available, and so reliable and capable of verification. The market price of a share will reflect all the known information about the company and its prospects, eg competitive position, future prospects, and Not just the more limited information in a company's financial statements. Subject CT2 April 2015 Question 11 The taxpayer has a much greater degree of control over the timing of the sale of an asset and Nene Sa COTTE THe selec be timed to ‘Take the best possible use of any tax allowances, eg by deferring a sale to the next taxyeor or ofkeling canal loses The sale of the asset, and hence the tax, can be delayed indefinitely. This However, government tax receipts are delayed. As tax is levied at the time of sale the taxpayer has cash with which to pay the tax bill, is not forced to sell the asset to pay the tax and the tax is based on an actual market value transaction (rather than an estimate which may be incorrect or need to be subsequently revised). Subject CT2 April 2015 Question 20 (part) (@ The new board of directors New chairman's role Itis good practice to separate the roles of the chairman and chief executive. This enables the chairman to oversee the board independently from the management. A fixed salary means the chairman has no incentive to take too much risk in pursuit of higher profits, or manipulate the accounts. The chairman will be keen to maintain his reputation by ensuring the company is well managed and the problems of the past are not repeated. New CEO role The CEO can focus full-time on the day-to-day management of the company. S/he is incentivised to do a good job for shareholders with the promise of a bonus for good performance, but runs the risk of losing his job and the substantial salary for poor performance. Page 62 © IFE: 2021 ExaminationsNew full-time director roles The full-time directors are similarly incentivised by the prospect of profit- related bonuses. As they have specific areas of responsibility, directors can be appointed with relevant skills and expertise to manage these areas well. New part-time director roles The part-time directors will support the role of the chairman. They will help provide advice and guidance, as well as oversee the management on behalf of shareholders. Similar to the chairman, the fixed salary means they are not personally dependent on the profits of the company and can be more impartial. They will want to enhance their reputations for overseeing well-managed companies and will ensure tight controls on expense expenditures are in place. Share bonus The CEO and full-time directors will be further incentivised to work on behalf of the shareholders by the prospect of a substantial shareholding in the company. The shareholding will be more valuable if the company succeeds and the share price increases. A.5% shareholding is highly significant compared to the current owners’ shareholdings. This would put the new CEO and directors on a par with the other family owners The three-year period ensures the management are not too focussed on short-term profits and are making decisions for the longer-term. Presumably this is consistent with the family shareholders’ objectives. Overall, shareholders should be reasonably confident that the new arrangements will protect their interests. The executive directors will have to be committed to the company and will have incentives to increase profitability over the longer term, but there will be strong oversight from the chairman and the part-time directors. © IFE: 2021 Examinations Page 6321 Subject CT2 September 2015 Question 11 Principals (eg shareholders) often need to appoint agents (eg managers) to make decisions on their behalf. The agents’ interests may be in conflict with those of the principal. For example, company managers may not wish to reveal information about problems with the performance of the company as it may endanger their job security. Shareholders incur costs to: * monitor the managers, eg pay for auditors * _ influence the actions of managers to be aligned with the shareholders, eg offer performance-related pay. Ultimately, manifest conflicts between principals and agents and excessive agency costs may impact adversely on the company's share price. Subject CT2 September 2015 Question 13 Advantages of a finance lease to acquire an asset: * as the lessee never owns the asset, the lessor retains ownership and may take possession in the event of default by the lessee. This security is likely to reduce the cost of the lease relative to using unsecured debt to purchase the asset. * such leases are often very flexible and can be constructed to meet the lessee’s needs (eg costs of servicing may be built into the lease terms giving a known cost over the life of the asset) * the lessee has no interest or responsibility for the asset once the lease is concluded, unlike if they had bought the asset and had a debt to repay. Disadvantages of a finance lease to acquire an asset: * the lessee is committed to the lease for the duration of the term. The lessee may not be able to replace the asset even if they not no longer require it or it becomes obsolete. if the asset had been purchased using the proceeds from a loan, it could have been sold if it was no longer required, and the lending repaid or a replacement bought. Page 64 © IFE: 2021 Examinations22 Subject CT2 September 2015 Question 16 Contributions to pension schemes attract tax relief. This makes it cheaper for individuals to save for retirement through a pension plan. This is particularly valuable for higher-rate taxpayers. Similarly, companies typically also receive tax relief on the payments they _make towards providing for pensions foriberamplayees ‘ide a pension are free of tax on investment income and free from capital gains tax. When a pension is payable, most individuals have a lower level of income than in employment. They therefore benefit from lower rates of tax on their income by deferring their income to retirement. There may be other tax-related incentives to save in a pension, such as the ability to take a tax-free cash sum on retirement. 23 Subject CT2 September 2015 Question 19 (part) ()_ Belief that the share price should have increased In theory, the investors will determine the share price as the net present value of anticipated cashflows. The announcement of the patented process should create the expectation of enhanced cashflows and so the share price should increase. However, in practice, the share price may not increase for a variety of reasons: \ investors and the capital markets may have already broadly anticipated such investments in such projects ... * __... $0, the announcement may simply confirm investors’ current expectations about the future growth in the company that they have already factored into the share price A investors may not agree with the directors about the prospects for this new process and discount the future value ‘the shareholders may not have been given full information (possibly ‘some details are still confidential) about the possible future cashflows and expected returns ... © IFE: 2021 Examinations Page 65©... and so are unable to reach the same optimistic conclusion as the directors ww the shareholders may feel that the risks are greater than the directors claim and reflect this in their lower valuation * indeed, they may believe the directors have a natural bias to overstate Le value of the opportunity or understate the risks @ the announcement may have been made at a bad time, when company share prices generally are depressed in the market. 24 Subject CT2 April 2016 Question 11 Dividend income is taxed alongside all other income, whereas gains are subject to capital gains tax. Difference in these systems may mean a shareholder prefers to receive income or gains. Allowances — both systems have allowances before tax is payable. Capital gains allowances tend to be higher than allowances for income. Rates — capital gains tax rates tend to be lower than income tax rates. Timing - it is generally not possible to control the timing of dividend income. It may be received at a time when an individual is subject to high marginal tax rates or has up their personal allowance. An individual has a much greater degree of control over the timing of any CGT liability. The sale can be timed to make the best possible use of any tax allowances, eg by deferring a sale to the next tax year, or offsetting capital losses. 25 Subject CT2 September 2016 Question 11 In general, governments will seek to ensure that revenue flows are taxed only once in the hands of the recipients. Where companies and individuals oS SS eS income or capital gains from overseas, these cashflows may end up being taxed twice — once in the country of origin, and then again locally. Double taxation relief (DTR) means that the local tax authority will allow taxpayers to offset tax paid overseas against their liability to domestic tax on that income or capital gains. Hence, this may be considered fairer by taxpayers. Page 66 © IFE: 2021 Examinations28 By not penalising those investing overseas, DTR encourages overseas investment. Chis stimulates exports and international trade and has wider economic bene! Such arrangements are usually reciprocal to ensure mutual benefit to both countries and may deter taxpayers from otherwise avoiding tax. Subject CT2 September 2016 Question 15 See Core Reading Questions 20 and 21 Subject CT2 April 2017 Question 11 The $800m market capitalisation will reflect the market's view of the company’s future earnings. In theory, it reflects an assessment of all information about the company and its future prospects and so represents an unbiased valuation of the company’s shares. It may be worth the engineering company paying more in order to acquire the company if it believes that it can improve Bolt’s future performance so that the future earnings are higher than those reflected in the current valuation. For example, the engineering company’s management may believe it is ‘superior to Bolt’s current management and that its better management of the business will lead to higher profits. Alternatively, the combined company may benefit from economies of scale, which would justify paying more than current market capitalisation ‘So, it may be worth engineering company paying more than $800m in order to acquire control of Bolt and benefit from these synergies. Subject CT2 April 2017 Question 12 Advantages of limited liability partnership (LLP) Operating as an LLP would limit the liability of the consultants. The LLP is a separate legal entity which would mean that future lenders would have a claim against the LLP’s assets, but not against the personal assets of the three actuaries. © IFE: 2021 Examinations Page 67Disadvantages of LLP If lenders are concerned about the limited liability of the actuaries, then they may seek additional security when lending that would constrain the extent to which the actuaries could limit their liability in practice. For example, lenders could seek personal guarantees from the actuaries to take over responsibility for any liabilities in the event that the LLP defaults. Potential clients may regard the LLP status negatively, regarding it as. implying a lack of confidence from the actuaries in the advice that they provide Subject CT2 April 2017 Question 13 Allowances: the amount of the tax-free allowance for capital gains may be higher than the allowance for dividend income. Rate of tax: the rate at which an individual pays capital gains tax may be lower than the rate at which they are taxed on income. Deferment: tax on capital gains only becomes due when the gain is actually realised (ie at some point in future when the shares are sold). Planning: an individual typically has more control over when they sell shares and realise a gain, which may enable them to time their disposals to make best use of their tax-free allowances. In particular, an individual could spread sales over a number of years, to maximise the use of annual allowances, rather than make a single, larger gain in one year. Subject CT2 September 2017 Question 11 A tax-free personal allowance is generally seen as a fair way of taxing people: * those on low incomes benefit as they can keep all (or most) of their income * those on higher incomes receive less benefit as the tax-free element of their earnings may be relatively small Thus the system helps ensure that the tax burden falls on those who can most afford it. Page 68 © IFE: 2021 Examinationsvn This may relieve the government from the need to otherwise subsidise low income households through the benefits system. It is time-consuming and expensive to collect small amounts of tax. Removing a large number of earners from paying tax reduces the overall cost and improves the efficiency of tax collection. Subject CT2 September 2017 Question 15 The main advantage of an LLP is that the liabilities of the accountants (the members of the partnership) is limited. In a traditional partnership, the partners have unlimited liability. They are jointly Rabie for any business debts. ot ereemnrmnrnonpormecnere saa deficiencies of the partnership. So, each individual is at ‘isk of large liabilities due to the actions of others. A limited liability partnership separates the members’ business from their personal wealth. The LLP is a separate legal entity, and this protects the members’ personal wealth being called on if the LLP’s assets are insufficient to meet its. liabilities However, even in an LLP, actions may be taken against individual members who are found to be negligent or fraudulent in their dealings. Subject CT2 September 2017 Question 16 Principals (eg shareholders) often need to appoint agents (eg directors) to make decisions on their behalf. The agents’ interests may be in conflict with those of the principal. For example, directors may be reluctant to risk their salary and career on a risky business venture even if itis in the interests of the shareholders. Paying a salary alone does not align these interests. The directors have no incentive to maximise shareholders’ wealth. Granting shares aligns the interests of the directors with the shareholders. The directors will have an incentive to perform well and improve the company’s share price, yet will also share the risk of underperformance. © IFE: 2021 Examinations Page 6933 The extent to which this solves the agency problem depends on the balance of salary to shares. Only paying a small number of shares will do little to solve the problem as the directors will have little incentive. Subject CT2 April 2018 Question 11 A partnership is a much simpler arrangement. Joan and Frank simply need to agree a partnership arrangement to go into business immediately. Frank can pay an agreed sum into the business and his capital and future profits can be shared in accordance with the agreement. A limited company would require the requirements of the Companies Act to be met, eg submitting audited financial statements. Lenders and creditors of the business know that Joan and Frank are personally liable for partnership debts. Subject CT2 September 2018 Question 11 Company directors will generally wish to maintain strong market share prices. If the company is not as well managed as it could be then market prices can be expected to drop. Price falls could signal the market's dissatisfaction with the directors and could result in a change to the directors’ behaviour in response. For example, if the shareholders are concerned that the directors will abuse their positions as agents, the directors could view that as an incentive to send out a positive signal such as hire a more creditable audit firm to demonstrate a commitment to transparency Market forces give the directors an incentive to maximise shareholder wealth. For example, if they waste money then the share price will fall, creating the opportunity for a bidder to offer a premium in order to acquire a controlling interest and correct matters by replacing the directors. Page 70 © IFE: 2021 Examinations38 Subject CB1 April 2019 Question 11 Social responsibility means taking account of ethical considerations and externalities, that affect many different stakeholders, as well as the maximisation of shareholder wealth. For example, these externalities include pollution, product safety and job security. Taking account of these items may involve short-term costs for a business, eg in reducing polluting emissions or in offering job security by retaining existing staff rather than moving production to cheaper locations ‘Such costs may reduce short-term profits, so businesses could choose to maximise short-term shareholder profit and not take account of social responsibilities, unless required to do so by regulation. However, in the longer-term, businesses taking into account their social responsibilities may actually be aligned with maximising shareholder wealth. For example, their responsible actions may lead to higher future sales. 36 Subject CB1 September 2019 Question 11 Formal policies set out the basis for deciding directors’ remuneration and give an established process to follow, so represent good corporate governance. The board is required by the UK Corporate Governance Code to put such procedures in place. Transparent procedures will enable all stakeholders to understand how directors’ remuneration is set and how it might motivate the directors. If directors are remunerated via share options this creates an incentive to manipulate share prices so that options are valuable when they are exercised. In the absence of formal and transparent remuneration procedures, directors could grant one another excessive salaries and other benefits. Allegations of excessive and unjustified directors’ pay attract negative publicity and formal and transparent procedures help promote shareholder confidence. © IFE: 2021 Examinations Page 7137 Directors can negotiate and sign contracts, including remuneration packages, without seeking the shareholders’ permission. Transparency around directors’ remuneration will help to reduce agency conflicts. Paying just a basic salary may not offer an incentive to excel because the rewards will be the same regardless of performance. Performance-related remuneration can raise problems if it encourages dysfunctional behaviour. Subject CB1 September 2019 Question 19 (part) (iil) Agency conflicts between shareholders and lenders The potential conflict between shareholders and the providers of debt finance may arise from the lenders’ short-term desire for security differing from the shareholders’ long-term interest in the development of the pany, This is especially true if the company is near insolvency as the shareholders may be keen for the directors to take risks to help turn the company around. Such a risky strategy would benefit the shareholders if it succeeded with little cost for them if it failed (as the shares may be near worthless anyway) ... ... whereas lenders may not wish to see their capital placed in jeopardy and do not share in the upside of successful projects (beyond their fixed return). Directors must make decisions in the best interests of the shareholders, whereas debt finance providers have little influence over the company's decisions. Loan agreements may give the lenders certain rights if the company breaches their contract, eg if a loan payment is late or gearing exceeds a given level. But if the company does not breach these conditions it can make decisions in the best interest of shareholders without interference from the lenders. Shareholders may wish to withhold information from lenders if disclosing that information may mean lenders demand repayment of their loan. Page 72 © IFE: 2021 Examinations38 Subject CB1 April 2020 Question 11 Shareholders’ main aim is to maximise their wealth. Management may have different interests, eg pursuing projects that personally interest them rather than the most profitable projects. A company's share price is a reflection of the market's perception of its current and expected future performance. "Ifa company’s directors are performing poorly, the share price will decrease. * This in turn will raise questions from investors about the quality of management. If the company’s share price falls enough, then it will become a target for takeover by a predator company. The predator company is likely to bring its own management team on board, meaning job losses for current management. ‘Share prices tend to be driven by informed, competent investors. If such investors think that a company’s management is performing badly, these investors will sell their shares and other less informed investors will then notice a fall in share prices and likely follow suit. © IFE: 2021 Examinations Page 73FACTSHEET This factsheet summarises the main methods and formulae required for tackling questions on these topics. You should not refer to this sheet until you have tackled all of the Core Reading Questions at least once. How to find a shareholder's liability for debts A shareholder's liability is limited to the fully paid-up value of his or her shares and if shares have been issued ‘partly paid’ then in the event of liquidation, the shareholder will be liable to pay the outstanding instalments. For example, if Mrs X holds 10,000 50p shares that are 50% paid up, then in the event of liquidation, she could be asked to contribute £2,500 to help towards the settlement of the company’s debts. If the shares were issued at 70p, the 20p share premium would have to have been paid at the outset, so if 25p of the nominal value had been paid, then in the event of liquidation, she could be asked to contribute £2,500 to help towards the settlement of the company’s debts. How to calculate taxable profit from accounting profit Taxable profit is: accounting profit + non- allowable expenses + depreciation — capital allowances - special reliefs Page 74 © IFE: 2021 Examinations