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Question 1

Assume the date is 8 November 2022

Zoomer Electric Cycles Ltd (ZEC) manufactures electrically powered bicycles (e-bikes) at its
factory in south-east England. Sales are made to consumers in the UK and mainland Europe.

You are an ICAEW Chartered Accountant who has recently joined ZEC’s strategy team. The
head of that team, Kamila Sienka, calls you into her office and opens the discussion:

‘I would like your help on a few matters. As you are new to ZEC, I have provided background
information and financial data on the e-bike industry and the company (Exhibit 1).

‘The ZEC board is pleased with the recent growth in sales, but success has created its own
problems. The board has asked me to report on the following matters:

‘The board is concerned about the capacity and reliability of ZEC’s inward supply chain. The
procurement director, Tracy Karne, has prepared a working paper (Exhibit 2) on the supply of e-
bike frames, a major component bought from two suppliers: Horace Ltd and Basten Inc.

‘The board wishes to expand production capacity by opening an additional factory. The
production director, Mark Bradney, has provided briefing notes (Exhibit 3).

‘The finance director, Elaine Howe, has identified two alternative methods of financing the
additional factory and she has provided notes (Exhibit 4).

‘I have set out instructions explaining in detail what I would like you to do regarding the above
matters (Exhibit 5).’

Requirement

Respond to Kamila’s instructions (Exhibit 5).

Total: 55 marks

Page 2 of 23
Exhibit 1: Background information and financial data – provided by Kamila Sienka, head
of ZEC strategy team

E-bike industry and market background

E-bikes are similar to traditional bicycles, but they have a battery and a small motor. This
reduces the effort needed by the rider to pedal, enabling longer journeys to be covered
irrespective of the rider’s level of fitness.

The most common use of e-bikes is for cycling to work, particularly in large cities. However, they
are increasingly being used for leisure purposes as an alternative to traditional bicycles.

The retail market for e-bikes has grown rapidly over the past few years. In 2021, the UK retail
market was worth £360 million, with 210,000 e-bikes sold and the retail market in mainland
Europe was worth £9,800 million in 2021, with 5.2 million e-bikes sold. Since 2021, both
geographical markets have experienced annual growth in volume terms of about 30%. This has
created shortages for consumers, long lead times and price increases.

Prices of e-bikes for consumers vary significantly depending on the frame, battery and motor. A
basic e-bike can be purchased for about £1,000. However, at this lower end of the market the
frames are made of steel, which makes the e-bike heavier. Towards the upper end of the
market, e-bikes are priced at around £4,000. These e-bikes have alloy or lightweight carbon
fibre frames and technology enhancements.

Company background

ZEC’s mission is: ‘To promote profitability for shareholders by enhancing mobility and promoting
sustainability through protecting the environment.’

ZEC manufactures a range of e-bikes with lightweight carbon fibre frames. The company
currently operates from a single factory in south-east England, located 10 kilometres from the
seaport of Dover to give easy access for imports from and exports to mainland Europe.

All ZEC’s sales are directly to consumers through its website. About 45% of ZEC’s e-bikes are
sold to UK consumers, with the remainder sold throughout mainland Europe, where ZEC’s
largest export markets are Germany, France and the Netherlands.

In the year ended 30 September 2022, ZEC e-bikes ranged in price from £2,100 to £4,200.

To simplify production, all ZEC e-bikes use the same high-quality lightweight carbon fibre frame.
ZEC imports about 70% of all its components by value from mainland Europe. The remainder
are from UK suppliers.

ZEC experienced significant sales volume growth in the year ended 30 September 2022. As a
result, the company operated at, or near, full production capacity for most of the year.

On 1 October 2022, ZEC was able to increase its prices by 20% as a result of increasing
demand. This is expected to result in the same sales volume of e-bikes for the year ending 30
September 2023 as for the year ended 30 September 2022.

Page 3 of 23
Inventories of e-bikes have been consistently low, as they are delivered to customers as soon as
they are produced.

ZEC’s accounting year end is 30 September and its functional currency is the £.

Corporate Governance

There are four executive directors:

• Sheena Tuladar – CEO

• Mark Bradney – production director
• Elaine Howe – finance director
• Tracy Karne – procurement director

Shareholdings at 30 September 2022 were:

Shareholder Comments Number of

group ordinary shares

Executive The four executive directors each own 12,500 50,000

directors ordinary shares in ZEC.

Venture capital Vattex required the appointment of a non- 20,000

firm – Vattex executive director, Holly Hanns, to represent its
interests on the board.

Private Approximately 100 private investors hold 30,000

investors ordinary shares in ZEC.

TOTAL 100,000

In addition to Holly Hanns, there is one other non-executive director, Sundeep Colley, who is
chair of the board. Sundeep was appointed to represent the interests of private investors and
has the casting vote if there is equal voting at a board meeting.

In August 2022, a large international competitor, Cyclonex Inc, offered £42 million to acquire the
entire ordinary share capital of ZEC. After giving it serious consideration, the ZEC board decided
to refuse the offer, claiming that it did not fully reflect the growth potential of ZEC.

Page 4 of 23
Extracts from the statement of profit or loss for the year ended 30 September

2022 2021
£000 £000
Revenue 59,664 42,720
Cost of sales:
Components – e-bike frames (10,450) (7,885)
Components – other (6,000) (4,750)
Labour costs (9,960) (7,180)
Variable overhead costs (2,688) (1,735)
Gross profit 30,566 21,170
Distribution and administration costs (23,900) (17,140)
Operating profit 6,666 4,030
Finance costs (240) (240)
Profit before tax 6,426 3,790

Extracts from the statement of financial position at 30 September

2022 2021
£000 £000
Non-current assets
Property, plant and equipment 4,840 4,620
Current assets
Inventories 1,740 1,210
Trade and other receivables 1,660 1,470
Cash 5,570 5,140
Total assets 13,810 12,440

Equity
£1 ordinary shares 100 100
Retained earnings 4,110 2,986
Non-current liabilities
Bank loans 6,000 6,000
Current liabilities 3,600 3,354
Total equity and liabilities 13,810 12,440

Other operating data 2022 2021

Number of e-bikes sold 22,600 17,800

Cost per e-bike frame – Horace Ltd £471 £451
Cost per e-bike frame – Basten Inc £450 £431

Page 5 of 23
Exhibit 2
ZEC’s supply chain for e-bike frames – working paper prepared by Tracy Karne,
procurement director

Each e-bike has a single frame. Other components are added to the frame in the manufacturing
process, so production cannot commence unless an e-bike frame is available. A reliable supply
of e-bike frames is therefore essential to production efficiency.

Current suppliers of e-bike frames

ZEC currently has two suppliers of e-bike frames: Horace Ltd and Basten Inc. Each supplier
provides almost identical carbon fibre frames, which are used interchangeably by ZEC in
production.

Horace Ltd

Horace is based in northern England, about 350 kilometres from the ZEC factory. Horace
provided approximately 60% by volume of ZEC’s e-bike frames in the year ended 30 September
2022. Horace has been working at near full capacity in recent months.

Horace and ZEC agreed to a 5% price rise from 1 October 2022. Horace invoices ZEC in £.

Basten Inc

Basten is based in Belgium. It provided approximately 40% by volume of ZEC’s e-bike frames in
the year ended 30 September 2022. Basten currently invoices ZEC in £.

Basten is operating at full capacity and has been unable to satisfy all the demands of its
customers, including ZEC. This has caused delayed deliveries and shortfalls in quantities
delivered by Basten. However, on 1 October 2023, Basten intends to open a new production line
which will significantly increase its production capacity.

Basten proposed a 10% price rise from 1 October 2022. ZEC has not accepted this proposal,
but negotiations are continuing. Basten agreed to continue supplying e-bike frames to ZEC after
1 October 2022, on the condition that, once negotiations had been completed, it could invoice at
the revised prices for all e-bike frames supplied from that date.

Basten’s latest alternative proposal is a 5% price increase for e-bike frames supplied from 1
October 2022, but with invoicing to ZEC in €, instead of £, from that date.

The ZEC board is considering both price proposals.

Reliability of supply

The ZEC board has concerns about the reliability of its suppliers of e-bike frames, including the
proportion of on-time deliveries and the number of faulty items delivered.

Page 6 of 23
The agreed terms in the contracts with both e-bike frame suppliers include:
• delivery within 7 days of the order
• a defect rate of no more than 1 in 100 e-bike frames delivered.

The procurement team has gathered data on orders and deliveries from both suppliers of e-bike
frames in the months of June and July 2022 (see pre-populated spreadsheet).

Increasing supplies of e-bike frames from 1 October 2023

Demand for ZEC’s e-bikes, in volume terms, is expected to continue to grow in the next few
years as a result of growth in the industry. ZEC needs to source sufficient e-bike frames to
expand production to meet the increased demand.

Two choices have been identified for the four-year period from 1 October 2023:

Choice 1 – select one of the two current e-bike frame suppliers as the preferred supplier.

The chosen supplier would need to increase the quantity of e-bike frames supplied to ZEC under
a four-year contract from 1 October 2023. This contract would specify a guaranteed minimum
quantity of e-bike frames to be supplied, with penalty clauses for any shortfall. The supplier that
is not chosen would be asked to supply ZEC’s remaining requirements for e-bike frames.

Choice 2 – select a third supplier from 1 October 2023.

ZEC’s existing two suppliers would continue to supply similar annual volumes as they did in the
year ended 30 September 2022. In addition, from 1 October 2023, a third supplier, located in
mainland Europe, would supply e-bike frames to meet the incremental demand, as ZEC’s sales
volumes grow above the existing level. Over the four years from 1 October 2023, the new
supplier would invoice in € under annual contracts which would set out minimum volumes and
provide scope for annual price reviews. Preliminary discussions suggest that a new supplier
would charge the equivalent of £500 per e-bike frame at 1 October 2023.

Page 7 of 23
Exhibit 3
Opening an additional factory – briefing notes prepared by Mark Bradney, production
director

The current factory near Dover will continue to operate at its full annual capacity of 22,600 e-
bikes over the four years from 1 October 2023 to 30 September 2027. It is not possible to
expand the existing factory because of government planning restrictions in the area.

The ZEC board therefore wishes to expand its production capacity at an alternative location to
satisfy increasing demand for its e-bikes. The additional factory will be used to satisfy the
incremental annual demand above 22,600 units.

Two alternatives have been identified:

• a factory in Hastings, in south-east England, about 50 kilometres from the existing factory
• a factory in the Netherlands, in mainland Europe.

Summary data

Alternative 1 Alternative 2
Hastings Netherlands

Initial investment in plant and machinery (P&M) £20m €23m

Useful life of P&M from 1 October 2023 4 years 4 years
Residual value of P&M at 30 September 2027 nil nil
Maximum annual production capacity 16,000 e-bikes 25,000 e-bikes
Variable production cost, in cash terms, per e-bike £1,700 €1,800
Annual fixed production cost, in cash terms – £10 million €15 million
including cash paid for factory rentals

Working assumptions for both alternatives:

• Either factory building will be leased for a period of four years from 1 October 2023.
• The initial investment comprises plant and machinery (P&M). It will take place on 1 October
2023 and production will commence on this date.
• Overall demand for ZEC e-bikes is expected to increase, in volume terms, by 20% per
annum in the four years to 30 September 2027.
• The selling price of ZEC e-bikes will average £3,168 and consumers will continue to be
invoiced in £.
• Variable production cost per e-bike and annual fixed production costs will remain constant
over the four-year period in the local currencies.
• All production costs will be paid at year ends, in £ for the Hastings factory (if it is selected) or
in € for the Netherlands factory (if it is selected).
• For the period from 1 October 2023 to 30 September 2024, the exchange rate will remain at
£1 = €1.15. From 1 October 2024 to 30 September 2027, the € will then appreciate against
the £, by 2% per annum. Exchange rates will move evenly within each year.

Page 8 of 23
• An annual interest rate of 6% is to be used for discounting.
• Ignore tax.

Board meeting

A board meeting was held on 31 October 2022 to discuss the potential expansion of production
by opening a new factory. The directors were presented with the above summary data and
working assumptions.

The production director, Mark Bradney, opened the discussion: ‘We need to select one of these
two alternatives. If we do nothing, the company will stagnate, with zero growth for many years.
The financial benefits and risks need to be considered carefully, but non-financial factors are
also relevant.

The CEO, Sheena Tuladar, joined the discussion: ‘We need the additional production capacity to
be located close to our main export markets in Germany, France and the Netherlands. It is clear
to me that, given the two alternatives, we need to produce in the Netherlands.’

The finance director, Elaine Howe, disagreed: ‘If we produce in the Netherlands, we expose
ourselves to currency risk. I also believe that the € will appreciate against the £ by 3% per year
from 1 October 2024 to 30 September 2027 and not, as in the working assumption, by 2% per
year.’

The board meeting ended without a decision and the board asked for further analysis.

Lease rentals – Netherlands factory

If the new factory in the Netherlands is selected, factory rentals will be €1.2 million per annum
paid annually in arrears over the four years from 1 October 2023 (ie, the first rental payment is
on 30 September 2024).

The annual interest rate implicit in the lease is 10%, based on € amounts.

The factory will be returned to the lessor on 30 September 2027.

Page 9 of 23
Exhibit 4
Financing the additional factory – notes prepared by Elaine Howe, finance director

ZEC intends to raise £20 million on 1 October 2023, to finance the initial investment in an
additional factory, either in Hastings or in the Netherlands.

I have identified two private equity funds, Green Finance Investments (GFI) and Lintern Finance
(Lintern). The ZEC board wants to select one method of finance as soon as possible.

Method 1 – GFI

GFI is a small, UK-based, private equity fund which specialises in investments in companies
which are environmentally aware, such as ZEC.

GFI is willing to invest £20 million on 1 October 2023 to acquire 50,000 newly-issued ordinary
shares in ZEC. Terms and conditions include the following:

• GFI will require the appointment of one executive director and one non-executive director to
the ZEC board on 1 October 2023. Both directors will provide advice on sustainability,
including environmental policy, based on their wide experience of helping other companies
with their sustainability policies and practices. Neither director has business experience in
the e-bike industry.
• The ZEC board agrees to an AIM listing by 30 September 2027. GFI has declared its
intention to sell its ZEC shareholding, following this listing, as an exit route.
• As part of a new shareholder agreement, the ZEC board agrees that no dividend can be paid
before 30 September 2027.

Method 2 – Lintern

Lintern is a large, private equity fund with operations and investments throughout Europe. It
invests in a narrow range of industries, including bicycle and motor-bike manufacture.

Lintern is willing to provide funding on the following basis:

• A £6 million loan to ZEC on 1 October 2023. Interest is payable annually in arrears, at 7%,
with a bullet repayment of principal on 30 September 2027.
• £14 million cash on 1 October 2023 in return for:
o 33,000 new £1 ordinary shares in ZEC; and
o a call option on a further 1,000 new ordinary shares in ZEC, exercisable before 30
September 2027, at an exercise price of £440 per share.

Terms and conditions include the following:

• Lintern will require the appointment of a non-executive director. The director will provide
business strategy and business management advice, based on a wide experience of helping
other companies. The director has little specific experience in sustainability and
environmental policies and issues.
• The ZEC board agrees to an AIM listing by 30 September 2027.

Page 10 of 23
• As part of a new shareholder agreement, the ZEC board agrees that no dividend can be paid
before 30 September 2027.

Page 11 of 23
Exhibit 5
Instructions – prepared by Kamila Sienka, head of strategy team

1. Regarding the supply chain for e-bike frames for ZEC (Exhibit 2):

(a) Assimilate and analyse the data in the pre-populated spreadsheet in relation to
the number of:
• late deliveries
• defective items.
You are not required to discuss the results.

(b) Evaluate and explain the relative performance of the two suppliers relating to
delivery dates and defective items. In so doing, use your results in (a) and the
information in Exhibit 2.

(c) Using the information in Exhibit 2 and the other information available, explain and
evaluate the benefits and risks of the two choices for increasing the supply of e-
bike frames. Provide a reasoned recommendation.

2. Regarding the decision to open an additional factory (Exhibit 3):

(a) Explain and evaluate whether the new factory should be located in Hastings or the
Netherlands and provide a reasoned recommendation. Include a calculation of the
NPV for each factory at 1 October 2023, using the working assumptions.

(b) Assuming that the ZEC board decides to locate the new factory in the Netherlands:
• Calculate and explain the impact on the NPV if the € appreciates against the £
by 3% per annum, as suggested by the finance director.
• Set out the financial reporting treatment of the Netherlands factory lease in
ZEC’s financial statements in each of the four years to 30 September 2027.
Assume the € will appreciate against the £ by 3% per annum, as suggested by
the finance director.

Notes:
Ignore methods of financing (Exhibit 4)
Ignore tax and deferred tax.

3. Explain and evaluate the factors that the ZEC board should consider in choosing between
the two methods of financing from the private equity funds (Exhibit 4).
Provide supporting calculations and a reasoned recommendation. Ignore tax.

Page 12 of 23
Question 2

Assume the date is 8 November 2022

Premier Hearing plc (PH) is listed on the London Stock Exchange. It manufactures high-quality,
technologically-advanced hearing aids.

You are an ICAEW Chartered Accountant and you have recently joined PH’s internal assurance,
review and monitoring team (IARM) as its deputy head. The PH technology director, Rose
Rogers, met with you and said:

‘I need your help as I have been asked to report to the next board meeting on a number of
issues. The head of IARM is currently ill, so I would like you to report directly to me. As you are
new to PH, I have provided background information on the hearing aid industry and PH
(Exhibit 1).

‘At a recent meeting, the board considered PH’s digital assets. Some directors expressed
concern about whether our digital assets represent value for money for PH, given the cost of
creating them. They also want to determine a value for PH’s digital assets and evaluate the
performance of its devices. I have provided more details (Exhibit 2).

‘At the same board meeting, the marketing director, Andy Anders, proposed new pricing
strategies for one of PH’s hearing aids. Andy has provided relevant information (Exhibit 3).

‘Emera Evans, the finance director, has raised ethical concerns about two matters. I have
provided you with Emera’s note to the board outlining these concerns (Exhibit 4).

‘I would like you to address the above matters so that I can report to the board. I have set out
instructions in a separate document (Exhibit 5) explaining what I would like you to do.’

Requirement

Respond to the instructions from the PH technology director, Rose Rogers (Exhibit 5).

Total: 45 marks

Page 13 of 23
Exhibit 1
Industry and company background information – provided by PH technology director,
Rose Rogers

Industry background

Hearing impairment is a common and growing medical problem worldwide. Hearing impairment
can occur in all age groups, but it is most common in older people.

A hearing aid (device) is designed to improve the hearing of users who are suffering hearing
impairment. Surgical procedures can treat some types of hearing loss, but the use of a hearing
aid is often the most effective treatment.

In many countries, the public sector health care service provides hearing aids free or at a
reduced price. However, government financial constraints mean that there are limits on the
number and quality of the devices that can be provided.

More technologically-advanced hearing aids can be purchased in the private sector. These are
normally fitted by specialist professionals (audiologists) working for pharmacists, private clinics
or specialist retailers.

Over the past 10 years, there have been many advances in hearing aid technology, including
smartphone compatibility, Bluetooth connectivity and artificial intelligence (AI). This has resulted
in a very competitive private sector market for hearing aid manufacturers, with a wide variety of
quality and prices.
Company background

PH sells its hearing aids in the UK private sector only.

A consumer (user) who requires a hearing aid visits a pharmacist, private clinic or specialist
retailer. An audiologist recommends and fits a suitable hearing aid device for the user, supplied
by PH or one of its competitors.

The contract for the sale of the device is between PH and the user. The user pays separately for
the audiologist’s services.

PH has three types of device in its portfolio of hearing aids. PH’s marketing team works with
audiologists to identify the users who are most suitable for each of its devices and encourages
audiologists to recommend suitable PH devices to potential users. For some potential users, all
three types of device are suitable, but for other potential users none of them is suitable.

PH has a large research and development (R&D) department which is responsible for
developing new types of hearing aid and supporting software to establish competitive
advantage. In 2021, a new AI-based hearing aid device and its supporting software were
patented by PH. The hearing aid (including the supporting software) was branded Synthetic
Intelligent Audio (SIA). Most of SIA’s R&D activities related to the software, rather than to the
SIA device. On 1 January 2022, sales of SIA commenced.

Page 14 of 23
PH has a financial year ending 31 December.

Page 15 of 23
Exhibit 2
Digital assets and performance of PH’s devices – prepared by technology director, Rose
Rogers

The board is undertaking a review of PH’s digital assets. These are assets held in digital form,
including software and data.

The board is concerned about the level of R&D expenditure being incurred to create digital
assets and devices. In particular, the finance director is concerned about whether the amount
spent on R&D is justified by the benefits that PH derives.

The board also wishes to value the digital assets to better understand their worth to the
business. However, there is no agreement on the most appropriate method of valuation.

The board has decided to evaluate the SIA project as an example.

The SIA technology

SIA is an AI-based hearing aid device with supporting software. It is marketed as an in-the-ear
computer with connectivity and transmissibility. SIA analyses surrounding noises for the user
and makes immediate adjustments to facilitate better hearing for a wide variety of sounds in
many different environments.

Whilst AI is not new in the hearing aid industry, SIA software is a stage ahead of competitors’
products in its real-time machine learning algorithms which adapt to different environments and
to the personal attributes of each user.

The SIA also collects and transmits data from the user’s device back to PH. The data captured
includes how much time a user was engaged in conversation and how long they wore the
hearing aid each day. The company is then able to learn from this data how to improve future
products and software.

PH has consent from users to monitor and analyse the data captured from SIA.

Digital assets relating to the SIA project

In the review of digital assets, two separate assets were identified relating to SIA:
• The software supporting SIA devices.
• The data captured by PH from transmissions by each user’s device.

Other devices

Apart from SIA, PH produces and sells two other types of hearing aid:
• DeepBlue uses Bluetooth technology connected to a user’s mobile phone. This
technology was new in the industry when DeepBlue was launched, but it is now
commonplace.
• Audex is a basic device which is suitable for mild hearing impairment only. There are
number of similar devices in the market produced by competitors.

Page 16 of 23
Financial data

PH has gathered the following preliminary information on the three devices, for comparative
purposes:

Revenue
Years to 31 December
Device Date Product life Price Gross
(with launched cycle per profit 2020 2021 2022
relevant from device margin Estimated
software) (1 January) launch £000 £000 £000

SIA 2022 4 years £3,000 40% - - 14,400

DeepBlue 2019 5 years £1,800 30% 11,520 10,368 8,294

Audex 2017 8 years £800 15% 16,000 15,200 14,440

Notes
• Gross profit margins exclude R&D costs and are expected to be similar in 2022 for DeepBlue
and Audex to that experienced in 2020 and 2021.
• Future growth rates beyond 2022 are uncertain for all devices.
• The product life cycle is the period when PH expects to sell the devices and supporting
software, before they are superseded by new versions or innovations developed by PH.
• The devices and software will continue to be useable beyond the end of the product life
cycle.
• The price per device includes the hearing aid and initial supporting software.
• PH uses an annual interest rate of 10% to evaluate projects’ NPVs.

SIA project – Post-implementation internal assurance review

At its recent meeting, the board asked IARM to undertake a post-implementation internal
assurance review to evaluate the SIA project to date.

The SIA project was selected for review as it is a recently implemented project from which the
board wishes to learn lessons about future R&D investment. There is no intention to abandon
the SIA project, but the board wishes to understand whether, with the benefit of current
knowledge, the original decision to invest still seems to have been appropriate. Different
opinions were expressed at the board meeting.

The finance director, Emera, argued: ‘The board needs to know whether all the benefits that PH
is likely to gain from the SIA project will outweigh all the costs that have been and will be
incurred, including R&D. I estimate that these R&D costs totalled £20 million in present value
terms at the date of SIA’s introduction on 1 January 2022. I do not believe that, with hindsight,

Page 17 of 23
the project represents value for money as we will never recover the R&D outlay. Although there
is some uncertainty, I think that SIA sales volumes will remain constant at their 2022 level over
the product life cycle. In my opinion, it would have been better if the R&D project on SIA had
never been started.’

The marketing director, Andy Anders, disagreed: ‘We can’t just look at the direct financial costs
and benefits. We could not have continued with only the two existing devices, DeepBlue and
Audex – this would have been unsustainable. We need to consider wider strategic and operating
factors which will inform future investment decisions on new devices.’

Page 18 of 23
Exhibit 3
Proposed new pricing strategies – prepared by marketing director, Andy Anders

Estimated sales volumes of SIA for 2022 are disappointing. Market research has revealed that,
while many potential users of hearing aids believe that SIA is worth the price, they find it difficult
to afford the total amount all at once at the time of purchase.

I therefore believe that, from 1 January 2023, we should sell the SIA (device and software) on a
subscription basis, where users make quarterly payments over three years for SIA supplied
during 2023. I believe that this would significantly increase sales volumes for SIA. If the
subscription model is successful, we can extend it to future years’ sales of SIA and to our other
products.

I asked the treasury department to provide some figures for various pricing strategies for SIA.

Treasury department figures

Three mutually exclusive choices were identified. In each case, the user is paying for the device
and initial supporting software.

Choice 1
Continue to sell SIA for £3,000 each, with the full amount payable by the user on the day of
purchase.

Choice 2
Provide SIA on a subscription basis for a payment of £319.66 per quarter for the three years
following the purchase date. This subscription price includes annual hearing tests for the
user, including checking the device. Subscriptions would be payable to PH by the user every
three months, with the first payment being three months after the day of purchase. The user
would be contractually committed to making all 12 payments. Ownership passes to the user
at the end of the three-year period.

Choice 3
This choice uses the same subscription basis as Choice 2, except that PH would then sell the
subscription contract rights, without recourse, to a bank, immediately after a user’s purchase.
The bank would pay PH £2,539 for each SIA to acquire the subscription rights. The quarterly
rentals of £319.66 would then be payable by the user to the bank.

The treasury department uses an annual interest rate of 10% to evaluate projects.

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Financial reporting concerns

The board would also like to understand the impact of the three choices on the financial
statements for the year ending 31 December 2023 using, as an example, the sale of one SIA on
1 January 2023.

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Exhibit 4
Ethical concerns, note to the board – prepared by Emera Evans, finance director

I am writing to inform the PH board of my ethical concerns about two separate matters:

Length of subscription contracts

The proposals to sell SIA under three-year subscription contracts (Exhibit 3 – Choice 2 and
Choice 3) are, in my opinion, unethical.

The product life cycle of SIA is estimated to end on 31 December 2025. This means that many
consumers will be tied into their SIA device later than this. They will still be paying subscriptions
for SIA past the end of the product life cycle, when better and more suitable products will be
available. If the subscription model for SIA is extended into new sales in 2024, this will make
matters worse.

Many consumers of SIA are old and vulnerable. To sell them devices that may become outdated
during the subscription period is, I believe, mis-selling and unethical.

Relationships with audiologists

It is good that PH works closely with audiologists. However, audiologists have an important role
in advising potential users about the most appropriate hearing aid, including the selection of
devices made by PH or by its competitors.

It concerns me that PH is attempting to provide inappropriate inducements to audiologists to

recommend its devices to users in preference to the devices of competitors.

I am not suggesting that PH is making any direct cash payments to audiologists. It is more
subtle than that. For example, PH held a seminar for audiologists to update them on recent
technical developments in PH devices. As a concept, this is fine. However, the only audiologists
invited were those who had recommended a minimum number of PH devices in the previous
year. All expenses were paid by PH for the seminar in a luxury hotel in Switzerland over three
days, with only two hours per day devoted to technical presentations. The audiologists were
invited to bring a guest with them.

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Exhibit 5
Instructions from technology director, Rose Rogers

I would like you to draft notes for me addressing the following matters.

1. Using the information in Exhibit 2:

(a) Evaluate:
• the performance of SIA for the year ended 31 December 2022 compared with
the other two devices for the three years to 31 December 2022; and
• whether the SIA project is likely to be ultimately beneficial to PH.

Consider financial and non-financial benefits, costs and risks.

(b) Explain and critically evaluate any methods that PH could use to determine an
appropriate commercial value for the following digital assets:
• The software supporting SIA devices.
• The data captured from each user’s SIA device.

You are not required to calculate a value for these digital assets.

Ignore:
o financial reporting rules
o tax
o the proposals in Exhibit 3.

2. For the post-implementation internal assurance review for the SIA project (Exhibit 2),
set out the assurance and review procedures to be carried out in respect of the
relevant historical data and forecast data, including any underlying assumptions.

3. Regarding the proposed new pricing strategies for SIA (Exhibit 3):

(a) Calculate the annual implicit interest rate earned by the bank under Choice 3.
(b) Evaluate each of the three choices and provide a reasoned recommendation.
Consider financial, operating and strategic issues. Show, using the treasury
department’s figures, supporting calculations for a sale on 1 January 2023 of one
device.
(c) For each of the three choices, set out and explain the financial reporting treatment
of the sale of one SIA on 1 January 2023 in PH’s financial statements for year
ending 31 December 2023.

Ignore:
o the concerns raised in Exhibit 4.
o tax and deferred tax.

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4. Set out any ethical issues for the PH board arising from the two matters raised by the
finance director, Emera Evans (Exhibit 4). Recommend any actions that the PH board
should take in respect of these matters.

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