Professional Documents
Culture Documents
HKCWCC
BAFS Accounting
Accounting Ratios For 2021 DSE
Summary and Revision Practice
Profitability (To measure how effectively a firm can earn profits) ratios
Formulae Interpretations
𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 It shows the efficiency in
Mark-up 𝑥 100% controlling the cost of goods sold
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 and the pricing policies.
It measures how a dollar of sales
will general the gross profit.
Gross profit 𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝑥 100% It shows the efficiency in
ratio/margin 𝑛𝑒𝑡 𝑠𝑎𝑙𝑒𝑠 controlling the cost of goods sold
and the pricing policies.
Capital employed=
1. sole proprietorship: capital balance It shows the effectiveness of
Return on 2. partnership: capital + current (if any) balance
3. limited companies: using the business capital to
capital employed
share capital + reserve + non-current liabilities generate profits
Liquidity (To show ability to convert short term assets to cash to pay short term liabilities) ratios
Formulae Interpretations
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 It shows the ability of a
Working capital /
∶1 business to repay short term
current ratio 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 debts when they fall due.
It shows the ability of a
Quick / liquid / 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
∶1 business to make instant debt
acid test ratio 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 payments.
P.1
HKCWCC BAFS Accounting Ratios, Revision Practice, P.2
Management efficiency (To indicate a firm’s ability to utilise its assets efficiently) ratios
Formulae Interpretations
It identifies the
average length of
Inventory 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠𝑙 𝑠𝑜𝑙𝑑 time that stock
turnover spends in the
(times) 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 business before it
is sold or used in
production.
Average trade It shows the
receivables 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 average number
collection 𝑥 365 𝑑𝑎𝑦𝑠 (12 𝑚𝑜𝑛𝑡ℎ𝑠) of days (months)
𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
period to collect debts
from customers
Trade
receivables 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
It shows the
turnover 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 efficiency of
(times)
credit control
Average trade It shows the
payables 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 average number
𝑥 365 𝑑𝑎𝑦𝑠 (12 𝑚𝑜𝑛𝑡ℎ𝑠)
repayment 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 of days allowed
period to pay trade debts
Trade payables 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 It is a source of
turnover
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 short-term
(times)
financing
It measures the
effieiency in the
Total asset 𝑠𝑎𝑙𝑒𝑠
utilization of
turnover 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 assets to generate
sales revenue.
Solvency (To indicate a firm’s ability to meet its long-term obligations) ratios
Formulae Interpretations
It shows the
financial
leverage (槓桿)
𝑛𝑜𝑛𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑖𝑒𝑠 + 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑠ℎ𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
Gearing 𝑥 100% i.e. the extent to
𝑛𝑜𝑛𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝑓𝑢𝑛𝑑 which the
ratio
resources of the
shareholders’ fund = total share capital + total reserves
company are
financed from
third parties
P.2
HKCWCC BAFS Accounting Ratios, Revision Practice, P.3
Formulae Interpretations
It shows the extent
Dividend
𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 − 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 to which ordinary
cover for
dividends are
ordinary shares 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑖𝑑 covered by the
(times)
distributable profit
It measures the
Earnings per 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 − 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 amount of profit
share (EPS) 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 𝑖𝑠𝑠𝑢𝑒𝑑 earned per issued
ordinary share.
It indicates the
number of years to
Price-earnings 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 recover the cost of
ratio (P/E
𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 buying share out of
ratio) (times)
the current earnings
of the company.
(i) The use of ratios eliminates the effects of scale of operation so that comparison can
be made between different years and different firms.
(ii) Accounting ratios provide indicators of the financial capacity including profitability,
liquidity, stability and activity of a firm to meet its commitments.
(iii) Accounting ratios can be used to explore the methods where the firm’s operations are
conducted, providing information for financial analysis.
(i) Accounting ratios can only disclose quantitative data but not qualitative data. Factors
like general economic condition, marketing position, degree of competition, labour
relations will influence or even determine the future success of the business.
(ii) It is difficult to make comparison of accounts between different firms which have used
different accounting policies and methods.
(iii) Ratios analysis based on the past results may not be useful for estimating the future
results of a business.
(iv) Comparison of ratios over a period of time at historical cost cannot be properly
comparable where inflation in prices occurs during the period.
(v) Ratios on their own cannot provide information to enable managers to assess
performance or market control decisions. It is necessary to provide ratios of previous
accounting periods or ratios of the overall industry for comparison.
(vi) Ratio analysis may identify the existence of a problem, but it cannot tell what the
problem is or how to solve it.
P.3
HKCWCC BAFS Accounting Ratios, Revision Practice, P.4
P.4
HKCWCC BAFS Accounting Ratios, Revision Practice, P.5
Areas Comment
Profitability • favourable / unfavourable ?
• effective / ineffective buying (operating) cost control ?
• higher / lower than previous year / other firms ?
• efficient / inefficient utlisation of capital employed ?
Liquidity • health liquidity position with current ratio of 2:1 and liquid ratio of more than 1
• efficient / inefficient use of capital tied up in current assets and/or inventory ?
• may make use of idle current / liquid assets for further investment
• strong / poor liquidity position ?
Management • high / low inventory turnover ?
efficiency • any excessive inventory e.g. damaged stock, bad buying policy ?
• may lead to increase in storage cost
• better / poor credit contril over customer debts ?
• may lead to the possibility of bad debt
• longer / shorter trade payables repayment period ?
• long payment period : improve cash flow (a source of short-term finance) vs lose
goodwill to suppliers
• effective / ineffective use of assets to create sales ?
Solvency • High / low-geared companies ?
• High-geared: pay fixed interests and preference dividends, company will be
vulnerable (地位不穩固) during economic downturn. Shareholders may not be
repaid on liquidation. More risky (as rate of increase in the profits available for the
equity shareholders in a highly geared company is greater than in a low geared
company)
• low-geared: potential to get funds from debt financing
Investment • stronger / weeker EPS ?
return • trend in EPS represents business growth (increasing trend shows the business is
expanding)
• P/E reflects the investors’ expected earnings growth and the risk associated with
the investment
• higher P/E : the faster the growth the market is expecting in the company’s future
EPS. Investors are willing to pay for premium in return for a higher growth rate of
share price in the future. However, this also means that the shares are not cheap.
• lower P/E : the more attractive the price of the share to investors. However, this
suggests a lack of confidence in the company’s ability to maintain future earnings
• higher / lower diviend cover ?
• safe or generous divdend policy
• higher dividend cover : (i) more profits are retained for reinvestment (ii) a similar
level of dividend can be maintained as the company has sufficient retained
earnings during economic recession
• lower dividend cover : risk of less or no ordinary share dividend to be distributed
if the profits in future years decline.
P.5
HKCWCC BAFS Accounting Ratios, Revision Practice, P.6
Example 1
The income statements and statement of financial position for the years ended 31 May 2019 and
2020 of Quam Ltd. are as follows:
Quam
Income statements for the year ended 31 May
2020 2019
$000 $000 $000 $000
Sales revenue 1,886 1,150
Cost of sales (940) (680)
Gross profit 946 470
Administration costs (349) (223)
Distribution costs (185) (115)
Interest payable (68) (13)
(602) (351)
Profit before tax 344 119
Taxation (95) (55)
Profit for period 249 64
Current assets
Inventory 240 130
Trade receivables 165 85
Bank - 405 300 515
Total assets 1,755 1,045
Liabilities
Non-current liabilities
Loans 650 150
Current liabilities
Trade payables 187 145
Taxation 80 50
Bank overdraft 120 387 - 195
Total equity and liabilities 1,755 1,045
P.6
HKCWCC BAFS Accounting Ratios, Revision Practice, P.7
Additional information:
(i) All purchases and sales for the years ended 31 May 2020 and 2019 were on credit.
$000
Inventory 80,000
Trade receivables 40,000
Trade payables 110,000
Ordinary share capital 550,000
General reserve 50,000
Retained profit 68,000
Long-term loans 150,000
Required:
(a) Calculate the following accounting ratios for 2019 and 2020: (10 marks)
(b) Using the ratios calculated in (a), comment on the profitability, liquidity, management
efficiency and solvency of Quam Ltd. (8 marks)
P.7
HKCWCC BAFS Accounting Ratios, Revision Practice, P.8
Answers to Example 1
(a)
2020 2019
(i) Gross profit percentage = 946 / 1,886 x 100 470 / 1,150 x 100
1
= Gross profit / Sales x 100% = 50.2% = 40.9%
(ii) Net profit percentage = 344 / 1,886 x 100 = 119 / 1,150 x 100
1
= Net profit before tax / Sales x 100% = 18.2% = 10.3%
(iii) Return on capital employed = 412 / = 132 / [(850+818)÷2]
= EBIT / (S. Cap + Res + Non current [(1,368+850)÷2] x 100 x 100 1
lia.) x 100% = 37.2% = 15.8%
(iv) Current ratio = 405 / 387 = 515 / 195
1
= Current assets / Current liabilities = 1.05 : 1 = 2.64:1
(v) Quick ratio = 165 / 387 = 385 / 195
= (Current assets – inventory) / Current = 0.43 : 1 = 1.97 : 1 1
liabilities
(vi) Inventory turnover = 940 / [(240+130)÷2] = 680 / [(130+80)÷2]
1
= Cost of sales / Average inventory = 5.08 times = 6.48 times
(vii) Average trade receivables collection [(165+85)÷2] / 1,886 x [(85+40)÷2] / 1,150 x
period 365 365
1
= Average trade receivables / Sales x = 24.2 days = 19.8 days
365
(viii) Average trade payables payment period = [(187+145)÷2] / = [(145+110)÷2 /
= average trade payables / purchases x (940+240-130) x 365 (680+130-80) x 365 2
365 = 57.7 days = 63.7 days
(ix) Gearing = 650 / 1368 x 100 = 150 / 850 x 100
= Loans / (Ord Share cap + reserves = 47.5% = 17.6% 1
Loans) x 100
(b)
Profitability
The profitability of the business has improved, as reflected by a significant increase in gross profit
percentage, net profit percentage and return on capital employed. This may be due to obtaining
better discounts from suppliers and better control over expenses. The ability to make good use of
capital employed to create profit has strengthened and is attractive to any prospective shareholders.
Liquidity
Quam Ltd.’s liquidity position has deteriorated sharply and may be suffering from liquidity
problems, as reflected by a decrease in current ratio and quick ratio with less than 1 in 2020. The
business may not be able to settle short term obligations as they fall due since the bank balances
have fallen from a $300,000 surplus to an overdraft of $120,000.
Management efficiency
There may be some inventory control and collection of trade receivables problems in 2020. The
trade payables period has decreased from 64 days to 58 days which suggests it is paying suppliers
more quickly. This will have an adverse impact on the cash flow position.
Gearing
Although the company has a low gearing (below 50%) in 2020, there has been a significant increase
in the gearing compared with 2019. It has taken on additional loans presumably to finance the
additional non-current assets.
P.8
HKCWCC BAFS Accounting Ratios, Revision Practice, P.9
Example 2
The following is the financial information of Tom Company for the year ended 31 October 2020:
Required:
(c) Tom’s Company main competitor is a company called Mountain Ltd. which has the following ratios:
Dividend cover 1.2 times
Earnings per share (EPS) $0.16
Price earnings ratio 4.8 times
Compare and comment on the investment return ability of Tom Company. (2 marks)
Answers to Example 2
Johnny Limited’s financial year ends on 31 December each year. Information for 2019 is as
follows:
$
Net profit after tax 80 200
Dividend declared and paid for 2019: - Ordinary shares 13 500
- Preference shares 8 000
Balance as at 1 January 2019
Retained profits 210 000
General reserve 100 000
Balance as at 31 December 2019
Current liabilities 129 580
3% Debenture, repayable in 2025 280 000
45,000 Ordinary share capital 900 000
20,000 4% Preference share capital 200 000
General reserve 100 000
REQUIRED:
(a) Prepare a statement to calculate the shareholders’ funds as at 31 December 2019. (4 marks)
(b) Calculate (to two decimal places) the following ratios for 2019:
(c) Johnny Limited plans to raise $1 million by long-term financing without deteriorating its
solvency. Suggest, with explanation, one financing method Johnny Limited should use.
(2 marks)
P.11
HKCWCC BAFS Accounting Ratios, Revision Practice, P.12
(a)
Statement to calculate the shareholders’ funds as at 31 December 2019
$ $
Ordinary share capital 900 000 0.5
Preference share capital 200 000 0.5
1 100 000
General reserve 100 000 0.5
1 200 000
Retained profits as at 1 January 2019 210 000 0.5
Add: Net profit after tax 80 200 0.5
290 200
Less: Dividend for 2019 ($13 500 + $8 000) 21 500 1
Retained profit as at 31 December 2019 268 700
Shareholders’ funds as at 31 December 2019 1 468 700 0.5
(4)
Explanation: 1
- this will lower the gearing ratio and the solvency of the company will be enhanced
- as there is no need to repay the issued ordinary share capital, the solvency of the company would not
be deteriorated
(1 mark for relevant explanation, max. 1 mark)
(2)
12 marks
P.12
HKCWCC BAFS Accounting Ratios, Revision Practice, P.13
2018
$
Sales (cash sales $11,600) 298,200
Cost of sales 210,700
Operating expenses 43,600
REQUIRED:
Calculate (to two decimal places) the following ratios for 2018:
(a) inventory turnover (in times)
(b) trade receivables turnover (in times)
(c) total assets turnover (in times)
(d) gearing ratio
P.13
HKCWCC BAFS Accounting Ratios, Revision Practice, P.14
The account balances of Rocky Company Limited as at 31 December 2016 and 31 December
2017 were given below:
2016 2017
$ $
3 % Long-term loan 753 800 180 000
5% Short-term loan / 90 000
Accrued expenses 8 200 15 000
Cash at bank 33 500 128 000
Equipment, net 782 000 663 000
Inventory (31 December) 136 500 364 000
Ordinary share capital 200 000 700 000
Retained profits (31 December) 42 000 158 000
Trade payables 58 000 202 000
Trade receivables 110 000 190 000
Additional information:
(i) All sales were made on credit and total sales for the year 2017 were $780 000. Some goods
were sent on a sale-or-return basis at a price of $17 000 in December 2017 and were recorded
as credit sales. On 31 December 2017, all these goods were returned by the customer and
were included in the closing inventory of the company, but no entries were made in respect
of this return.
(ii) Total purchases for the year 2017 amounted to $778 050, of which 80% were credit purchases
and 20% cash purchases.
REQUIRED:
(a) Calculate (to two decimal places) the following ratios for 2017 (365 days a year): (8 marks)
(b) (i) Calculate (to two decimal places) the gearing ratios of Rocky Company Limited for
2016 and 2017. (2 marks)
(ii) Comment on the solvency of Rocky Company Limited for 2017. (3 marks)
P.14
HKCWCC BAFS Accounting Ratios, Revision Practice, P.15
P.15
HKCWCC BAFS Accounting Ratios, Revision Practice, P.16
ABC Limited drafted a trial balance as at 31 December 2016, before the preparation of the
closing entries. As the trial balance did not agree, a suspense account was opened.
(i) Discounts allowed of $3400 had not been recorded in the books.
(ii) A cash sale of $28 050 to Pearl Limited was recorded in the sales journal as $28 500 and
posted to the ledgers accordingly. No entry for the receipt was made in the books.
(iii) An invoice for credit purchase was overstated by $270.
(iv) Goods returned to a supplier for $440 were debited to both trade payables account and returns
inwards account.
REQUIRED
(a) Prepare the necessary journal entries to correct the above. Narrations are not required. (5
marks)
On 31 December 2016, the following balances were extracted from the ledgers of ABC Limited,
before recording the adjustments in (a) above:
$
Ordinary share capital 1 305 000
Preference share capital 760 000
Retained profits, 1 January 2016 10 000
Loans, repayable in June 2018 320 000
The draft net profit for the year ended 31 December 2016 was $7700. No dividends were
declared for 2016.
REQUIRED:
(b) Prepare a statement to calculate the retained profits as at 31 December 2016, showing all
necessary adjustments and the adjusted net profit for 2016. (4 marks)
(c) Calculate the gearing ratio of ABC Limited for 2016. (2 marks)
(d) Explain two differences in terms of the right to dividends for ordinary shareholders and
preference shareholders. (2 marks)
P.16
HKCWCC BAFS Accounting Ratios, Revision Practice, P.17
= 45% (2)
(d) - The dividend per share for preference shares is usually fixed while it varies for ordinary shares. Max. 2
- The preference shareholders usually receive dividend prior to ordinary shareholders.
(1 mark for each difference, maximum 2 marks)
(2)
5. DSE 2016 2A-Q8c
Explain how the acid test ratio at 31 December 2015 is affected if Gary Company Limited
decides to repay part of its long-term bank earlier, on 1 June 2016. (2 marks)
Pearl Ltd had the following financial information related to the year 2014:
As at 1 January 2014 $
The retained profits as at 31 December 2014 amounted to $128 000 and no profit appropriations
were made during year.
(i) Pearl ltd had trade payables only as its current liabilities.
(ii) An electricity bill for December 2014 amounting to $2500 was received on 16 January 2015.
As the payment would be made in February 2015, no accounting record had been made by
the bookkeeper.
(iii) A physical inventory count on 4 January 2015 showed that the value of inventory on that date
was $31 700, which had been used for computation of profits for the year 2014. During the
period 1 January to 4 January 2015, there were credit purchases with a total list price of $3000.
A trade discount of 10% had been given by the supplier on these purchases and a 2% cash
discount would be received if the settlement was made in two weeks. Goods costing $5000
were sold during these 4 days.
P.18
HKCWCC BAFS Accounting Ratios, Revision Practice, P.19
Required:
(a) Identify the relevant accounting principle or concept violated in (ii) above. Briefly explain.
(3 marks)
(c) Calculate (to two decimal places) the following ratios for the year 2014:
(i) net profit ratio (2 marks)
(ii) quick ratio (2 marks)
(iii) trade payables turnover (in times) (2 marks)
(iv) inventory turnover (in times) (2 marks)
Lily Ltd and Jasmine Ltd are two listed companies in the same industry and have a similar scale
of production. They have a similar share price. Their financial ratios for the year 2014 are shown
below:
Required:
(d) Pearl Ltd is planning to invest a designated amount of cash, for the same percentage of
shareholding, in one of the above companies. Advise and explain which company Pearl Ltd
should invest in based on the three ratios above. (4 marks)
P.19
HKCWCC BAFS Accounting Ratios, Revision Practice, P.20
P.20
HKCWCC BAFS Accounting Ratios, Revision Practice, P.21
Although accounting ratios are useful tools in financial analysis, there are limits to their usefulness.
State two of these limitations. (2 marks)
Limitations:
- Accounting ratios are calculated based on historical cost and hence may not fairly reflect
current performances
- Accounting ratios are calculated based on past financial information. Past performance of a
company does not necessarily indicate its future performance
- Accounting ratios are affected by accounting estimates.
- Accounting ratios can only identify the symptoms, but not the cause. They are not able to
provide any suggestions or advice to solve the existing or future problems
- Non-monetary but significant items, such as the quality of the products, leadership of the
management and the business environment, are ignored.
(1 mark for each relevant limitation, max. 2 marks)
If Windy Company Limited issued debentures instead of ordinary shares in December 2013,
explain how the profitability and solvency of the company will be affected in 2014. (4 marks)
- Profitability:
Debentures increase a deducted from earnings and hence will result in a smaller profit. Ordinary
dividend is only a profit appropriation item. (2)
P.21
HKCWCC BAFS Accounting Ratios, Revision Practice, P.22
2011 2012
$ $
4% Long-term loans 67 000 120 000
8% Short-term loans 23 100 60 000
Accounts payables 43 300 100 200
Accounts receivables 37 500 85 864
Bank overdraft - 15 000
Cash at bank 32 020 -
Cash in hand 200 500
Inventory 79 680 162 936
$5 Ordinary share, fully paid 155 000 155 000
Property, plant and equipment, net 254 000 333 622
Retained profits 115 000 132 722
Additional information:
(i) All sales were made on credit.
(ii) On 31 December 2010, inventory and accounts receivables were $88 320 and $37 260
respectively.
(iii) Total sales amount shown in the sales journal for 2011 and 2012 amounted to $454 790 and
$625 942 respectively. Gross profit was $96 110 for 2011 and $230 191 for 2012. However,
it was then discovered that a sales invoice of 2012 for $14 000 had been omitted from the
records of the books.
(iv) There had been no change in share capital since 2010. The balance of the retained profits at
31 December 2010 was $69 521.
(v) In 2011 and 2012, no tax expenses were incurred and no dividend was declared.
REQUIRED:
(a) Calculate (to two decimal places) the following ratios for 2011 and 2012 (assume 365 days
per year): (14 marks)
(i) current ratio
(ii) liquid ratio
(iii) days’ sales in accounts receivables
(iv) inventory turnover (in times)
(v) net profit ratio
(vi) earnings per share
(b) Assume that the management of Eva Company is considering offering a 5% commission on
all sales. Briefly comment on the profitability of Able Company for the year 2012. (3 marks)
P.22
HKCWCC BAFS Accounting Ratios, Revision Practice, P.23
P.23
HKCWCC BAFS Accounting Ratios, Revision Practice, P.24
(3)
10. DSE Practice Paper Q9b
As compared with 2010, many of the financial ratios of BC Ltd in 2011 had improved. Therefore,
the Chief Executive Officer (CEO) of the company concluded that the performance of BC Ltd in
2011 was better. Give two reasons why the CEO’s conclusion might be incorrect. Explain your
answers. (4 marks)
- Ratios may not reflect the reality of a business as accounting figures are not adjusted for
price-level changes.
- Analysis may not be comprehensive as only transactions expressed in monetary terms are
included in the financial statements, while qualitative information is ignored.
- Short run fluctuations of the company may be hidden through window dressing.
(2 marks for each relevant reason, max. 4 marks)
Easy Company makes all purchases and sales on credit. The following balances of the company
as at 31 December 2011 were extracted:
$
Sales 10 186 000
Purchases 7 294 500
Inventory − as at 1 January 2011 878 000
− as at 31 December 2011 990 000
Trade
receivables − as at 1 January 2011 856 000
− as at 31 December 2011 996 000
REQUIRED:
Calculate (to one decimal place) the following accounting ratios for 2011:
(1) Trade receivables collection periods = ($856 000 + $996 000)/2 12 months 1
$10 186 000
= 1.1 months
(W1) Cost of goods sold = $878 000 + $7 294 500 – $990 000
= $7 182 500
P.24
HKCWCC BAFS Accounting Ratios, Revision Practice, P.25
Good Prospect Limited commences its business on 1 January 20X6 and has made a net profit of $3
000 000 for the year ended 31 December 20X6. However, the company experienced problem in getting $1
800 000 to finance the acquisition of a plant in Tai Po for expansion. Lee, the managing director, could not
understand why the amounts in each of the following pairs of items were not equal:
(i) net profit for the year and net increase in cash and bank balance for the year
(ii) bank balance in the cash book and the bank statement balance as at 31 December 20X6
REQUIRED:
(a) Explain to the managing director why the amounts in each of the above pairs of items would differ.
(6 marks)
As at 31 December 20X6, the long-term financing of Good Prospect Limited was as follows:
$‘000
Capital and reserves
200 000 Ordinary shares 3 000
150 000 12% Preference shares 1 500
Retained profits 600
After studying the information above, Mok, the executive director, proposed the following alternatives to
finance the acquisition of the plant:
Alternative 1:
To issue 100 000 ordinary shares at $18 per share. The annual ordinary dividend will
remain at 20% on the net profit available for distribution to ordinary shareholders.
Alternative 2:
To issue 1 800 000 8% debentures (repayable in June 20Y2) at par, payable in full on application.
Debenture interest is payable twice a year on 1 January and 1 July.
Alternative 3:
To purchase the plant on credit. The terms of agreement provide for five annual payments of $480 000,
commencing at the end of the first year, Assume that interest accrues evenly over the credit period.
It was estimated that following this expansion, the profit before interest for the first financial year would
amount to $3 600 000.
REQUIRED:
(b) Calculate the gearing ratio under each alternative immediately after the acquisition. (3 marks)
(c) Calculate the earnings per share under each alternative for the first financial year after the expansion.
(Note: Ignore taxation.) (3 marks)
(d) Based on your answer in (b) and (c), evaluate the above three financing alternatives from the
perspective of shareholders. (6 marks)
(e) List two non-financial factors that should be taken into account before making the decision. (2 marks)
P.25
HKCWCC BAFS Accounting Ratios, Revision Practice, P.26
(a)
(i) Net profit for the year vs net increase in cash and bank balance for the year:
- Net profit for the year is arrived at matching all expenses and revenues of a particular
trading period with adjustments of accruals and prepayments.
- Cash and bank balances represent the amount of cash in hands and on demand (net of
cash inflows and outflows)
- The business makes profit by converting cash into assets like accounts receivables,
inventories, investment, etc. and then converting such assets back into cash.
- A business wants to get hold of cash in the shortest possible time but to keep the least
amount of cash in hands so as to increase the number of trading cycles and hence the
trading profits.
(Max 3 marks)
(ii) Bank balance in the cash book vs the bank statement balance as at 31 December 20X6:
- The cash book makes records from the company’s point of view. It debits all cash and
cheques deposited into the bank account, and credits bank charges and cheques drawn
on payees.
- The transactions recorded in the bank statement are shown from the point of view of
the bank, in that payments are debited and receipts are credited.
- The balance in the bank statement rarely agrees with the cash book balance of the same
date. The discrepancy may arise from:
- items arising from time difference e.g. cheques issued to suppliers not yet
presented to the bank for payment, deposits made by the company not yet
credited by the bank
- errors made by the bank errors present in the cash book
(Max 3 marks)
P.26
HKCWCC BAFS Accounting Ratios, Revision Practice, P.27
P.27
HKCWCC BAFS Accounting Ratios, Revision Practice, P.28
The following data relates to Gordon Limited for the year ended 31 December 2010:
$
Non-current liabilities: 4% debentures (issued in 2008) 800 000
Ordinary share capital (485 000 shares) 970 000
6% preference share capital (600 000 shares), issued in 2009 600 000
Retained profits brought forward, 1 January 2010 880 000
Net profit after tax for the year 2010 320 000
Taxation 90 000
Preference share dividend paid 36 000
Ordinary share dividend paid 72 000
REQUIRED:
(a) Based on the information above, calculate (to two decimal places) the following accounting
ratios for Gordon Limited for the year ended 31 December 2010 using year-end figures: (5
marks)
(b) Gordon Limited plans to seek additional long-term finance and expand its business, while
maintaining a low capital gearing ratio to strengthen its creditworthiness and financial
stability. Advise what financing arrangements Gordon Limited should undertake. (1 mark)
(ii) (net profit before interest and tax ÷ year end non-current liabilities and shareholders’
fund)x100%
Net profit before interest and tax: $320 000+$90 000+$800 000x4% = $442 000
(iii) Net profit after tax and preference share dividend ÷ no. of ordinary shares issued
($320 000-$36 000) ÷ 485 000 shares = $0.59 per share 1
P.28
HKCWCC BAFS Accounting Ratios, Revision Practice, P.29
Joey and Sam are in a partnership selling local and imported accessories. The following ratios
relate to the partnership and the industry average for the year ended 31 December 2009:
Required:
With reference to all ratios, comment on the liquidity of Joey and Sam’s partnership in 2009.
(4 marks)
P.29
HKCWCC BAFS Accounting Ratios, Revision Practice, P.30
At 31 December 2000, the number of ordinary shares issued were 6 000 000. The market
price per ordinary share of Ming Ltd was $5. Dividend declared and paid on the ordinary
shares amounted to $0.20 per share in 2009. The 8% preference shares were issued in
2007. There was no movement in ordinary share capital during the year 2009.
REQUIRED:
Calculate (to two decimal places) the following accounting ratios for the year 2009:
(a) Earnings per share (1 mark)
(b) Price-earnings ratio (1 mark)
(c) Dividend cover (1 mark)
P.30
HKCWCC BAFS Accounting Ratios, Revision Practice, P.31
Marks
(A) (a) Dividend cover measures the number of times annual ordinary dividend is covered 1
by annual profit attributable to ordinary shareholders
Interpretation: the higher the ratio, the more likely that the dividend can be 1
maintained in the future.
(b) Limitation of ratio analysis:
- Misleading results if the underpinning financial information is poor 1
e.g. poor estimation on depreciation and allowance for doubtful debts.
- Timeliness of financial information 1
i.e. ratio is based on past financial information, however, past performance
of a firm does not necessarily indicate its future performance.
- Different judgement on the accounting policies used for certain accounting 1
transactions
I.e. with different accepted accounting policies used for the transaction
by different companies, it is difficult to compare and draw conclusion on
their performance.
- Different interpretations can be made 1
I.e. ratios can only identify the symptoms, but not the causes.
- Adhere to the money measurement concept 1
i.e. non-monetary but significant items, such as quality of goods,
management, the diversity of products, could not be reviewed.
(1 mark each, max 3 marks)
P.31
HKCWCC BAFS Accounting Ratios, Revision Practice, P.32
$
Non-current assets 7 530 000
Working capital 3 316 000
Non-current Liabilities – 5% Debentures (5 500 000)
Net assets 5 346 000
The 5% debentures were issued at par on 1 January 2007. There was no movement in ordinary
share capital during the year 2007.
REQUIRED:
(a) Based on the information above, calculate (to two decimal places) the following accounting
ratios for the year 2007: (4 marks)
(b) Referring to gearing structure and return on capital employed in (a), evaluate the investment
opportunity from the view point of shareholders in Tai Wo Ltd. (3 marks)
P.32
HKCWCC BAFS Accounting Ratios, Revision Practice, P.33
(a)
(1) [$5500000 ÷ ($5500000+$5346000)] x 100% = 50.71% 1
(b)
-Tai Wo Ltd. is a highly geared company with half of its capital employed contributed by loan
capital 1
-When the overall return of the company exceeds the fixed return to debenture holders, the profit
in excess will go to the shareholders
-In this case, the return on capital employed is 13.62%, which is in excess of 5%. The profit in
excess of 5% will go to the shareholders
(any one, 2 marks each)
P.33
HKCWCC BAFS Accounting Ratios, Revision Practice, P.34
$
Ordinary share capital (8 000 000 shares) 9 500 000
General reserve 600 000
Retained profits 1 280 000
In order to increase the market share, Hearty Limited planned to establish three more outlets
over the next few months. The total cost incurred for this expansion would be $5 000 000 which
was to be financed by the issue of 1 200 000 ordinary shares at $2.50 and $2 000 000 6%
debentures at par (repayable in 2017)
If the financing scheme was effected on 1 January 2007, the estimated profit before interest and
tax for the year ended 31 December 2007 would be $3 700 000, and tax expense $200 000.
REQUIRED:
(b) Calculate (to two decimal places) the following estimated accounting ratios for the year
ended 31 December 2007: (5 marks)
P.34
HKCWCC BAFS Accounting Ratios, Revision Practice, P.35
(a)
Equity capital Loan capital
Shareholders have voting right Debenture holders have no voting right
Dividend is an appropriation of profit Interest is an expense
Dividend rate is not fixed Interest rate is fixed
There is no stipulated date for There is a stipulated date for redemption
repayment of capital of debentures
In case of liquidation, shareholders rank Debenture holders rank before
the last to receive back the fund shareholders in case of liquidation.
invested.
(2 marks for each relevant comparison, max 4 marks)
(b)
(1)
$
Ordinary share capital ($9 500 000 + $2.5x1 200 000) 12 500
000
General reserve 600 000
Retained profit ($1 280 000+$3 700 000-$2 000 000x6%-$200 000) 4 660 000
6% debentures 2 000 000
Capital employed 19 760 00
0
(2) ($3 700 000 - $2 000 000x6% - $200 000) / (8 000 000 + 1 200 000) shares
= 36.74 cents 2
P.35
HKCWCC BAFS Accounting Ratios, Revision Practice, P.36
The following financial statements were prepared by the accountant of Wise Limited:
Trading and profit and loss account for the years ended 31 December
2001 2000
$ $
Sales 12 000 000 7 600 000
Opening inventory 460 000 420 000
Purchases 7 580 000 3 350 000
Less closing inventory (1 140 000) (460 000)
Cost of sales 6 900 000 3 310 000
Gross profit 5 100 000 4 290 000
Less operating expenses (4 770 000) (4 040 000)
Net profit for the year 330 000 250 000
Retained profits brought forward 350 000 100 000
Retained profits carried forward 680 000 350 000
Balance Sheet as at 31
2001 2000
$ $
Non-current assets 3 900 000 2 720 000
Current assets
Inventory 540 000 460 000
Trade receivables (net) 2 366 800 640 000
Cash 23 200 40 000
2 930 000 1 140 000
Total assets 6 830 000 3 860 000
REQUIRED:
(a) Calculate (up to 2 decimal places) the following ratios for Wise Ltd. for 2001 and 2000:
(b) Comment on the profitability of Wise Ltd. based on the answers calculated in (a). (4 marks)
(c) Suppose the bank loan agreement states that if the company’s liquid ratio falls below1.8 in 2001, the
bank has the right to ask for immediate total repayment of the loan. Comment on how this would
affect the liquidity position of Wise Ltd. Support your answers by current ratio and liquid ratio. (4
marks)
P.36
HKCWCC BAFS Accounting Ratios, Revision Practice, P.37
(a)
(i) Net profit ratio:
2001: ($330 000 ÷ $12 000 000) x 100% = 2.75% ½
2000: ($250 000 ÷ $7 600 000) x 100% = 3.29% ½
(b)
The net profit to sales reduced from 3.29 % in 2000 to 2.75% in 2001 and gross profit ratio also
reduced from 56.45% to 42.5%. 1
The fall in net profit ratio was smaller than the fall in gross profit ratio, so operating expenses
have increased at a slower rate than sales. 1
The return on capital employed(ROCE) increased from 7.75% in 2000 to 9.85% in 2001,
showing that the company was able to make a profitable use of capital employed, including
borrowed fund. 1
However, ROCE was lower than the loan interest rate, reflecting that the company was incurring
a relatively high cost of finance. 1
(c)
Liquid ratio: ($2 366 800+$23 200) ÷ $1 650 000 = 1.45 1
Wise Ltd’s liquid ratio (1.57) is lower than 1.8, the bank loan may have to be repaid
immediately.
Current liabilities would then increase to $3 650 000 1
Wisr Ltd. could then face a very serious liquidity problem. 1
Current ratio: [$2 930 000÷ ($1 500 000+$1 650 000)] = 0.93:1 ½
Liquid ratio: ($2 366 800+$23 200)÷($1 500 000+$1 650 000) = 0.76:1 ½
P.37
HKCWCC BAFS Accounting Ratios, Revision Practice, P.38
Universe Ltd was incorporated and commenced business on 1 January 1999, issuing 200 000
ordinary shares at $10 each. On 1 January 2000, the company issued a further 100 000 ordinary
shares at $10 per share. Universe Ltd buys and sells watches. After drafting the final accounts of
Universe Ltd, the following information related to the accounting year ended 31 December 2000
was revealed:
$
(i) Sales for the year 3 612 000
(ii) Inventory on 1 January 2000 226 800
(iii) Inventory on 31 December 2000 Increased by 20%
(iv) Gross profit margin 40%
(v) Trade receivables collection period Two months
(vi) Proportion of credit sales to cash sales 2:1
(vii) Trade payables turnover (year end trade payables) 4 times
(viii) Gearing ratio 5%
(ix) Current ratio 2:1
(x) Non-current assets, net ?
Further information:
(xi) There were no cash purchases and all purchases were on credit during the year ended 31
December 2000.
(xii) Sales of goods were seasonal. The monthly average sales for January, February, November
and December were double those of the other months.
(xiii) Selling and distribution expenses for the year amounted to $206 500 while administration
expenses are equal to 3 times selling and distribution expenses.
(xiv) A bank loan was obtained on 1 January 2000, repayable in 2020. Loan interest accrued at
31 December 2000 amounted to $13 200.
(xv) The company had a bank overdraft at 31 December 2000 and the bank overdraft interest for
the year amounted to $5600
(xvi) The return on capital employed for 1999 (based on shareholders’ fund at the year end) was
20%. There was no non-current liabilities and other reserves on 31 December 1999. A
dividend of $1 per share was paid during the year ended 31 December 2000.
REQUIRED:
(a) Prepare the income statement for the year ended 31 December 2000. (7 marks)
(b) Prepare the statement of financial position as at 31 December 2000. (7 marks)
P.38
HKCWCC BAFS Accounting Ratios, Revision Practice, P.39
P.39
HKCWCC BAFS Accounting Ratios, Revision Practice, P.40
The following balances as at 31 March 1996 relate to two companies operating in the same
industry:
A Ltd. B Ltd.
$’000 $’000
Gross profit 9 000 9 000
Ordinary dividend paid 1 800 1 200
Preference dividend paid 100 --
Profit tax 700 800
Operating expenses 5 200 4 900
Ordinary share capital 9 000 6 000
Preference share capital 1 000
12% debentures 1 000 4 000
Retained profit on 31 March 1996 1 380 980
Additional information:
(i) The number of ordinary shares for A Ltd. and B Ltd. were 9 000 000 and 5 000 000 on 31
March 1996.
(ii) The market price per ordinary share at 31 March 1996 for A Ltd. and B Ltd. was $1.98 and
$5.81 respectively.
(iii) There were no changes either in the number of shares or debentures in issue during the year
to 31 March 1996 for both companies.
REQUIRED:
(a) Calculate the following ratios (up to 2 decimal places) for both A Ltd. and B Ltd.:
(b) Compare and comment briefly on the investment ratios, calculated in (a), of the two
companies. (4 marks)
P.40
HKCWCC BAFS Accounting Ratios, Revision Practice, P.41
(a)
(1) Earnings per share:
A Ltd: ($9000-$5200-$700-$100) ÷ 9 000 = $0.33 per share 1
B Ltd.: ($9000-$4900-$800) ÷ 5000 = $0.66 per share 1
(b)
The earnings per share of B Ltd. doubled that of A Ltd. and the P/E ratio of A Ltd. was a bit low
and that of B Ltd. 1
The market appeared to have a higher regard for the shares of B Ltd. than it did for the shares of
A Ltd. 1
The dividend cover of A Ltd. was only 1.67 times and that of B Ltd. was 2.75 times. The
dividend payment of A Ltd. was more vulnerable unless the company became more profitable.
Thus in terms of dividend it was less risky to invest in B Ltd. 2
P.41
HKCWCC BAFS Accounting Ratios, Revision Practice, P.42
The following are the draft statement of financial positions of Happy Limited as at 31 March 1990:
$
Machinery 2,200,000
Accumulated depreciation (820,000)
1,380,000
Inventory 227,000
Trade receivables 1,200,000
Short term investments at cost 165 000
2,972,000
The following summary data are extracted from the company’s income statement for the year
ended 31 March 1990:
$
Sales 4,000,000
Cost of sales (2,400,000)
Expenses (1,388,000)
Net profit 212,000
Dividend paid (130,000)
Tax paid (72,000)
Retained profit for the year 10,000
Additional information:
(i) All sales and purchases were on credit terms.
(ii) Selected balances on 31 March 1989 were as follows:
$
Trade receivables 170,000
Inventory 45,000
Trade payables 340,000
REQUIRED:
Calculate the following ratios for the year ended 31 March 1990:
(i) current ratio (1 mark)
(ii) liquid ratio (1 mark)
(iii) gearing ratio (1 mark)
(iv) return on closing capital employed (1 mark)
(iv) average trade receivables turnover (1 mark)
(v) average trade payable turnover (2 marks)
P.42
HKCWCC BAFS Accounting Ratios, Revision Practice, P.43
Profit before interest and tax / (closing non-current liabilities +closing shareholders’ fund)
P.43
HKCWCC BAFS Accounting Ratios, Revision Practice, P.44
The following items for the year ended 31 December 2010 are available:
$
Sales 621 500
Returns inwards 38 000
Cost of goods sold 311 000
Operating expenses 230 370
REQUIRED:
(a) Calculate (to two decimal places) the following items for the year ended 31 December 2010:
(10 marks)
(b) Calculate the amounts of the following items as at 31 December 2010: (4 marks)
P.44
HKCWCC BAFS Accounting Ratios, Revision Practice, P.45
(a)
(i) Net profit ratio:
[($621 500 - $38,000) - $311 000 - $230 370] / ($621 500 - $38,000) x 100% = 7.22%
($56 175 + $85 850 + $10 000) / ($67 200 + $7 525) = 2.03 : 1
[($70 400 + $85 850)/2] / ($621 500 - $38,000) x 12 months = 1.61 months
(b)
(i) Working capital
($36 000 + $56 175 + $85 850 + $10 000) - ($67 200 + $7 525) = $113 300
$425 700 + $41 000 + ($621 500 - $38,000) - $311 000 - $230 370 = $508 830
P.45
HKCWCC BAFS Accounting Ratios, Revision Practice, P.46
The BB company’s information below relates to the year ended 31 December 2005:
$
As at 1 January 2005:
Inventory 62 430
Ordinary share capital (480 000 shares) 750 000
Trade debtors 60 080
Retained profits 213 000
During year 2005:
Sales (credit) 800 000
Purchases 500 000
Operating expenses 320 000
As at December 2005:
Ordinary share capital ?
Inventory 156 230
Trade debtors 102 400
Cash in bank 168 370
Trade creditors 184 200
Accruals 4 000
During the year ended 31 December 2005, 200 000 ordinary shares were offered to the public at
$1.25 per share. Only 120 000 shares application were received and all were accepted for
subscription.
Required:
(a) Calculate (to one decimal place) the following for year 2005: (5 marks)
(i) Quick ratio
(ii) Credit period allowed to debtors (in days)
(iii) Stock turnover rate
(iv) Earnings per share
(c) Calculate the amount of shareholders’ fund as at 31 December 2005. (3 marks)
P.46
HKCWCC BAFS Accounting Ratios, Revision Practice, P.47
(a)
(i) Quick ratio:
$102 400 + 168 370 = $270 770
$(184 200 + 4 000) $188 200
= 1.4:1 (1)
Cost of sales: $62 430 + $500 000 - $156 230 = $406 200
P.47
HKCWCC BAFS Accounting Ratios, Revision Practice, P.48
Required:
Calculate (to two decimal places) for Vera Limited the following ratios for the year ended
31 March 2004: (8 marks)
P.48
HKCWCC BAFS Accounting Ratios, Revision Practice, P.49
(A)
(a) Liquidity ratios measure the ability if an enterprise to pay its short-term obligations and to
meet unexpected needs for cash. 1
(b) Profitability ratios measure the operating performance of an enterprise for a given period of
time. 1
(B)
(a) Quick ratio
($30 340 + $660) ÷ ($26 900 + $3010) = 1.04 : 1 1
P.49
HKCWCC BAFS Accounting Ratios, Revision Practice, P.50
Hamilton Limited has issued 100 000 ordinary shares and the following information relating to
the year 2001 were:
$
As at 1 January 2001:
Retained profit brought forward 19 000
Current assets 45 000
Total assets 180 000
Non-current Liabilities 57 000
As at 31 December 2001: $
Non-current assets 153 000
Total assets 213 000
Required:
P.50
HKCWCC BAFS Accounting Ratios, Revision Practice, P.51
P.51
HKCWCC BAFS Accounting Ratios, Revision Practice, P.52
26. CE 2002 Q3
The financial information of Grand View Limited for the year ended 31 December 2001 is presented
below:
Profit and loss account for the year ended 31 December 2001
$ $
Cash sales 252 000
Credit sales 1 008 000
1 260 000
Less: Cost of sales
Opening stock 210 000
Purchases 955 500
1 165 500
Less: Closing stock 385 000 780 500
Gross profit 479 500
Less: Operating expenses 360 500
Net profit 119 000
Grand View Limited had also produced the following ratios for the year 2000.
Current ratio 1.93:1
Quick ratio 1.01:1
Stock turnover rate 3.02 times
Debtors’ collection period 3.26 months
Net profit ratio 10.07%
Return on capital employed 6.11%
Required:
(a) Compute the following ratios for the year 2001: (8 marks)
(i) Current ratio
(ii) Quick ratio
(iii) Stock turnover rate
(iv) Debtors’ collection period (in months)
(v) Net profit ratio
(vi) Return on capital employed
(Calculations to two decimal places)
(b) Based on the ratios for the year 2000, comment briefly on the liquidity and profitability of the
company for the year 2001. (4 marks)
P.52
HKCWCC BAFS Accounting Ratios, Revision Practice, P.53
(a)
(i) Current ratio =Current assets ÷ current liabilities
=(385 000 + 262 500 + 451 500) ÷ (420 000 + 119 000)
=2.04 : 1 1½
(ii) Quick ratio =(Current assets - stock) ÷ current liabilities
=(262 500 + 451 500) ÷ (420 000 + 119 000)
= 1.32 : 1 1½
(iii) Stock turnover rate = Cost of goods sold ÷ average stock
= 780 500 ÷ [(210 000 + 385 000) x 1/2]
= 2.62 times 1½
(iv) Debtors’ collection period = (Debtors ÷ credit sales) x 12 months
= (262 500 ÷ 1 008 000) x 12
= 3.12 months 1
(v) Net profit ratio= (Net profit ÷ sales) x 100%
= (119 000 ÷ 1 260 000) x 100%
= 9.44% 1
(vi) Return on capital employed = (Net profit ÷ capital employed) x 100%
=[119 000 ÷ (1 925 000 + 161 000)] x 100%
= 5.70% 1½
(b)
Liquidity
- there seems to be slight improvement in the liquidity position of the company 1
- the current ratio and quick ratio increased in 2001 1
- the company had also shortened the debtors’ collection period 1
- the stock turnover rate shows that the company was slower in selling the stock in 2001 1
(Max 2 marks)
Profitability
- the company’s profitability has worsened during 2001 1
- as shown by decreases in net profit ratio and return on capital employed 1
P.53
HKCWCC BAFS Accounting Ratios, Revision Practice, P.54
The profit and loss account of Sunny Fashion for the year ended 31 December 1999 is shown below:
$ $ $
Sales 1,125,000
Less: Sales returns 45,000
1,080,000
Cost of goods sold
Opening inventory ?
Purchases ?
Less: Purchases returns 28,000 ?
?
Less: Closing inventory ? 648,000
Gross profit 432,000
Less: Rent rates 185,500
Salaries 120,000
Selling expenses 8,000
Depreciation of non-current assets 6,500
Sundry expenses 6,000 336,000
Net profit 96,000
Additional information:
(i) The closing inventory and the opening inventory amounted to the same figure.
(ii) The inventory turnover rate was 8 times.
(iii) Debtors’ collection period (using year-end figures) for the year was two months and
creditors’ repayment period (using year-end figures) was three months.
(iv) Sales and purchases accrued evenly throughout the year.
(v) All purchases and 90% of the net sales were on credit.
(vi) The current ratio was 2.1 : 1.
(vii) Current assets consisted of cash at bank, debtors, inventory and prepayments.
(viii) Cash at bank amounted to 40% of working capital.
(ix) The non-current assets had a cost of $339,800 and an accumulated depreciation of $191,500
at 1 January 1999. There were no additions and disposals of non-current assets during the
year.
(x) The return based on the owner’s capital at 31 December 1999 was 30%.
(xi) Drawings during the year amounted to $36000.
Required:
(a) Calculate the amounts for closing inventory and gross purchases. (2 marks)
(b) Prepare the statement of financial position of Sunny Fashion as at 31 December 1999. (10 marks)
(c) Briefly comment on the liquidity and profitability of Sunny Fashion for 1999 if the company had
the following figures in 1998: (4 marks)
P.54
HKCWCC BAFS Accounting Ratios, Revision Practice, P.55
(b)
Sunny Fashion Store
Statement of financial position as at 31 December 1999 ½
$ $
Non-current assets at cost 339,800 ½
Less: accumulated depreciation ($191,500+6,500) 198,000 1
141,800
Current Assets
Inventory 81,000 ½
Debtors ($1,080,000x90%x2/12) 162,000 1½
Prepayment (balancing figure) 25,920 1
Cash at bank ($178,200x40%) 71,280 1
34,0200
Less: Current liabilities
Creditors ($648,000x3/12) 162,000 1
Working capital 178,200
320,000
Capital
Balance as at 1 January 1999 (balancing figure) 260,000 1
Add: Net profit 96,000 ½
356,000
Less: Drawings 36,000 ½
Balance as at 31 December 1999 ($96,000 30%) 320,000 1
(c)
The liquidity of Sunny Fashion has improved as revealed by an increase in current ratio and a shortening of debtors’
collection period. However, the company was slower in selling its inventory in 1999. 2
The profitability of the company has deteriorated as shown by a decrease in return on owner’s capital. 2
P.55
HKCWCC BAFS Accounting Ratios, Revision Practice, P.56
Required:
(a) Compute the following ratios for 1999 and 1998: (7 marks)
(b) Comment briefly on the profitability and liquidity of Global Limited for 1999. (3 marks)
P.56
HKCWCC BAFS Accounting Ratios, Revision Practice, P.57
82800
1999: 100 % = 10.34% ½
800400
90000
1998: 100% = 12.52% ½
718800
(ii) Return on average capital employed
722400 − 422400
1999: = 0.87 : 1 ½
343200
596400 − 383200
1998: = 0.67 : 1 ½
320400
( 249600 + 181200 ) / 2
1999: 12 months = 3.23months 1
800400
(181200 + 165600 ) / 2
1998: 12 months = 2.89 months 1
718800
(b) Profitability
The company’s profitability deteriorated during 1999 as shown by decreases in net profit ratio and return
on average capital employed or decrease in earnings per share. 2
Liquidity
There seems to be improvement in the liquidity position of the company since the quick ratio increased in
1999. However, the company was slower in collecting its debts from debtors in 1999. 2
P.57
HKCWCC BAFS Accounting Ratios, Revision Practice, P.58
The financial information of Games Limited for the year ended 31 December 1996 is presented below:
$ $
Credit sales 504 000
Opening inventory 84 000
Add: Purchases 382 200
466 200
Less: Closing inventory 154 000
Cost of sales 312 200
Gross profit 191 800
Required:
(b) Give two possible dangers of having too little working capital. (2 marks)
P.58
HKCWCC BAFS Accounting Ratios, Revision Practice, P.59
(b) - If a business has too little working capital, there is the danger that creditors will take legal action against
the company to get payments, and that the business well go into liquidation as a result.
- At best, the business will acquire a reputation for being a slow payer, and it may find suppliers are only
willing to supply goods for immediate cash payments, i.e., they are not able to buy on credit.
- Shortage of working capital will also mean that stock is likely to be kept below optimum level for the
potential business and that the business may not be able to offer credit terms to its own customers.
(Max 2)
P.59
HKCWCC BAFS Accounting Ratios, Revision Practice, P.60
The draft balance sheets of Rita Limited as at 31 March 1994 and 1995 are shown below:
1994 1995
$ $ $ $
Non-current assets (at net book value)
Plant and equipment 57 500 98 000
Vehicles 21 000 40 500
Fixtures and fittings 25 000 24 000
103 500 162 500
Current assets
Inventory 43 000 88 500
Debtors 24 500 31 000
Prepayments 6 500 5 000
Bank 20 000 94 000 10 000 134 500
197 500 297 000
Non-current Liabilities
Bank loan 40 000 50 000
Current liabilities
Creditors 36 000 66 000
Accruals 10 000 46 000 15 000 81 000
197 500 197 500
Sales were $270 500 and $337 500 for the years ended 31 March 1994 and 1995 respectively.
Corresponding figures for cost of sales were $184 500 and $240 500 respectively. Purchases for 1994
amounted to $194 500.
Required:
Calculate the following ratios for 1994 and 1995: (10 marks)
(a) gross profit ratio
(b) inventory turnover rate
(c) current ratio
(d) quick ratio
(e) credit period received from trade creditors (in months)
(f) gearing ratio
(Calculations to one decimal place)
P.60
HKCWCC BAFS Accounting Ratios, Revision Practice, P.61
1994 1995
(a) Gross profit ratio
$94000÷$46000 = 2.0 : 1 ½
$134500÷$81000 = 1.7 : 1 ½
($94000-$43000)÷$46000 = 1.1 : 1 ½
($134500-$88500)÷81000 = 0.6 : 1 ½
P.61
HKCWCC BAFS Accounting Ratios, Revision Practice, P.62
Mr Lee commenced his business with $50 000 000, of which $40 000 000 was used in buying an office.
He was engaged in retail trading and all sales were made on a credit basis.
After a year's trading, he was surprised to have a bank overdraft of $8 255 000 as indicated by the bank
statement at 30 April 1993 whereas the cash at bank account showed a credit balance of $7 865 300.
(i) Six cheques (which amounted to $750 000 in total) were deposited on 30 April 1993 but were not yet
credited by the bank.
(ii) An electricity bill settled by the bank's autopay system in April 1993 amounted to $6290. It is the
practice of the company to record this expense upon receipt of the bank statement of the month.
(iii) The March balance of $65 870 in the cash at bank account was carried forward as $56 780.
(v) Interest of $58 000 was charged by the bank on the overdraft. No record of this had yet been made.
(vi) A cheque for $89 000 received from a debtor was returned by the bank marked "UNPAID". This
amount was deducted from the balance in the bank statement but had not been entered in the books.
(vii) Two cheques drawn by Mr Lee were not yet presented to the bank for payment. They were (#80967)
$420 000 and (#80973) $75 000.
(viii)A debt of $78 000 previously written off as bad was now recovered and a cheque dated 2 May 1993
was received from the customer concerned. This bad been recorded in the cash at bank account but
the cheque still remained in the cash till.
Mr Lee tried to draw up a balance sheet to reveal the financial situation of the business but he was hesitant
on most of the figures:
P.62
HKCWCC BAFS Accounting Ratios, Revision Practice, P.63
Required:
(a) Update the bank balance in the books of Mr Lee as at 30 April 1993. (7 marks)
(b) Prepare a bank reconciliation statement as at 30 April 1993. (3 marks)
(c) Draw up the balance sheet for Mr Lee as at 30 April 1993, filling in all the missing figures. (10
marks)
P.63
HKCWCC BAFS Accounting Ratios, Revision Practice, P.64
(a)
Cash at bank account
$ $
1 (iii) Feb balance understated 9 090 Balance b/d 7 865 300 ½
1 (iv) Debtors: credit transfer 87 500 (v) Bank interest payable 58 000 1
½ Balance c/d 8 000 000 (ii) Electricity: standing order 6 290 1
(vi) Debtor 89 000 1
(viii) Debtor 78 000 1
8 096 590 8 096 590
(b)
Bank Reconciliation Statement as at 30 April 1993
$
Bank overdraft as per bank statement (8 255 000)
Add: (i) uncredited cheques 750 000 1
(7 505 000)
Less: (vii) unpresented cheques ($420 000 + 75 000) 695 000 1
Adjusted bank overdraft as per cash at bank account (8 000 000) 1
(c)
Balance Sheet as at 30 April 1993
($'000) ($'000) ($'000) ($'000)
Non-Current Assets
1 Premises, net 30 000 Capital 50 000
1 Delivery van, net 5 300 35 300 Net profit 6 600 1
56 600
Drawings 16 300 1
40 300
Workings
P.64
HKCWCC BAFS Accounting Ratios, Revision Practice, P.65
1991 1990
$ $
Non-current assets
Premises (net) 739 000 650 000
Plant and machinery (net) 84 000 71 000
Motor vehicles (net) 8 000 20 000
Current assets
Inventory 32 000 43 000
Sundry debtors 37 500 52 000
Cash in hand 56 320 61 200
956 820 897 200
Issued capital 500 000 ordinary shares 500 000 500 000
General reserves 47 900 84 600
Profit and loss account 82 390 12 330
Profit for the year 37 670 70 060
667 960 666 990
Current liabilities
Trade creditors 227 060 230 210
Bank overdraft 61 800
956 820 897 200
Required:
(a) Calculate the returns on capital employed (using the year end capital employed) and quick
ratios for the accounting years 1990 and 1991. (4 marks)
(b) Basing on your calculations in (a), comment on the profitability and liquidity position of
Stone Limited. (3 marks)
P.65
HKCWCC BAFS Accounting Ratios, Revision Practice, P.66
Quick ratios:
(b) -The profitability of Stone Limited in 1991 was worse than in 1990, the return on capital
employed in in 1991 was about half of that in 1990. 1½
-The liquidity of Store Limited in 1991 were weaker than in 1990, the amount of liquid asset
to pay for every dollar of current liability decreased from nearly 50 cents in 1990 to 32 cents
in 1991. 1½
why
P.66