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BSB110 ACCOUNTING

SOLUTIONS TO REVISION QUESTIONS FOR FINAL EXAM

QUESTION 1
(a) Gatton Gardeners Cash Flow Statement
For the year ended 30 June 2007
Inflow
(Outflow)
Cash flows from operating activities
Receipts from customers 241000
Payments to suppliers & employees (221000)
Net cash provided by operations 20000

Cash flows from investing activities

Purchase of equipment (3000)
Purchase of land (10000)
Net cash used in investing activities (13000)

Cash flows from financing activities

Capital contributed 3000
Increase in mortgage 30000
Drawings (40200)
Net cash used in financing activities (7200)
Net (decrease) in cash held (200)
Cash at beginning of year 5200
Cash at end of year 5000

(b) --cash is not related to profitprofit of $1600 and cash decreased by $200
--profit is based on accrual accounting measured as revenue earned less expenses incurred
not cash in or cash out
--need to be clear about difference between cash balance and profit
--best way to explain to Gary is via the Cash Flow Statement
--the cash provided by operating activities ie. Related to profit activities is $20,000 ie. the
cash inflows from profit activities is much greater than the accrual profit of $1600.
--need to explain how cash decreasedhe invested in additional assets equipment and land
total of $13,000
--he withdrew $40,200 and this is the major contributor to decline in cash balancethis
amount does not affect profit but does affect cash balance
--he increased the mortgage and did contribute additional capital but only to the extent of total
of $33,000
--so overall the major factor causing the decrease in cash is the drawings he made

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QUESTION 2
(a) Kody Anthony
Cash Flow Statement for the year ended 30 June 2006

Cash Flows from Operating Activities:

Receipts from customers 39,300
Payments to suppliers and employees (35,700)
Net Cash provided by Operating Activities 3,600

Cash Flows from Investing Activities:

Payment for land (15,000)
Payment for plant and equipment (3,300)
Net Cash used in Investing Activities (18,300)

Cash Flows from Financing Activities:

Capital contributions 9,000
Proceeds from Long-term loan 12,000
Drawings (3,600)
Net Cash provided by Financing Activities 17,400

Net increase in cash held 2,700

Cash held at the beginning of the financial year (1,200)

Cash held at the end of the financial year $1,500

(b) See Lecture Notes

QUESTION 3
(a) Albert Clarence
Cash Flow Statement for the financial year ended 30 June 2005
Cash flows from operating activities
Receipts from customers 41470
Payments to suppliers and employees (23085)
Net cash provided by operating activities 18385
Cash flows from investing activities
Payments for purchase of office furniture (13600)
Payments for purchase of delivery vehicles (26835)
Net cash used in investing activities (40435)
Cash flows from financing activities
Increase in borrowings 11640
Capital contributed 15000
Drawings (7535)
Net cash provided by financing activities 19105
Net (decrease) in cash held (2945)
Cash at beginning of year 260
Cash at end of year $(2685)

(b)

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Net profit = Accrual basis accounting $6030.

Ie. Revenue EARNED less expenses INCURRRED. Not just cash items but includes all
accruals, prepayments, and credit transactions
Cash flows = only cash items included
Net decrease in cash = $2945
Net profit is related to cash flows from operations
But cash flows from operations does not include: depreciation, Bad debts expense,
Prepaid expenses, Accrued expenses, Credit transactions
ONLY CASH
Cash profit
Cash is used for other purposes besides profit, ie. Investing and Financing
Investing = purchase and sale of non current assets
Financing = liabilities and equity
For Albert, - cash used in investing $40435
- net cash inflow from financing $19105
-net cash provided from ops $18385
Main reason why cash decreased was the Investing activities

QUESTION 4
(a) Louisa Hannah
Cash Flow Statement for the year ended 30 June 2006

Cash flows from operating activities

Receipts from customers 5980
Payments to suppliers (3420)
Net cash provided by operating activities 2560
Cash flows from investing activities
Purchase of office equipment (2100)
Purchase of delivery vehicles (1550)
Net cash used in investing activities (3650)
Cash flows from financing activities
Proceeds from borrowings 1600
Capital contributed 1000
Drawings (1230)
Net cash provided by financing activities 1370
________________
Net increase (decrease) in cash held 280
Cash at beginning of year ______(100)_____
Cash at end of year ______$180______

(b) Can a company have a good net profit and little cash generated from operations in the
same year? Provide an explanation including examples to justify your answer.
Yes net profit based on accrual accounting - if large amounts of sales on credit but
little amount of collections from customers
Also if payments to suppliers is greater then purchases on credit
Then there will be little cash generated from operations but large profit
Cash flow Statement based on CASH flowsnot accrual accounting.

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QUESTION 5
(1) INVENTORY CARDAVERAGE COST
Date Explanation Purchases Cost of Goods Sold Balance
Un Unit Total Un Unit Total Un Unit Total
it Cost Cost it Cost Cost it Cost Cost

Jan 1 Balance 4 1500 6000

Mar 3 Purchase 5 5 1608 8040 9 1560 14040

Apr 9 Sold 6 6 1560 9360 3 1560 4680

May10 Purchase 6 6 1620 9720 9 1600 14400

Aug 22 Sold 4 4 1600 6400 5 1600 8000
Total $15760
Ending Inventory = $ .....8000...........
Cost of Goods Sold = $ ...15760.........

(2) INVENTORY CARD--FIFO

Date Explanation Purchases Cost of Goods Sold Balance
Unit Unit Total Unit Unit Total Unit Unit Total
Cost Cost Cost Cost Cost Cost
Jan 1 Balance 4 1500 6000
Mar 3 Purchase 5 1608 8040 4 1500 6000
5 1608 8040
Apr 9 Sales--6 4 1500 6000
2 1608 3216 3 1608 4824
May Purchase 6 1620 9720 3 1608 4824
10
6 1620 9720
Aug Sales4 3 1608 4824
22
1 1620 1620 5 1620 8100
TOTAL 17760 15660
Ending Inventory = $8100
Cost of Goods Sold = $15660

(3) The calculations are different because we have used two different inventory costing
methods for the inventory cardsFIFO and Average Cost
Note that in this question, inventory purchase price (cost) rose during the month.
The effect of this is dependent on the Inventory Costing method used
--FIFO ending inventory (asset) is higher than Average Cost
--FIFO Cost of Goods Sold (expense) is lower than Average Cost
--thus FIFO profit is higher than Average Cost.

The opposite effects would occur if inventory purchase price fell during the period

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(4) The best valuation of inventory depends on what management wants to achieve and its
goals for the firm.
Because, the costing method used affects assets and profits
Management must choose the most appropriate method
Depending on the type of inventory that the firm is selling
This then in an important decision for Management
The items affected by the inventory costing method are:
*COGS
*Gross Profit
*Net Profit
*Inventory in the Balance Sheet and
*Owners Equity (as net profit is affected)
--The specific unit cost method assigns each inventory item its particular cost. The specific
unit cost method is used for inventory items that are individually identifiable, like jewels and
motor vehicles.
--The average cost method assigns the weighted-average cost of inventory available during
the period to ending inventory and cost of goods sold.
--Under the first-in, first-out (FIFO) method, the first inventory costs incurred during the
period are assigned to cost of goods sold. The latest unit costs are assigned to ending
inventory. When prices are rising, FIFO produces the highest reported profit.
--Under the last-in, first-out (LIFO) method, the last inventory costs incurred during the period
are the first to be assigned to cost of goods sold. The earliest unit costs of the period are
assigned to ending inventory. When prices are rising, LIFO produces the lowest
reported profit.
In general: FIFO results in the ending inventory being valued at the most current cost. The
earliest costs of the period are assigned to cost of goods sold, leaving the last (that is, the most
current) costs for ending inventory. LIFO results in the cost of goods sold amount being
valued at the last (the most current) cost.

QUESTION 6
(1) Inventory Card--FIFO
Date Explanation Purchases Cost of Goods Sold Balance
Unit Unit Total Unit Unit Total Unit Unit Total
Cost Cost Cost Cost Cost Cost
Apr 1 Balance 7 220 1540
2 Purchase 12 225 2700 7 220 1540
12 225 2700
4 Sales--10 7 220 1540
3 225 675 9 225 2025
10 Purchase 14 230 3220 9 225 2025
14 230 3220
18 Sales--16 9 225 2025
7 230 1610 7 230 1610
22 Sales--4 4 230 920 3 230 690
TOTAL 6770
Ending Inventory = $ 690 Cost of Goods Sold = $ 6770

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(2) Inventory CardAverage Cost

Date Explanation Purchases Cost of Goods Sold Balance
Unit Unit Total Unit Unit Total Unit Unit Total
Cost Cost Cost Cost Cost Cost
Apr 1 Balance 7 220 1540
2 Purchase 12 225 2700 19 223.1 4240
579
4 Sales--10 10 223.15 2231.58 9 2008.42
79
10 Purchase 14 230 3220 23 227.3 5228.42
226
18 Sales--16 16 227.32 3637.16 7 1591.26
26
22 Sales--4 4 909.29 3 681.97
TOTAL 5920 6778.03
Ending Inventory = $681.97 Cost of Goods Sold = $6778.03

(3) Highest profit for April is the method with the LOWEST cost of goods sold = FIFO.

QUESTION 7
(a)
5/4 Inventory 1,400
Accounts PayableGolden Ltd 1,400

10/4 Accounts PayableGolden Ltd 250

Inventory 250

14/4 Accounts PayableGolden Ltd 1,150

Cash 1,150

(b)
11/3 Accounts ReceivableP. Scott 900
Sales 900

Cost of Goods Sold 300

Inventory 300

16/3 Sales Returns and Allowances 150

Accounts ReceivableP. Scott 150

Inventory 50
Cost of Goods Sold 50

21/3 Cash 750

Accounts Receivable 750

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(c) 1. Sales - Sales Returns & Allowances = Net Sales = $21,500 - $165 = $21,335

2. Net Sales - Cost of Goods Sold = Gross Profit = $21,335 - $15,975 = $5,360

3. Gross Profit - Operating Expenses = Net Profit = $5,360 - $1,650 = $3,710

QUESTION 8

(EXTRACT) CASH RECEIPTS (EXTRACT) CASH PAYMENTS JOURNAL

JOURNAL
Total to date 56,431 Total to date 68,798

NSF (540) Bank Charges 35

Note Receivable 2,650

Interest earned 74

TOTAL $58,615 TOTAL $68,833

CASH AT BANK ACCOUNT

Balance
Date PR Debit Credit
Debit Credit

1 Oct Bal 2,287

31 Oct CRJ 58,615 60,902

31 Oct CPJ 68,833 7,931

Bank Reconciliation at 31October

Balance as per Bank Statement 31 October--credit 6,484 CR

Add deposits in transit 2,937

9,421

Less Outstanding cheques 18,432

9011 o/d

Less Bank error on cheque no. 424 1080

Agrees with balance as per ledger cash account--credit 7,931 CR

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QUESTION 9

Cash Receipts Journal $ Cash Payments Journal $

Total to date 4778 Total to date 3896
Bill Receivable 650 Bank charges 25
NSF (100) $3921
$5328

CASH AT BANK A/C

DEBIT CREDIT BALANCE
April 1 Balance 13641
April 30 CRJ 5328 18969
CPJ 3921 15048

Bank Reconciliation
As at 30 April
Balance as per Bank Statement 30 April 15405 CR
Add outstanding deposit 570
15975
less bank error on Chq no. 828 100
15875
less Unpresented cheques:
No. 818 369
827 248
830 210 827
Balance as per Cash at Bank A/C in ledger 30 April $15048 DR

QUESTION 10

Schedule of Cash Collections

CREDIT SALES JULY AUGUST SEPTEMBER
April $15600 1560
May $14500 5800 1450
June $12800 6400 5120 1280
July $16100 8050 6440
August $11200 5600
TOTAL $13760 $14620 $13320

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QUESTION 11
Hannah's Hair Fashions--Cash Budget for May
Cash balance at 1 May 775
Add receipts
Collections from customers
60% of May sales 2200 1320
40% of April sales 1760 704
Cash available 2799
Less payments
Purchases
70% of May 1320 924
30% of April 1020 306

Rates 270
Rent 150
Wages 550
New equipment 180
Total payments 2380
Cash balance at 31 May $419

(ii) If Hannah wants to maintain a cash balance of $600 she will need to CONTRIBUTE
additional cash of ($600 419) = $181

QUESTION 12

(a)
Cash Receipts Journal $ Cash Payments Journal $
Total to date 387 Total to date 459
Dividend received 100 Fee 10
NSF (22) Int. on O/D 82
$465 $551

CASH AT BANK A/C

DEBIT CREDIT BALANCE
May 31 Balance 3742 CR
June 30 CRJ 465 3277 CR
CPJ 551 3828 CR

Bank Reconciliation As at 30 June

Balance as per Bank Statement 30 June 3532DR
Add Unpresented cheques
No. 7392 200
7407 21
7411 135 356
3888
less Deposits not yet credited 17
16 33
3855
less Bank error Chq No 7412 27
Agrees balance as per ledger 30 June $3828 CR

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(b) Bank Rec is an EXTERNAL, INDEPENDENT check of cash recordsvery

strong control as it is TOTAL separation of custodianship and record keeping
YES__DEFIN ITELY WORTH DOINGas need to find items that Bank knows about and
the firm does not e.g. bill receivable collected; bank charges; NSF cheques ; direct debits
--need to confirm that all cheques have been presented and all deposits make INTACT
--in this questiondeposit of the 8th June has not yet been made at the bank
--need to check to see what has happenedcould be an indication of very big FRAUD
perhaps
--therefore Bank RecsEXCELLENT form of internal control

(c) Country Motors Ltd

Collections from Customers
Credit Sales (70% of total sales) September October
June 36 400 (5%) 1820
July 38 500 (15%) 5775 (5%) 1925
Aug 40 600 (80%) 32480 (15%) 6090
September 42 000 (80%) 33600
$40075 $41615
Schedule of Cash Receipts
September October
Cash Sales (30%) 18 000 18 600
Collection from Customers 40075 41615
Interest - 2 000
Total $58075 $62215

QUESTION 13
(a)
Cost = 160000 RV = 20000 Depreciable Amount = 140000 EUL = 4 years
140000
Straight line = = 35000 p.a.
4
for 2000 = 35000
for 2001 = 35000

Reducing balance = for 2000 = 40% of 160000

= 64000
for 2001 = 40% of 96000
= 38400

140000
Units of production = per unit = = 70c/unit
200000

for 2000 = 80000 x 70c = $56000

for 2001 = 60000 x 70c = $42000

Total depreciation exp = $140000 under all methods as total exp

= Total depreciable amount
The different methods merely allocate that total depreciable amount in a
different way
(b) land $450000 (not depreciable)
bldgs $675000
plant $82400

Depreciation under HC accounting

= ALLOCATION of COST of asset over its useful life

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attempts to measure the decline in service potential of the asset

decline caused by wear and tear
technical obsolescence
commercial obsolescence
in fact = allocation of depreciable amount
LAND not depreciated as its service potential does not
Depreciation is NOT a valuation technique, i.e. does not show in VALUE
Depreciation is NOT a measure of current worth of asset
the fact that L & B can be sold for $1,500,000 is IRRELEVANT
must still depreciate bldgs regardless of current value
same for plant dep difference between cost and market value

Depreciation does NOT create cash reserves

depreciation cash, nothing to do with cash
a BOOK entry to allocate cost and show the EXPENSE of using the asset

QUESTION 14
(a)
(i) Straight lineuniform charges over the life of an assetequal amounts each year
depreciation is a function of time
--ideal for buildings
(ii) Reducing Balanceaccelerated depreciation i.e. greater depreciation in early years as
compared to later years when smaller depreciation
--ideal for assets which are used a lot in early years and then not so much in later
yearsequipment which deteriorates quickly
--or computer equipment which suffers from technical and commercial obsolescence
and thus greater depreciation in early years of life
(iii) units of productiondepreciation is a function of USErequires extra record
keeping to measure the production output (or usage) of the asset
--ideal for assets whose usage can be measured easily e.g. machines which produce
units; or e.g. motor vehiclesuse kilometres travelled
(b)
Note: cost of asset = 15,000 + 600 + 400 = $16,000

Year Reducing Balance Straight Line Units of Use

Depn Book value Depn Book Value Depn Book Value
30/6/99 4800 11200 3750 12250 3750 12250
30/6/00 3360 7840 3750 8500 3000 9250

Note: RB = 30% of 16000; 30% of 11200

Straight Line = (16000 -1000) / 4 = 3750 per year
Units of use:
Depreciation per unit = (16000 -1000) / 360000 = 0.041666 per unit
Depreciation year 1 = 0.041666 x 90000 units = 3750 (round to nearest dollar)
Depreciation year 2 = 0.041666 x 72000 units = 3000 (round to nearest dollar)
(c)
1. Alex says price of truck NOW = price of truck 1 year ago
BUT depreciation does NOT equal market price or decrease in market
Price, hence, Alex is WRONG. Depreciation is not a valuation technique.
2. Alex says in 2nd year VALUE will drop---WRONG again.
Depreciation is not a valuation technique.
3. Alex says cash obtained from depreciation.
WRONG, as depreciation does not equal cash

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Depreciation is a book entry and has nothing to do with cash.

Depreciation does not put aside funds or create any funds for replacement
Depreciation simply decreases profits and decreases assets
4. What depreciation is = allocation of the depreciable cost of the asset over the assets
useful lifeto show that the asset has been used to produce revenue.
Matching revenues and expenses.
Depreciable cost = cost less residual value.

QUESTION 15
(a) Book value of asset=cost less accumulated depreciation
Depreciation is simply an ALLOCATION of the cost of the asset over the useful life
--depreciation is NOT a valuation technique i.e. selling price is NOT what book value equals
--depreciation is NOT a measure of efficiency or value of asset i.e. efficient value of asset is
not what book value equals
NBBook Value is also written down value
The production manager and the managing director are BOTH WRONG IN THEIR
ARGUMENTS

(b) (i)
Straight line Reducing balance 37.5% Units of Production
Depreciation Carrying Depreciation Carrying Depreciation Carrying
amount amount amount
Year 1 7500 32500 15000 25000 8250 31750
2 7500 25000 9375 15625 9000 22750
3 7500 17500 5625 10000 6750 16000
4 7500 10000 ------ 10000 6000 10000

Workings Straight line = (40000 10000) /4 = 7500 p.a.

Units of Production = (40000-10000)/200000 =15 cents per klm
(ii) Depreciation DOES affect ANNUAL profit figuresdifferent deprn expense
depending on the method usedsee table above to illustrate
--the higher the deprn exp, the lower the profit for the year
--over the life of the asset, the total deprn expense is the same regardless of the
method usedthe total deprn exp must always equal the depreciable amount==cost
less residual valuesee the table abovefor all methods, the total deprn expense is
$30,000
--accounting is concerned with periodic profitaccounting period convention
therefore the choice of a depreciation method is critical to profit determination

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QUESTION 16

Sales Budget - 2nd Quarter

1st month 2nd month 3rd month Total
$4,200 $5,400 $7,200 $16,800
Multiply number of units by unit cost.

Purchases, Cost of Goods Sold, and Inventory Budget

1st month 2nd month 3rd month Total

Cost of Goods Sold1 $2,100 $2,700 $3,600 $8,400
+ Desired Ending Inventory2 1,080 1,440 1,2005 1,200
Subtotal 3,180 4,140 4,800 9,600
- Beginning Inventory3 6004 1,080 1,440 600
= Purchases $2,580 $3,060 $3,360 $9,000

1
Cost of Goods Sold is 50% of budgeted sales: $3/$6 = 50%
2
Desired Ending Inventory is 40% of the following months Cost of Goods Sold.
3
Beginning Inventory is 40% of current months Cost of Goods Sold (or simply last
months Ending Inventory!)
4
Beginning Inventory is 200 units $3 ea = $600
5
The next months projected Cost of Goods Sold = 1,000 units $3 ea = $3,000; Ending
Inventory = 40% $3,000 = $1,200

QUESTION 17

(a) (i) contribution margin = sales variable costs

= $20 - $9.50 = $10.50

(ii) breakeven (units) = fixed expenses / contribution margin

= $15,000 / $10.50 = 1,428.5714 units
= 1,429 units (rounded to nearest unit)
Breakeven (dollars) = breakeven (units) x selling price per unit
= 1,429 x $20
= $28,580

(iii) NEW contribution margin = sales variable costs

= $20 - $10 = $10

NEW breakeven (units) = fixed expenses / contribution margin

= $15,000 / $10
= 1,500 units
NEW breakeven (dollars) = breakeven (units) x selling price per unit
= 1,500 x $20
= $30,000

Contribution Margin Income Statement

Sales (2,000 x $20) 40,000
Less Variable expenses (2,000 x $10) 20,000
Contribution margin 20,000
Less Fixed costs 15,000
Net profit 5,000

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Check calculation: if sell 2,000 balls then that is 500 above the break even point. Every sale
above the break even point earns the CM per unit in profit. 500 x $10 = $5000 = profit as
per the profit and loss statement.

QUESTION 18 Cayden Kent

a. Contribution margin per unit:
Sale price...................................... 9
Variable expenses.................................. 3
Contribution margin per unit.................... $6

b. Break even sales Fixed expenses

=
in units Contribution margin per unit
$1200
=
$6
= 200 meals

c. Breakeven sales in $ = 200 x $9 = $1800

d.
Sales revenue (200 $9) $1800
Less Variable expenses (200 $3) 600
Contribution margin 1200
Less Fixed expenses 1200
Profit $ 0

e. Target sales in units Fixed expenses + Profit

=
Contribution margin
1200 + 900
=
$6
= 350 meals
Target sales in $ = 350 x $9 = $3150
To earn target profit of $900, Cayden Kent must sell 350 meals.

f. Verify this by preparing a Contribution Margin format Income Statement

Sales (350 x $9) 3150
Less Variable expenses (350x $3) 1050
Contribution Margin (7875 x $40) 2100
Less Fixed expenses 1200
Net profit $900

QUESTION 19
Sales $280,000
Less: Variable Expenses
Cost of Goods Sold $120,000
Marketing Expense 24,500
General Expense 35,000 179,500
Contribution Margin 100,500
Less: Fixed Expenses
Marketing Expense 10,500
General Expense 35,000 45,500
Net Profit $ 55,000

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QUESTION 20
Clarence Enterprises
(a) Purchases, Cost of Goods Sold and Inventory Budget

August September Total

Cost of Goods Sold 68000 62400 130400
+ ending Inv. ** 42440 49160 49160
110440 111560 179560
- Beginning Inv 69000 42440 69000
Total Purchases 41440 69120 110560

** ending inventory = 5000 plus 60% of the budgeted cost of good sold for the
following month
August = 5000 + 60% of 62400
September = 5000 + 60% of (80% of 92000)

(b)

Budgeted Income Statement

for the month of September

Sales 78000

Less cost of Goods Sold 62400

Gross Profit 15600
Less operating expenses 15000
Net Profit 600

QUESTION 21
(a)
Liquidity = ability to pay debts in short term
Current Ratio = amount of CA available to pay CL --Rule of thumb is 2:1.
For 2000 good just above rule of thumb
--Improved since 1999 = good
Acid Test Ratio = amount of very liquid assets available to pay CL
--A mere stringent test of liquidity--Rule of thumb is 1:1.
For 2000 good just above rule of thumb
--Improved since 1999 = good
Inventory T/O very industry dependent
no information here as to what industry, difficult to comment higher the better
increased since 1999= good
at 3.75 times not a fruit shop which should have T/O of roughly 185 times
approximately
must be selling slow moving items that have long shelf life
A/Cs Rec T/O increased since 1999 good higher better

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convert to average collection period and compare to average credit period

365
52.29 days
6.98
if credit period is 30 days then this is good.

Financial Stability = ability to pay debts in long term

ability to service debts from current profits
Debt Ratio = decreased since 1999 good the lower the better
above 70% is not good in Australia
- 60% is good level and secure
need to look at decreasing the debt and increasing the OE in equity structure
Times Interest Earned = ability to pay interest out of profits
coverage of interest--3 or 4 times is safe. 2000 figure = good
has increased since 1999 good

Profitability ability of business to generate profits-- overall good

rate of return on net sales = 6% in 2000, a large increase from 1999 good
= sales are producing dollars.
rate of return on total assets = 16.70% in 2000 tripled from 1999 excellent
the assets are working efficiently
management is using assets in a good combination

(b) Other information:

-- industry averages
horizontal analysis of the 2 years given
trend analysis of past 3 or 4 years data
common size financial statements
any info about the firm management or directors reports etc.
cash flow statement
Any relevant piece of data.

QUESTION 22
Profitability Analysis:
The profit ratio measures the profit per dollar of sales. Profitability has fallen sharply
from 15.00% in 1998 to 6.67% in 1999 as indicated by the profit ratio. In other words,
for every dollar of sales, the company is only earning 6.67 cents. This is of major
concern.
The rate of return on net assets measures the return earned by management through
activities; shows the success a company has in using its assets to earn a profit. This ratio
has also dropped from 15.52% to 9.04% indicating that the ability of the assets to
generate profits has declined. This, too, is of major concern.

Liquidity Analysis:
The current ratio measures the company's ability to satisfy its obligations in the short-
term. The company's current ratio has fallen from 7.00 times to 2.33 times, indicating
that it is finding it more difficult to pay its debts as and when they fall due. This is an
area of concern, although 2.33 times is satisfactory - a rule of thumb is usually 2:1.
The quick ratio tells us whether the company could pay all of its current liabilities if
they became due and payable immediately. The company's quick ratio has fallen
dramatically from 4.00 times to 1.11 times. This is an area of concern, although 1.11
times is satisfactory - a rule of thumb is usually 1:1.
The inventory turnover ratio is a measure of the adequacy of inventory and how
efficiently it is being managed. Inventory turnover has increased slightly between 1998

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and 1999. The higher the turnover, the better, as it means that inventory is being turned
over more frequently. Steps should be taken to try to increase this.

Financial Stability Analysis:

The debt ratio measures the proportion of the company's assets financed by debt. The
debt ratio is a measure of the relationship between total liabilities and total assets. The
company's debt position has deteriorated dramatically between 1998 and 1999. In 1998
only 9.09% of the entity was debt financed, whereas in 1999, this amount has increased
to 35.14%. Upon further investigation, a long term loan of $24,000 was taken out to
purchase non-current assets. This is a perfectly acceptable strategy. Also, the ratio is
well below 50% so there is no need for alarm at this stage.

QUESTION 23
(i)
PROFITABILITY shows the ability of the firm to earn profits
Profit Margin has improved from 97 to 98. Shows the % of each $ of
sales that is profit.

LIQUIDITY shows the ability of the firm to pay its debts in the short term
Current ratio current assets to current liabilities has decreased from 97
to 98. Rule of thumb is usually 2:1; was OK for 97 at 2.3:1 and has
declined in 98 to below the 2:1 benchmark. But beware of Rules of Thumb
as they are only averages and should look at the industry. Also the more
liquid the firm, the less profitable. As liquid assets are not usually
profitable.
Quick ratio more stringent test of liquidity only "quick" assets included in
numerator rule of thumb 1:1; OK for 97 and then decreased to 0.67:1. Not
too bad though.
Inventory T/O measures number of times inventory is turned over during
year. Has decreased from 97 to 98. Industry dependent.
Receivables T/O measures how quickly the cash is received from
receivables has decreased. Compare to average credit period of 30
days.

FINANCIAL STABILITY shows the ability of the firm to survive in long run
security
Debt Ratio shows % of assets funded by outside debt. In Australia, 60%
is the maximum preferred Rose Wines very stable with only 30%+ then
increase to 34.3% therefore very secure.

(ii)
Profitability Rate of Return of Assets measures return that assets produced
Liquidity Receivables Collection Period convert receivables T/O to Days
Inventory T/O period covert inventory T/O to Days
Financial Stability - Times interest earned shows how well net profit covers interest
expense commitment

(iii)
would expect this to be the case
ie. profit margin increased and current ratio decreased
profitability versus liquidity

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liquid assets are generally not profitable eg. cash at bank earns very low interest, prepaid
expenses earn no interest, the more liquid the assets the less profitable the firm and
vice versa
here--less liquid increased profits

(iv)
would expect this to be the case
ie. profit margin increased and inventory T/O decreased
profitability versus liquidity
they usually move in opposite directions
though an increased inventory T/O would likely lead to increased profits as selling more
but perhaps cost of sales is too high to allow for much increase in profits

(v) Other info = Industry averages, Past years data, Trend analysis
Info re: economic climate , Investor's preference for risk and returns
(vi) Changing dep'n method affects dep'n exp and accumulated dep'n net assets
affects net profit and Total Assets
all ratios which include there two items will be affected

NOT LIQUIDITY ratios.

PROFITABILITY - Profit margin
- Rate of return on assets
FINANCIAL STABILITY - Times Interest Earned
- Debt Ratio

QUESTION 24
(a)
Inventory T/O increase means good newsinventory was sold more quickly therefore better
liquiditymore sales alsowould also expect this would lead to higher potential profits

Receivables T/O increase means good newscollected money from customers more quickly
quicker cash collectionbetter liquidityless problems with bad debts perhapsthis does
not affect profitability

BUT net profit decreasedtherefore COGS must have been increased at a GREATER rate
than sales OR operating expenses have increased at a greater rate than sales

Overall any kind of expense must have risen at a greater rate than the increased turnover

(b) PART (i) FOR THIS SECTION NEED TO LOOK JUST AT THE RATIOS GIVEN
CANNOT DO COMPLETE DISCUSSION BECAUSE OF THE LACK OF DATA AND
THE LIMITATIONS AS PER SECTIONS (ii) and (iii)

PROFITABILITY
Ability of firm to generate profits
Profit Margin=the return on sales
Has decreased from 10% to 7% --on the face of itnot a good signbut at least profits are
being earned

Return on Assets=measures the efficiency of the assets

Decreased from 15% to 11%--not good to have a decreasebut profits are being earned
Overall profitability is OK for 19X9 but the decreases are a cause for concern

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LIQUIDITY

Ability of firm to pay its short term debts as they fall due
Current Ratio = current assets compared to current liabilities
Decreased from X8 to X9 was 2:1=rule of thumb
Beware use of the Rule of Thumbtoo much liquidity can lead to decreased profitability
Quick Ratio = more stringent test of liquidityrule of thumb here is 1:1firm quick ratio
has DECREASED cause for concern
Both these measures are STATIC measures of liquidityfor a more complete analysis look at
Receivables collection period and Inventory T/O
Receivables collection period = no. of days to collect accounts receivablecompare to
credit period for firmusual credit period is 30 daysthis firm was doing well at 30 days
and has now DECLINED to 45 daystaking longer to collect receivablesleads to
decreasing cash balancescould lead to BAD DEBTS
Inventory T/O = no. of times inventory is turned over during the yearmore times the better
higher T/O would lead to higher liquidityhas DECREASED in this case form 33 times to
28 timesthe firm must not be selling perishablesfruit shop T/O would be 60 or greater
timesMercedes Benz retailer T/O around 15 times approx

OVERALL, all liquidity ratios have worsened

FINANCIAL STABILITY
Ability of firm to survive in the futurelong term liquidity
Debt Ratio = % of assets funded by debt as opposed to equityaverage in Aust approx 60%
The more debt in a firmthe higher interest expense and the lower the profits and the more
debt repayments
Has increasedBAD newsfrom .64 up to .72 above Aust Averagemore debt to service
and repay
Times Interest Earnedability of profits to cover interest expenserule of thumb around 3
or 4 times
--has DECLINED from 2 down to 1.7area of concern

OVERALL financial stability has worsened.

FOR THE FIRM OVERALL ALL AREAS HAVE WORSENED FROM X8 TO X9

(ii)
NONOT ENOUGH INFORMATION TO MAKE A DECSION
OTHER INFO NEEDED;
--industry averages
--past years data to see if the decline is a trend
--trend analysis
--info re the economic climate
--the friends preference for risk and return

(iii) LIMITATIONS
--based on past data
--based on historical cost measurement
--based on year-end data
--limited disclosures by certain companies
--entities may not be comparable
e.g. different industries
different accounting methods
different sizes
--must consider info in other reports

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--existence of extraordinary items can cause problems in the analysis

BSB110 2011 revision solutions