Accounting Situation Analysis - Assignment Example

Question 1 Billy Bristol has a job working as a skilled labourer for a business which builds home extensions and does renovations. He earns $25 per hour and works for 40 hours per week Monday to Friday. Billy enjoys the type of work that he does, and is very good at his job but he is not really happy working for other people. He would prefer to work for himself. Billy has always been a handyman. He enjoys making and fixing things and has learned many skills whilst working for the building firm. During April 2014 he has decided to leave his job and start his own home maintenance business (Bristol Maintenance). Billy is trying to earn as much money as possible as he would like to buy a new car. Billy has never owned or run a business before. To start the business on 1st May 2014, he deposited $1,500 of his own money into a new bank account opened in the name of the business. He also contributed $2,400 worth of his personal tools and equipment to the business, Billy believes that these will last four years after which they will have no value. He was not sure that his $1,500 would be enough cash to get the business started so on 2nd May he borrowed a further $1,500 from his mother and added this money to the business bank account. Billy does not have to pay any interest to his mum but has agreed that he will repay her the $1,500 at the start of September 2015. Before long Billy has lots of work to do. As he is so busy, he keeps few records other than his business cheque book and a list of amounts owed to him by customers. Twice a month Billy sends invoices to his customers for the work he has done. One customer insisted on paying in cash at the time the job was done, this customer paid $260 and Billy decided that it was not worth producing an invoice for an amount which had already been received. All work done during the period has been invoiced. By 30th June invoices totalling $13,300 had been issued. At 30th June his customers still owe him $1,500. His business cheque account shows payments for building supplies totalling $3,700, he used $80 worth of supplies to fix some taps at his own flat and he still has supplies that cost $450 on hand. He paid some contractors $2,400 for work that he was unable to do himself, and he still owes them a further $270. He has also paid $127 for various sundry expenses. Billy rented a cement mixer from Marsden Hire Co. On 1st May, he signed a twelve-month rental agreement and paid $1,200 for the full period. The agreement states that Billy must keep the equipment that he has hired in good working condition. To do this during June he had to have repaired and service work performed on cement mixer at a cost of $300, he has not paid for this work yet. To transport equipment to jobs, Billy used an old van that he bought on 1st May for $2,000. He believes that the period’s work used up 5% of the van’s service potential. The business cheque book lists a payment of $1,960 for private cash withdrawals by Billy during the period. On 30th June Billy paid his mobile telephone bill of $270 from his personal bank account. He estimates that 70% of the calls made were for business use. Billy believes that his business will do better in subsequent periods as he now has an existing customer base to work from and has started to receive enquiries from family and friends of his people he has already worked for. Imagine that you are an accounting student on a work experience assignment during your final year of study. One of the partners at the firm where you are engaged has asked you to prepare some financial reports for a new client (Billy Bristol). She has also asked you to use the reports you have prepared to assist in the preparation of a decision making case which she can present to Billy. She would like to do this because Billy is unsure whether he is financially any better off running his business compared to working as an employee. He wonders if he should continue with Bristol Maintenance or return to working for somebody else. Required 1. Prepare the business Income Statement for the period. (14 marks) 2. Prepare the business Statement of Changes in Equity for the period (6 marks) 3. Prepare a classified Balance Sheet at the end of the period. (16 marks) 4. Using the steps outlined in the decision making model you studied at the beginning of this course explore whether the venture has been successful? In the final step (review/feedback) provide some discussion points which your boss can use to assist Billy in his decision making. (9 marks) Total for Question 1: 45 marks Answer on following pages please Answer Question 1 1. Bristol Maintenance Income Statement For the Period Ended 30 June 2014 Item Amount ($) Amount ($) Sales 13,560 Cost of Sales Opening Stock 0 Purchases 3,700 Less: Closing Stock -450 -3,250 Gross Profit 10,310 Expenses Contractor Wages 2,670 Sundry Expenses 127 Rent for Mixer 1,200 Depreciation 200 -4,197 Net Profit 6,113 2. Bristol Maintenance Statement of Changes in Owner’s Equity For the Period Ended 30 June 2014 Item Amount ($) Amount ($) Starting Owner’s Equity 1,500 Add: Injection 81 Add: Net Profit 6,113 Less: Withdrawals 2,040 Closing Owner's Equity 5,654 3. Bristol Maintenance Balance Sheet As at 30 June 2014 Item Amount ($) Amount ($) Assets Current Assets Cash at Bank 3,913 Accounts Receivable 1,500 Cash at Hand 260 Inventory 450 Total Current Assets 6,123 Fixed Assets Tools and Equipment 2,400 Less: Depreciation -100 Motor Van 2,000 Less: Depreciation -100 Total Fixed Assets 4,200 Total Assets 10,323 Liabilities Current Liabilities Accrued Repair Expenses 300 Accrued Wages 270 Total Current Liabilities 570 Long-Term Liabilities Loan Payable 1,500 Total Long-Term Liabilities 1,500 Total Liabilities 2,070 Owner's Equity Capital 1,500 Add: Injection 81 Add: Net Profit 6,383 Less: Withdrawals 2,040 Total Owner's Equity 5,654 Total Liabilities and Equity 7,724 4. 1) Establish Goals: Objective: Billy’s objective is to earn as much money as possible. Constraints: Billy has $1,500 to invest plus some personal items. He also has to depart from his current job as a handyman since he wants to work for himself. 2) Gather available information on alternatives & Determine consequences of alternatives Solution Technique: To evaluate the incomes generated from each of the two alternatives. Prediction: For the alternative to work for continue working: Total future return = Salary For business alternative: Total future return = Net profit from business 3) Choose a course of action Choice: In light of Billy’s objectives as defined, the business alternative is chosen given that no other qualitative factors influence Billy’s decision. 4) Implementation & Review: Billy should hire an assistant to help him manage his business venture to ensure that he has enough time to attend to his customers and that the business ought to be performing as it should. If the business fails, Billy should review the decision making process to see whether it was proper. If the business succeeds, Billy should seek for ways to expand and grow his business, especially through collecting adequate information and analysing it properly. This will help him in future decision making and planning. Question 2 1. The owner of a business reviews the Income Statement prepared by you and asks, “Why do you report a profit of only $70,000 when cash collections of $180,000 were received and cash payments for expenses during the period totalled only $80,000?” How would you respond to the owner’s question? (7 marks) 2. Give two examples which support your answer to part 1 of this question. (5 marks) Total for Question 2: 12 marks Answer Question 2 1. One of the accounting principles is the prudence principle. This principle states that the amounts of revenue should not be overestimated, nor should the amount of expenses be underestimated. It requires that an allowance for doubtful accounts be made as an expense in the income statement; as a matter of anticipating that that event will probably occur. These amounts do not necessarily mean that they were incurred, but they are deducted to reflect the true profit realised. These amounts are usually not paid to anyone but they are a matter of prudence. 2. Examples of the amounts referred to are: (1) depreciation/amortisation of fixed assets, and (2) provisions for doubtful debts. Depreciation is provided for given that some assets used in generating the incomes get worn out with time. The depreciation is therefore estimated and deducted from the collections. Provisions for doubtful debts is an amount provided for seeing as some debtors may fail to honour their debt obligations they owe to the business. Question 3 Michael Stone’s accountant moved interstate in April 2014 leaving Michael to complete his draft accounts for the year ended 30 June 2014, and a Balance Sheet as at that date. He thinks that he may have made a few mistakes and asks for your help. An examination of the accounting records reveals the following: A.   Interest of $600 on the investments held by the business was due, but has not been recorded or received. B.   Repairs to Michael's private motor vehicle, $840, have been debited to the vehicle expenses account. C.   Commission due to sales representatives for the month of June, $2,000, has been overlooked. D.   A payment of $1,300 for new office furniture has been incorrectly debited to the sundry expenses account. The furniture had been purchased on 30 June 2014. E.   Rent due from customers of $1,350 is not included in the accounts. F.   An insurance policy covering buildings was taken out on 30 April 2014; the annual premium of $720 was paid in advance on this date and debited to the Prepaid Insurance account. G.   A payment of $11,000 on 1 July 2013 for additions to buildings has been debited to repairs and maintenance. H.   No depreciation has been recognised for the year ending 30 June 2014. The draft Balance Sheet shows the following: Buildings (at cost) $80,000 Less Accumulated Depreciation 16,000 $64,000 Office Furniture & Equipment (at cost) 10,500 Less Accumulated Depreciation 6,500 4,000 These amounts do not include any of the Transactions listed above. Annual depreciation is to be calculated as follows:  Buildings: 2% of cost  Office furniture and equipment: 20% of cost Required 1.   Ignoring GST, show the journal entries required to make the necessary adjustments/corrections listed. Make sure that your journal entries are complete and properly formatted. (19 marks) 2.   Calculate the effect (increase or decrease) of each of the adjustments on the profit figure of $63,500 as shown in Michael’s draft accounts. (4 marks) Total for Question 3: 23 marks Answer on following pages please. Answer Question 3 1. Date Details Debit Credit June 30 Interest Receivable A/C 600 Revenue A/C 600 For interest on investments not received June 30 Withdrawal A/C 840 Vehicle Expense A/C 840 For repairs to Michael's private motor vehicle debited to the vehicle expenses account June 30 Commission A/C 2,000 Bank A/C 2,000 For commission to sales representatives overlooked June 30 Office Furniture A/C 1,300 Sundry Expenses A/C 1,300 Bank A/C 1,300 For office furniture bought but debited in sundry expense account June 30 Debtors A/C 1,350 Rent A/C 1,350 June 30 Insurance Expense A/C 90 Prepaid Insurance A/C 90 Insurance for period extracted from prepaid insurance June 30 Additions A/C 11,000 Repairs and Maintenance A/C 11,000 For additions to buildings recorded in the repairs and maintenance June 30 Depreciation A/C 4,180 Income statement A/C 4,180 2. Profit 63,500 Add: Withdrawals 840 Overcharged Insurance 630 New furniture expense 1,300 Additions Expense 11,000 Less: Commission (2,000) New Profit 72,270 Question 4 Brisbane Ltd Perth Ltd Income statement data for the year ended 30th June 2014 Net sales $260,000 $415,000 Gross profit 99,000 104,000 Selling and admin expenses 50,000 65,000 Interest expense 22,000 10,000 Other expenses 2,000 4,000 Profit before tax 25,000 25,000 Income tax expense 7,500 7,500 Profit after tax 17,500 17,500 Balance Sheet Data as at 30th June 2014 Current assets Cash $8,000 $15,000 Accounts receivable 41,000 30,000 Inventory 24,000 25,000 73,000 70,000 Non-current assets Plant and equipment (net) 90,000 110,000 Total assets 163,000 180,000 Current liabilities Accounts payable 20,000 24,000 Non-current liabilities Loans 120,000 80,000 Total liabilities 140,000 104,000 Equity Total shareholders’ equity 23,000 76,000 The following balances were recorded as at 30 June 2013 for each company: Brisbane Ltd Perth Ltd $ $ Accounts receivable 35,000 24,000 Inventory 30,000 20,000 Total assets 170,000 195,000 Required 1. Calculate the following ratios (for each company): A. Gross Profit Margin B. Profit Margin C. Return on Assets D. Current Ratio E. Quick Ratio F. Receivables Turnover G. Inventory Turnover (28 marks) 2. Write a short report (300 – 400 words only) which uses the ratios your have calculated in part 1 of this question to compare the profitability and liquidity of the two companies. (12 marks) Answer on following pages please. Total for Question 4: 40 marks Answer Question 4 1. Ratio Formula Brisbane Ltd. Perth Ltd Profitability Ratios Gross profit margin 38% 25% Profit margin 6.73% 4.22% Return on Assets 10.29% 8.97% Liquidity Ratios Current ratio 4 times 3 times Quick ratio 2 times 2 times Efficiency/Activity/turnover Ratios Inventory turnover 5.96 days 13.82 days Receivable turnover 6.84 days 15.37 days 2. Profitability Analysis Profitability ratios review earnings performance relative to sales, assets or investment. The ratios try to gauge management’s abilities along with the company’s actions by assessing their performance based on the profits generated by the business. The profitability ratios analysed are the gross profit margin, the profit margin and the return on assets. The gross profit margin compares the gross profit to the sales revenue. The profit margin compares the net profit to the sales revenue, and the return on assets compares the net profit to the total assets. Brisbane Ltd recorded higher profitability than Perth Ltd. The company’s gross profit margin was 38 per cent whereas Perth Ltd reported a gross profit margin of 25 per cent. Also, Brisbane Ltd had a profit margin of 6.72 per cent compared to a 4.22 per cent profit margin for Perth Ltd, and Brisbane Ltd’s return on assets was 10.29 per cent compared to 8.97 per cent for Perth Ltd. These show that Brisbane Ltd’s performance weighed against the sales and assets was better than the performance for Perth Ltd. Liquidity Analysis Liquidity ratios evaluate the ability of the company to meet up its short-term obligations using its current asset components. The two most common liquidity ratios are the current ratio and the quick ratio. The current ratio compares the current assets to the current liabilities. The quick ratio compares the current assets less the inventory to the current liabilities. Both Brisbane Ltd and Perth Ltd reported high liquidity. Both companies current ratio was above the conventional norm of 2:1 for the current ratio, and 1:1 for the quick ratio. However, the current ratio for Brisbane Ltd was higher at 4 times compared to Perth Ltd’s 3 times. Both companies reported a quick ratio of 2 times. High liquidity posted by both companies may imply that they are conservative in their operations; hence they prefer to be liquid as opposed to taking the risk invest their assets in other opportunities to generate more incomes. References Beranek, W, 1963, Analysis for financial decisions. Homewood, Ill, R. D. Irwin Blecke, C. J, Gotthilf, D. L, 1980, Financial analysis for decision making. 2nd edn. Englewood Cliffs, N.J, Prentice-Hall Chiappetta, B., Shaw, K., Wild, J. 2009, Principles of Financial Accounting. 19th edn. McGraw-Hill/Irwin. Pamela Peterson Drake, Financial Ratio Analysis: Richard Loth, Financial Ratio Tutorial: John Bajkowski, Financial Ratio Analysis: Putting the Numbers to Work< https://www.aaii.com/journal/article/financial-ratio-analysis-putting-the-numbers-to-work> Martin, S.F and Fernando, A 2002, Financial Statement Analysis: A Practitioner's Guide, 3 edn, John Wiley & Sons Steven, M.B, 2006, Financial Analysis: A Controller's Guide, 2nd edn, Wiley Steven, M.B, 2012, Business Ratios and Formulas: A Comprehensive Guide, 3rd edn, Wiley Read More