Accounting

By Saad Imran
LO1.
Introduction
Accounting's goal is to collect and report financial information on a company's performance,
financial position, and cash flows. This data is then used to make judgments about how to run
the company, invest in it, and lend money to it. This data is gathered in accounting records
through accounting transactions, which are either standardized company operations like
customer invoicing or supplier bills, or more specialized transactions like journal entries.
This financial data is frequently organized into financial statements, which contain the
following documents:

1. Income statement

2. Balance sheet

3. Statement of cash flows

4. Statement of retained earnings

5. Disclosures that accompany the financial statements

Financial statements are compiled using accounting systems, the most well-known of which
are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting
Standards (IFRS. Depending on the framework employed, the outcomes displayed in
financial statements can vary. The framework that a company employs is determined by the
preferences of the financial statement recipient. As a result, a European investor may prefer
to view financial statements prepared in accordance with IFRS, whilst an American investor
may prefer statements prepared in accordance with GAAP.

Two main forms of accounting

Managers breakdown down the accounting function into two basic forms: managerial
accounting and financial accounting, in order to correctly use the data collected. While they
both use the same underlying financial data stream, the key distinction is in their focus and
timeliness. The focus of managerial accounting is internal and forward-looking, whereas
financial accounting is outward and backward-looking.
Internally, managerial accounting is used for planning and guiding a company ahead in a
financially prudent manner. Accountants use this function to analyze historical financial data
as well as the current economy to develop assumptions about patterns and what they signify
for the organization's future.
Managerial accountants examine the organization in parts, such as departments, regions, or
product lines, and provide predictions concerning sales forecasts, performance, pricing,
expenses, and labor requirements. Smart managers use management accounting to forecast an
organization's financial future and make wise decisions based on their predictions.
The focus of financial accounting is on analyzing historical data in order to determine an
organization's overall value. Shareholders and investors will use the data to determine if a
public firm is inexpensive and hence worth investing in, or overvalued and therefore should
be avoided. Before giving money, creditors will examine the same information to determine
whether a nonprofit organization is a good risk. The same data will be used by government
entities to charge taxes on for-profit businesses.
Most significantly, financial accounting is necessary, and because it is shared with others, it
must be accurate; therefore, financial accounting must follow widely recognized accounting
standards to prevent legal complications. Managerial accounting however, since it is used
internally, need not be quite so precise, nor is it mandatory. Thus, while organizations must
report financially accurate information to the public, they remain free to do as they wish for
internal planning purposes.

Functions
1. It Helps in Evaluating the Performance of Business
Your financial records represent the financial situation of your small business or corporation
as well as the results of operations. In other words, they assist you in gaining a better
understanding of your company's financial situation. Clean and current records will not only
help you keep track of spending, gross margin, and potential debt, but they will also allow
you to compare current data to past accounting records and allocate your budget accordingly.

2. It Ensures Statutory Compliance

Although state laws and regulations differ, efficient accounting systems and processes will
assist you in ensuring statutory compliance in your organization. Liabilities like as sales tax,
VAT, income tax, and pension funds, to name a few, will be treated effectively by the
accounting department.

3. It Helps to Create Budget and Future Projections

Budgeting and future estimates can make or break a company, and your financial records will
be critical in this regard. To maintain your operations profitable, business trends and
estimates are based on previous financial data. This financial data is most useful when it
comes from well-organized accounting operations.

4. It Helps in Filing Financial Statements

Businesses are required to file their financial statements with the Registrar of Companies.
Listed entities are required to file them with stock exchanges, as well as for direct and
indirect tax filing purposes. Needless to say, accounting plays a critical role in all these
scenarios.
The importance of ethics in accounting
Purpose
Accountants deal with the personal and business finances of individuals and businesses.
Some can handle multimillion-dollar deals, while others help cab drivers and social workers
protect their retirement assets.
Accounting professionals choose to adhere to ethical rules in order to improve their
profession, preserve public trust, and display honesty and fairness. People who join
organizations and obtain the credentials to present themselves to the public as CPAs or IIAs
are committed to upholding the profession's reputation.
Regrettably, not everyone in the accounting sector can be trusted. Daily breaches of public
and private trust occur, and ethical challenges aren't always resolved in a positive way.
The following are five areas that deserve the attention of anyone considering working in the
accounting profession;
1. Independence and Objectivity
In the accounting profession, ethics and independence go hand in hand. Making fair
decisions and recommendations that benefit the client is a crucial component of trust.
Conflicts of interest, for example, must be disclosed in accordance with the independence
rules. Profiting from the selling of one financial product over another could lead to a bias
in financial advice given to a client.
It is also vital to ensure that recommendations are not exposed to outside influence in
order to stay objective and independent. Subordinating one's professional judgement to
that of another jeopardizes an accountant's professional judgement.

2. Integrity
Integrity entails being direct and honest in all commercial and professional interactions.
Accountants must not identify themselves with information that they know is materially
inaccurate or misleading — or that misleads by omission — in order to maintain their
integrity.

3. Confidentiality
Unless there is a legal or professional need to do so, an accounting expert's disclosure of
financial information or revealing the disposition of a potential merger without express
authorization undermines the trust that is the core of a professional relationship.

4. Professional Competence
A professional accountant must keep up with changes in technology, regulation, and best
practices. To make sound decisions, an accountant must stay current on events that could
influence the outcome of a choice.
Due care entails acknowledging your competence level and not implying that you are an
expert in a field in which you are not. Consulting with other experts is a common
occurrence that helps to bind a group of people and build respect.
Accounting professionals who manage others should follow similar rules. These
accountants must guarantee that their employees are properly trained and guided in the
performance of their duties.

5. Professional Behavior
Accounting professionals must follow the rules and regulations that govern their domains
and bodies of work as a matter of ethics. Avoiding behaviors that could harm the
profession's reputation is a legitimate expectation that business partners and others should
have.

Importance of accounting for business stakeholders

In a single day, we make an astonishing number of decisions. Take, for example, what
you ate for breakfast this morning. What information was used to make the decision? A
quick list can include the foods you had on hand, how much time you had to prepare and
eat the food, and what sounded good to eat this morning. Let's pretend you don't have
much food in your house right now since you're behind on your grocery shopping.
Choosing to eat at a nearby restaurant opens up a whole new set of possibilities. Can you
think of any elements that might impact a person's decision to eat at a local restaurant?
Consumer behavior and decision-making have been the subject of several academic
research. It's a fascinating field of research that aims to figure out what form of
advertising works best, where a business should be located, and a variety of other
business-related tasks.
According to a study conducted by Cornell University researchers, people make over 200
food-related decisions per day.
This is remarkable given the number of decisions reported in this study that were only
linked to food decisions. Consider how many of our daily decisions are influenced by
other concerns, such as what to wear and how to get from point A to point B. Provide and
explain some of the recent food-related decisions you made for this exercise.

Solution
There are numerous options to consider while making food-related decisions. What kinds
of ethnic groups or styles, for example, do you prefer? Do you want a fine dining
experience or something quick and cheap? Do you struggle with food allergies? These are
just a few of the numerous options available to you.
When it comes to financial decisions, it's no different. To make effective decisions,
decision makers rely on unbiased, relevant, and timely financial data. In this sense, a
stakeholder is a person or group that makes decisions based on financial information
since they are often interested in an organization's or business's economic viability.
Stakeholders may be stockholders, creditors, governmental and regulatory agencies,
customers, management and other employees, and various other parties and entities.
 Stockholders
A shareholder is a person who owns stock in a company. Owners are referred to as
stockholders since they receive a stock ownership stake in the company in exchange for
cash. The term "stock" is occasionally interchanged with "shares." Stockholders used to
get paper certificates that listed the number of shares they owned in the company. Many
stock transactions are now documented digitally. Stock is discussed in further depth in
Introduction to Financial Statements. Corporation Accounting delves deeper into the
many types of stock as well as the accounting that surrounds stock transactions.
Remember that businesses can be categorised as for-profit, governmental, or non-profit.
Stockholders are a part of for-profit companies. While governmental and non-profit
organisations have constituents, these organisations do not have direct ownership.
Other decisions made by stockholders may be influenced by the company's nature.
Stockholders of privately held companies, for example, are frequently also employees,
and the decisions they make might range from day-to-day operations to longer-term
strategic decisions. Owners of publicly traded companies, on the other hand, are typically
solely concerned with strategic matters such as company leadership, acquisitions, and
CEO compensation agreements. In essence, stockholders are primarily concerned with
profitability, predicted stock value growth, and corporate stability.

Customers
Customers can have several meanings depending on one's perspective. Consider a store
that sells electronics for a moment. Customers buy electronic products from that
company. These clients are referred to as the product's end users. Customers, deliberately
or unknowingly, have an interest in the company's financial performance. When a
business succeeds financially, the customers benefit. Profitable businesses will continue
to provide the items that customers desire, maintain and enhance their buildings, employ
community members, and engage in a variety of other activities that contribute to a
healthy and vibrant community.
Customers are also businesses. In the case of the electronics store, the company buys its
products from other companies, including the electronics manufacturers. Business
customers benefit from suppliers who are financially successful, just as end-user
consumers benefit from suppliers who are financially successful. A financially successful
supplier will assist ensure that electronics are available for purchase and resale to end-
user customers, that investments in developing technologies are made, and that delivery
and customer service are improved. As a result, the retail electronics store can keep its
prices low while still offering a wide range of products to its clients.

Advantages to Accounting
Some negatives include the possibility of biased accounting information based on the accountant's
personal influence on the scenario. Another risk is that the current replacement cost and the initial cost
of a fixed asset can fluctuate due to a variety of factors such as technological advancements, time
management, and so on. The balance sheet does not necessarily reflect an organization's true financial
situation. An accountant also runs the danger of misleading or manipulating a company's earnings.
Because money fluctuates in value, accounting data may not necessarily reflect a company's true
financial status. It is possible that the information provided is not entirely correct. For a small business
or a start-up, hiring an accounting team can be prohibitively expensive. The accounting team also
presents a lot of information which can be used as evidence in legal matters that the firm may come
across in the future.

Disadvantages to Accounting
Some negatives include the possibility of biased accounting information based on the accountant's
personal influence on the scenario. Another risk is that the current replacement cost and the initial cost
of a fixed asset can fluctuate due to a variety of factors such as technological advancements, time
management, and so on. The balance sheet does not necessarily reflect an organization's true financial
situation. An accountant also runs the danger of misleading or manipulating a company's earnings.
Because money fluctuates in value, accounting data may not necessarily reflect a company's true
financial status. It is possible that the information provided is not entirely correct. For a small business
or a startup, hiring an accounting team can be prohibitively expensive. Another disadvantage is that
accounting takes away the privacy of a business since all accounts are shown to the general public and
their competitors.

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International Financial Reporting Standards

The International Financial Reporting Standards (IFRS) are a collection of accounting regulations for
financial statements that assist them to be uniform and transparent. It essentially lays out how
businesses must report their expenses and income. Investors, auditors, and government authorities all
understand this set of principles on a worldwide scale.
Importance of accounting to stakeholders
Accounting data can influence management decision-making in two ways: directly as a source of data
for choices, or indirectly through influencing managers' behaviour. Accounting enables stakeholders
to make better business decisions. They need to know how well the company is performing and
whether or not they should invest in it. Stakeholders also want to know if the company is making
more money than it is spending on resources. Another reason is that stakeholders require knowledge
of the management's strategic and tactical strategies.
LO2.
1. Partnership
Both Marcel and Naomi are in partnership. According to the partnership agreement, Marcel
and Naomi each receive a third of the revenues and losses. Interest on capital is set at the rate
of 4% per annum. Interest will be charged on drawings (excluding salaries) made during the
year at the rate of 5%. Marcel receives a salary of $8000.
The following balances were taken from the books on 30 April, 2019.

Particulars $

Purchases 184,000

Revenue 328,000

Purchases returns 17,500

Inventory at 1 May, 2018 31,300

Non-current assets (at cost) --

Premises 90,000

Motor vehicles 80,000

Fixtures and fittings 52,000

Wages and salaries 46,000

Motor vehicle expenses 17,450

Provisions for depreciation -

Premises 38,000

Motor vehicles 8,000

Fixtures and fittings 23,000

Provision for doubtful debts 600

General expenses 18,600

Marketing expenses 22,000

Trade payables 27,500

Trade receivables 36,000

Bank overdraft 28,500

Electricity and water 10,650

Insurance 6,500

Capital Accounts -
 Marcel 80,000

Naomi 60,000

Current accounts at 1 May, 2018 -

Marcel 300 Cr

Naomi 5,100 Cr

Drawings -

Marcel 10,000

Naomi 12,000

Additional information at 30 April, 2019

1. Inventory was $36,400
2. The annual insurance premium of $4,600 was paid on 1 November, 2018
3. General expenses of $1,150 were outstanding
4. Wages and salaries included the salary paid to Marcel.
5. Depreciation is to be charged on all non-current assets owned at the end of the year as
follows:

Particulars

Premises 2% per annum on cost

Motor vehicles 25% per annum using the diminishing

(reducing) balance method

Fixtures and fittings 20% per annum using the straight-line

method

6. The provision for doubtful debts is to be maintained at 5%.

7. A cheque payment of $1,300, made to a credit supplier on 15 April, had not been
recorded in the books.

(a) Prepare the income statement and appropriation account for the year ended 30 April, 2019.

Marcel and Naomi

Income Statement and Appropriation Account for the year ended 30 April, 2019

Particulars $ $

Revenue - 328,000

Inventory 1 May, 2018 31,300 -

Purchases 184,000 -
Returns outwards (175,500) -
197,800 (1)

Inventory 30 April, 2019 (36,400)

Cost of sales - (161,400)(1)

Gross profit - 166,600(1)OF

Less expenses: - -

General expenses 18,600 + 19,962(1) -

1,150

Marketing 22,000(1) - -

Wages and salaries 46,000 - 38,000(1) -

8,000

Motor vehicle expenses 17,450(1) -

Electricity and water 10,650(1) -

Insurance 6,500 - 2,300 4,200(1) -

Depreciation: Premise 1,800(1) -

Motor vehicles 18,000(1) -

Fixtures and fittings 10,400(1) -

Increase in Provision for 1,200(1) -

doubtful debts

- (143,450)
23,150

Profit for the year - -

Interest on drawings: - -

Marcel 500(1) -

Naomi 600(1) -

- 1,100
24,250

Interest on capital: - -
 Marcel (3,200)(1) -

Naomi (2,400)(1) -
(5,600)

Salary - Marcel (8,000)(1) -

- (13,600)
10,650

Share of Profit: - -

Marcel - 6,390(1) OF

Naomi - 4,260(1)
10,650

b) Prepare the current accounts for the year ended 30 April, 2019 on the next page. Balance the
accounts and bring down the balances on 1 May, 2019.
Current Accounts
Date Details Marcel Naomi Date Details Marcel Naomi

2019 $ $ 2018 $ $

April 30 Drawings 500 600 (1) May 1 Balance 300 5,100

interest OF b/d

Drawings 10,000 12,000 (1) 2019 Interest 3,200 2,400 (1)OF

April 30 on capital

Wages and 8,000 (1) Salary 8,000

salaries

Profit 6,390 4,260 (1)OF

share

18,600 12,600 18,500 12,600

May 1 Balance b/d 610 840 (1)

OF

c) Prepare the statement of financial position at 30 April 2019

Marcel and Naomi

Statement of Financial Position at 30 April, 2019
Cost Accumulated Net Book Value
Depreciation

Non-current assets $ $ $
Premises 90,000 39,800 50,200(1)OF

Motor Vehicles 80,000 26,000 54,000(1)OF

Fixtures and fittings 52,000 33,400 18,600(1)OF

222,000 99,200 122,800

Current assets

Inventory 36,800(1)

Trade receivables 36,000 (1)

Less provision for (1,800) (1)OF

doubtful debts

34,200

Other receivables 2,310(1)OF

72,900

Total assets 195,700

Capital and Liabilities

Capital:

Marcel 80,000

Naomi 60,000

140,000(1)

Current accounts:

Marcel (610)

Naomi (840)

(1,450)(1)OF

Current liabilities

Trade payables 26,200

(27,500 (1) - 1,300(1))

Other payables 1,150(1)OF

Bank overdraft 29,800

(28,500 (1) + 1,300
(1))

Total Liabilities 57,150

195,700

2. Sole Trader
Suri is in business as a sole trader. The following balances were extracted from her books of on 31
September, 2016

Particulars $

Revenue 287,000

Purchases 143,800

Returns inwards 3,150

Inventory at 1 April, 2015 15,340

Capital 70,000

Drawings 28,000

Leasehold premises at cost (25 year lease) 100,000

Computers at cost 44,000

Office furniture at cost 15,500

Provisions for depreciation

Leasehold premises 7,000

Computers 16,600

Office furniture 12,000

Wages and salaries 26,500

Computer maintenance 12,200

Commision receivable 4,900

Rent and rates 10,000

Provision for doubtful debts 910

6% bank loan (repayable 30 June, 2016) 40,000

Bank interest paid 1,500

Heat and light 7,300

Advertising 12,600

General expenses 8,700

Cash and bank 520 Debit

Trade payables 18,600

Trade receivables 27,900

Additional information at 31 March 2016

1. Inventory was valued at $17,990
2. Commission receivable of $1200 was outstanding.
3. Advertising included a payment of $5,700 for a series of advertisements being published in
six months ending as of 31 July, 2016.
4. General expenses accumulated were $2,400.
5. A computer costing $8,000 had been logged in the computer maintenance account.
6. Depreciation is to be charged on all non-current assets owned at the end of the year as
follows;
(i) an appropriate amount on the leasehold premises
(ii) computers at the rate of 25% per annum using the diminishing (reducing) balance method
(iii) office furniture at the rate of 10% per annum using the straight-line method
7. Trade receivables of $1,900 are irrecoverable. The provision for doubtful debts is to be
maintained at 4%.

a) Prepare the income statement of Suria for the year ended 31 March, 2016
Suria
Income statement for the year ended 31 March, 2016
Particulars $ $

Revenue 287,000

Less Sales returns (3,150) (1)

283,850

Less inventory 1 April, 2015 15,340 (1)

Purchases 143,800 (1)

159,140

Less inventory 31 March, 2016 17,970) (1)

Cost of sales (141,150) (1)

Gross profit 142,700 (1)OF

Commission receivable (4,900 + 1,400) 6,300 (1)OF

142,700
Less expenses:

Wages and salaries 26,500 (1)

Computer expenses (12,200(1)-8,000(1)) 4,200 (2)

Rent and rates 10,000 (1)

Bank loan interest (1,5000(1) + 900(1)) 2,400 (2)

Heat and light 7,3000 (1)

Advertising (12,600 (1) - 3,800 (1)) 8,800 (2)

General expenses 11,210 (1)

Depreciation:

Leasehold 4,000 (1)

Computers (6,820 (1) + 2,000 (1)) 8,850 (2)

Office furniture 1,550 (1)

Bad debts 1,990 (1)

Increase in PDD (1040)(1) 130 (2)

(86,730)

Profit for the year 62,270

b) Prepare the statement of financial position on 31 March, 2016.

Suria
Statement of Financial Position at 31 March, 2016
Non-current Cost Aggregate Book Value
assets Depreciation

$ $ $

Leasehold 100,000 110,000 89,000 (1of)

Computers 52,000 25,450 26,550 (1of)

Office 15,500 13,550 1,950 (1of)

furniture

Current assets

Inventory 17,990 (1)

Trade 27,900 (1) - 26,000

receivables 1,900 (1)
(1of)
Less provision (1of) (1040) 24,960 (3)
for doubtful
debts

Other 1,400 (1) + 5,200 (2)

Receivables 3,800 (1of)

Cash and bank 520 (1)

48,670
166,170

Financed by:

Capital 70,000

Profit for the 62,270

year

132,270

Less drawings (28,000) (1)

104,270

Current
liabilities

Trade 18,600 (1)

payables

6% Bank loan 40,000 (1)

Other 2,400 (1) + 3,300 (2)

payables 900 (1of)

61,900

166,170

3. Nonprofit organisation

The Long Lane football club's treasurer has created a receipts and payments account, but members
have protested that it is inadequate. As a result, she hires an accountant to create a balance sheet,
income and expense account, and trading account for the bar. A copy of the receipts and payments
account, along with details on the company's assets and liabilities at the start and end of the year, are
given to the accountant by the treasurer.
 Long Lane Football Club
Receipts and Payments Account for the year ended 31 December 2006

Receipts £

Bank balance at 1.1.2006 524

Subscriptions received for -

2005 (arrears) 1,400

2006 14,350

2007 (in advance) 1,200

Bar sales 61,280

Donations received 800

79,554

Payments -

Payment for bar supplies -

Wages -

Groundsman and assistant 19,939

Barman 8,624

Bar expenses 234

Repairs to stands 740

Ground upkeep 1,829

Secretary's expenses 938

Transport costs 2,420

Bank balance at 31.12.2006 6,210

79,554

Additional information:
1.
31.12.2005 31.12.2006

£ £

Inventory in the bar - at cost 4,496 5,558

Owing for bar supplies 3,294 4,340

Bar expenses owing 225 336

Transport costs - 265

2. The land and football stands were valued at 31 December 2005 at: land £40,00; football stands
£20,00; the stands are to be depreciated by 10 per cent per annum.
3. The equipment at 31 December 2005 was valued at £2,500, and is to be depreciated at 20 per cent
per annum.
4. Subscriptions owing by members amounted to £1,400 on 31 December 2005, and £1,750 on 31
December 2006.

a) Draw up a statement of affairs at the end of the previous period in order to identify the
balance on the Accumulated Fund brought forward to 2006.

Statement of Affairs as at 31 December 2005

£ £

Non-current assets

Land 40,000

Stands 20,000

Equipment 2,500
62,500

Current assets

Inventory in bar 4,497

Accounts receivable for 1,400

subscriptions

Cash at bank 524

6,420
71,920

Total assets

Current liabilities

Accounts payable 3,294

Bar expenses owing 225

Total liabilities - (3,519)

Net assets 65,401

Accumulated fund (difference) 65,401

 Long Lane Football Club
Bar Trading Account for the year ending 31 December, 2006

Particulars £ £

Sales

Less Cost of goods sold: 61,280

Inventory 1.1.2006 4,496

Add purchases 39,666

44,162

Less Inventory 31.12.2006 (5,558)

Gross Profit (38,604)

22,676

Less Bar expenses 345

Barman’s wages 8,624

Net profit to income and (8,969)

expenditure account 13,707

Purchases Control

Cash 38,620

Balances c/d 4,340

= 42,960

Balances (creditors 3,294

b/d)

Trading account ( 39,666

difference) = 42,960

Bar Expenses
£

Cash 243

Balance c/d 336

 = 570

Balances b/d 245

Trading account (difference) 345

=570

Long Lane Football Club

Income and Expenditure Account for the year ending 31 December, 2006
£ £ £

Income 16,100

Subscriptions for 2006 13,707

Donations received 800

30,607

Less Expenditure

Wages - Groundsman 19,939

and assistant

Repairs to stands 740

Ground upkeep 1,829

Secretary’s expenses 938

Transport costs 2,685

Depreciation

Stands 2,000

Equipment 500

2,500

(28,631)

1,976

Subscriptions Received
£

Balance (accounts receivable) b/d 1,400

Income and expenditure (difference) 16,100

Balance (in advance) c/d 1,200

18,700

Cash 2005 1,400

2006 14,350

2007 1,200

Balance (accounts receivable) c/d 1,750

18,700

The Long Lane Football Club

Balance Sheet as at 31 December, 2006

£ £

Non-current assets

Land at valuation 40,000

Football stands at valuation 20,000

Less Depreciation (2,000)

18,000

Equipment at valuation 2,500

Less Depreciation (500)

Current assets 2,000

60,000

Inventory of bar supplies 5,558

Accounts receivable for 1,750

subscriptions

Cash at bank 6,210

13,518
Total assets 73,518

Current Liabilities

Accounts payable for bar 4,340

supplies

Bar expenses owing 336

Transport costs owing 265

Subscriptions received in 1,200
advance

Total liabilities (6,141)

Net assets 67,377

Accumulated fund

Balance as at 1.1.2006 65,401

Add Surplus of income over 1,976

expenditure 67,377

LO3.
Victular Walk in the footsteps of a top tutor
Victular would like to acquire 100% of a suitable private entity. It has obtained the following draft
financial statements for two entities, Grappa and Merlot. They operate in the same industry and their
management have indicated that they would be receptive to a takeover.
Statements of profit or loss for the year ended 30 September 20X8

Grappa Merlot

$000 $000

Revenue 12,000 20,500

Cost of Sales (10,500) (!8,000)

Gross profit 1,500 2,500

Operating expenses (240) (500)

Finance costs

Loan (210) (300)

Overdraft nil (10)

Lease nil (290_

Profit before tax 1,050 1,400

Income tax expense (!50) (400)

Profit for the year (900) 1,000

Dividends paid during the year 250 700

Statements of financial position as at 30 September 20X8

Assets

Non-current assets

Freehold factory (note (i)) 4,400 Nil

Owned plant (note (ii)) 5,000 2,200

Owned plant (note (iii)) 5,000 2,200

Current assets 9,400 7,500

Inventory 2,000 3,600

Trade receivables 2,400 3,700

Bank 600 Nil

Total assets 5,000 7,300

14,400 14,800

Equity and liabilities

Equity shares of $1 each 2,000 2,000

Property revaluation surplus 900 Nil

Retained earnings 2,600 800

3,500 800

5,500 2,800

Non-current liabilities

Lease liabilities (note (iii)) Nil 3,200

7% loan notes 3,000 Nil

10% loan notes Nil 3,000

Deferred tax 600 100

Government grants 1,200 nil

4,800 6,300

Current liabilities

Bank overdraft nil 1,200

Trade payables 3,100 3,800

Government grants 400 Nil

Lease liabilities (note (iii)) nil 500

 Taxation 600 200

4,100 5,700

Total equity and liabilities 14,400 14,800

Notes
(i) Both entities operate from similar premise
(ii) Additional details of the two entities plant are:

Grappa Merlot

$000 $000

Owned Plant - cost 8,000 10,000

Right of use plant - initial value Nil 7,500

There were no disposals of plants during the year by either entity.

(iii) The interest rate implicit within Merlot’s leases is 7.5% per annum. For the purpose of calculating
ROCE and gearing, all lease obligations are treated as long term interest bearing borrowings.
(iv) The following rations have been calculated for Grappa and can be taken to be correct:

Return on year end capital employed (ROCE) 14.8%

(capital employed taken as shareholders’ funds
plus long-term interest bearing borrowings - see
note (iii) above)

Gross profit margin 12.5%

Operating profit margin 10.5%

Current ratio 1:2:1

Closing inventory holding period 70 days

Trade receivables collection period 73 days

Trade payables payment period (using cost of 108 days

sales)

Gearing (see note (iii) above) 35.3%

Required:
(a) Calculate for Merlot the ratios equivalent to all those given for Grappa above.
(b) Assess the relative performance and financial position of Grappa and Merlot for the
year ended 30 September 20X9 to inform the directors of Victular in their acquisition
decision.
 (c) Outline the problems in using rations for comparison purposes between entities and
suggest what additional information would be useful for Victular in reaching its
decision.

Analysing Financial Statements

(a) Equivalent ratios from the financial statements of Merlot (workings in $000)

Return on year end capital 20.9% (1,400 + 590) / (2,800 +

employed (ROCE) 3,200 + 500 + 3,000) x 100

Pre-tax return on equity 50% 1,400/2,800 x 100

(ROE)

Net asset turnover 2.3 times 20,500/(14,800 - 5,700)

Gross profit margin 9.8% 2,000/20,500 x 100

Current ratio 1:3:1 7,300/5,700

Closing inventory holding 73 days 3,600/18,000 x 365

period

Trade receivables collection 66 days 3,700/26,500 x 365

period

Trade payables payment 77 days 3,800/18,000 x 365

period

Gearing 71% (3,200 + 500 + 3,000) /

9,500 x 100

Interest cover 3.3 times 2,300/600

Dividend cover 1.4 times 1,000/700

As required by the question, Merlot’s lease liabilities (3,200 + 500) have been treated as debt when
calculating the ROCE and gearing ratios.

(b) Assessment of the relative performance and financial position of Grappa and Merlot for
the year ended 30 September 20X8

The provided financial accounts form the foundation for this report. Despite the fact that the report
has been approached from a point of view that is equal to the two entities, it covers a wide range of
performance and financial condition issues.

Compared to Grappa's 14.8 percent return, Merlot's ROCE of 20.9 percent is significantly
better. ROCE is used as a gauge of management's general effectiveness in allocating
resources and funds. According to a more thorough review, Merlot's excellent performance is
attributable to the effective use of their net assets. Compared to Grappa's 1.2 times, they have
a 2.3 times net asset turnover. For every $1 that is spent on Grappa, Merlot generates
revenues of $2.30. Profit margins are another element that affects ROCE. Merlot performs
worse overall than Gappa, although Gappa has a higher operational profit margin (10.5%)
than Merlot (9.8%%). The ROCE is largely influenced by the amount of non-current assets
that are carried. Unlike Grappa, which owns its own assets, Merlot does not. This kind of
circumstance wouldn't typically provide either business a ROCE advantage because, in both
cases, the more capital utilised by an organisation that owns its manufacturing would be offset
by a higher return owing to the absence of a rental expenditure. A larger ROCE would result
if Merlot's rental expense was lower than its overall ROCE. To make a determination
regarding this, though, would require further information. Another point is that Merlot is
replacing its owned facility with one that is rented because the former is almost out of use.
The leased assets' finance cost is significantly less than the ROCE as a whole (7.5 percent ).
This enhances Merlot's ROCE. The factory that makes grappa is valued at its current price,
and note (ii) denotes that historical plant costs were used. The ROCE of Grappa is
significantly impacted by using current value for the factory. Merlot, however, is unaffected
by this as they do not own a factory.

It would be crucial to take the return on equity into account since Victular is thinking about
purchasing the equity of one of the two organisations. Pre-tax profits are used to generate the
ratios, which account for financing costs without affecting the comparisons' tax implications.
Grappa's ROE is 19.9 percent while Merlot's is 50%, placing Merlot in a lower place. If there
hadn't been a revaluation, Grappa's manufacturing would have made this ratio appear worse
than it actually is, and it would have gone unnoticed.

From the gearing ratio, it is evident that 71% of Merlot’s assets are financed by borrowings
(39% is due to Merlot’s policy of leasing its plant.) This is extremely higher than the amount
of Grappa’s gearings. The effect of gearing essentially means that all of the profit after
finance costs is attributable to equity even though the equity represents just 29% of the
financing to the net assets. The interest cover of Merlot is only 3.3x while Grappa is 6x.
Merlow’s low interest cover is a direct result of its high gearing and it makes profits subject to
small changes in the operations Another aspect is that Merlot does not benefit from receiving
government funds, although Grappa does. This is mostly because Grappa bought its plant,
whereas Merlot just leased its plant. The lessor may have passed on benefits to Merlot with
decreased lease finance charges after receiving funds available for the purchase of the plant
(at 7.5 percent per annum).

For Grappa and Merlot, respectively, both organisations have low liquid ratios of 1.2 and 1.3.
While Merlot has a $1.2 million overdraft, Grappa has at least $600,000 in the bank. Both
entities share similar attitude toward inventories. For instance, Grappa takes longer to collect
its receivables than Merlot and collects them one week earlier than Merlot.
Merlot generates sales revenues that are more than 70% more than Grappas, is heavily
indebted, and leases rather than purchases real estate and agricultural equipment. Merlot's
statement is superior to Grappas in comparison.
 c) Potential problems of using ratios for comparison purposes are:
● Inconsistent ratios
● Financial statements that have been manipulated
● Different organisations have various accounting policies
● Various managerial policies
● The statement of financial position isn’t normally representative of annual values
● Price changes over time
Victular should consider the information stated below when purchasing a business:
● Draft financial statements can often be unreliable and are subject to change
● High profitable organisations often have a risk to them
● It’s important to consider profit, financial positions and cash budgets
● The price to actually purchase the business would also be an important factor.
Sometimes businesses with low performances might be a better choice
because it is cheaper and there is more space to grow.
LO4.
Scenario 1:
Zeresh Limited provides the following information from its sales budget for 2014.

Particulars Units Sales Price Per Unit

$

January 10,000 20

February 11,000 20

March 11,000 21

April 12,000 21

May 12,000 21

June 14,000 24

Additional Information
● Inventory of finished goods at each month end is maintained at 20% of the units
expected to be sold in the following month.
● Each unit requires 0.5 kilos of raw materials, which costs $3 a kilo.
● Half a month’s inventory of raw materials is maintained, based on the expected usage
in the following month.
● The total production cost of each unit is $11 and this is the value used for inventory
valuation.

Required
(a) (i) Prepare the production budget for each of the five months January to May 2014.
(ii) Prepare the purchase budget for raw materials for each of the four months January to April
2014. Show purchases of raw materials in both kilos and dollars.
 (b) Calculate the value of finished goods and raw materials inventory at both 1 January 2014 and
30 April, 2014.
(c) (i) Prepare a summarised manufacturing account for the four month period ending 30 April,
2014
(ii) Prepare the trading account section of the income statement for the same period.
(d) State two advantages and two disadvantages to a company of using a budgetary control
system.

Solution
(a) (i)

Particulars January February March April May

Units Units Units Units Units

Sales 10,000 11,000 11,000 12,000 12,000

Closing
inventory

Next month 2,200 2,200 2,400 2,400 2,800

sales x 20%

Opening (2,000) (2,200) (2,200) (2,400) (2,400

inventory

Production 10,200 11,000 11,200 12,000 12,400

(ii)

Particulars January February March April May

Kg Kg Kg Kg Kg

Consumptio 5,100 5,500 5,600 6,000 6,200

n
(production
x 0.50)

Closing 2,750 2,800 3,000 3,100

inventory
(next month
consumption
x 50%)

Opening (2,550) (2,750) (2,800) (3,000)

inventory

Purchases 5,300 5,550 5,800 6,100

(Kg)

Purchase 3 3 3 3
Price ($)
 Purchases 15,900 16,670 17,400 18,300
($)

(b) Finished goods inventory at 1 January, 2014 (2,000 x $11) = $22,200

Finished goods inventory at 30 April, 2014 (2,400 x $11) = $26,400
Raw material inventory at 1 January, 2014 (2,550 x $3) = $7,650
Raw material inventory at 30 April, 2014 (3,100 x $3) = $9,300

(c) (i) Summarised Manufacturing Account for the four months ending 30 April, 2014

Particulars $ $

Opening raw materials 7,650

inventory

Purchases of raw materials 68,240

($15,900 + $16,650 +
$17,400 + $18,300)

Closing raw materials (9,300)

inventory

Cost of raw materials 66,600

consumed

Other manufacturing costs 421,800

($11 - $1.50) x producing (
44,400)

Cost of production 488,400

(ii) Summarised Income Statement for four months ending 30 April, 2014

Particulars $ $

Sales (sales volume x sales 903,000

price)

Cost of sales:

Opening finished goods 22,000

inventory

Cost of production 489,400

Closing Finished goods (26,400) (484,000)

inventory

Gross profit 419,000

(d)
 Advantages:
1. It is easier to identify future problems before they become big.
2. It can motivate workers by setting targets and setting rewards for them.
Disadvantages:
1. It might restrict the performance of a business since the employees might not want to work
beyond the achievable performance.
2. It might result in wasting important resources and materials to avoid a reduction of the
budget.

Scenario 2:
The directors of Drosnan Retail Limited provide the following budgeted information.

Particulars Revenue Purchases Monthly Administration

Depreciation Costs

2014 $ $ $ $

November 24,000 14,000 120 6,300

December 26,000 17,000 120 6,200

2015

January 30,000 18,000 120 6,200

February 26,000 15,000 120 6,800

March 28,000 19,000 150 7,100

April 32,000 13,000 150 6,700

Other information is as followers.

1. 10% of all revenue is cash sales.
2. 50% of credit customers pay in the month following the sale and receive a 4% cash discount.
Remaining trade receivables pay in the second month following the sale.
3. All purchases are on credit and are paid for in the month following purchase, after deducting a
5% early settlement discount.
4. The business rent is $9000 a year. This is paid in two equal instalments on 1 february and 1
August each year.
5. A dividend of $3100 is expected to be paid on 19 January 2015.
6. Administration costs are paid in the month after the one in which they are incurred.
7. The company expects to take out a bank loan of $10,000 with an interest rate of 7.8% per
annum on 1 March, 2015. This is to help finance the purchase of a new vehicle in March
which is expected to cost $12,000. The loan is to be repaid in full together with the interest
after one year.
 8. The company directors intend to sell an old vehicle in April 2015. This originally costs
$7,200 and by the date of disposal will have accumulated depreciation of $5,100. The sales
proceeds are anticipated to be $1100.
9. Inventory on 1 January 2015 is expected to have a value of $2,100. Inventory on 30 April,
2015 is expected to be valued at $3,800.
10. It is expected that there will be a bank overdraft of $1,303 on 1 January, 2015.

Required
(a) Prepare a cash budget for each of the four months January to April 2015.
(b) Prepare a budgeted income statement for the four month period ending 30 April, 2015.
(c) Explain two reasons why the change in the bank balance calculated in (a) is different from the
profit figure in (b).
(d) State two reasons why management prepares a cash budget.
Additional Information
Drosnan Retail Limited has a financial year end of 31 July, 2015. 40% of its annual profit is expected
to arise in the four month period ending 30 April. The dividend in January will be the interim
dividend; the final dividend is expected to be double the interim dividend.

Required
(e) Calculate the expected dividend cover for the year ending 31 July, 2015

Solution:
(a) Cash Budget

Receipts January February March

$ $ $

Cash sales [current 3,000 2,600 2,800

month sales x 10%]

Receipts from
receivable:

Last month sales 11,232 12,960 11,454

Sales two months 10,800 11,700 13,500

earlier

Loan 10,000

Proceeds of vehicle
sale

25,032 27,260 37,532

Payments:

Payments to 16,250 17,100 14,250

suppliers
 Rent 4,500

Dividends 3,100

Administration costs 6,200 6,200 6,800

Vehicle 12,000

25,450 27,800 33,050

Net receipts (418) (542) 4,482

(payments)

Balance b/d (1,303) (1,721) (2,261)

Balance c/d (1,721) (2,61) 2,221

(b) Drosnan Limited

Income statement for the period ended 30 April, 2015

$ $

Revenue [30,00 + 26,000 + 116,000

28,000 + 32,000]

Less cost of sales: 2,100

Opening inventory

Purchases [18,000 + 15,000 65,000

+ 19,000 + 13,000]

Closing inventory (3,800) (63,300)

Gross profit 52,700

Add discount received 3,450

[(17,000 + 18,000 + 15,000
+ 19,000) x 5%]

56,950

Less expenses

Administration costs [6,200 26,800

+ 6,800 + 7,100 + 6,700]

Discount allowed [(26,000 + 1,980

30,000 + 26,000 + 28,000) x
90% x 50% x 4%]

Rent ($9,000 x 4/12) 3,000

Loan interest ($10,000 x 130

 7.8% x 2/12)

Depreciation (120 + 120 + 540

150 + 150)

Loss on disposal [(7,200 - 1,000 (33,450)

5,100) - 1,100]

Profit for the year 22,700

(c) Profit calculation is based on matching of revenue earned and expenses incurred regardless of
cash. Whereas bank balance depends on receipts and payments. The profit calculation is based on
revenue items only while bank balance depends on both capital and revenue items. Profit calculation
involves cash and non-cash items while bank balance involves cash items only.
(d) So that adequate time is available to plan for any future cash shortage, it makes activities objective
oriented.
(e) Four months profit (As per part (b) above) = $22,700
Annual profit = 22,700/40%
= 22,700 x 100/40 = $56,750
Total dividends = interim + final [C-1]
= $3,100 + ($3,100x2) = $9,300
Dividend cover = profit available for ordinary shareholders / ordinary dividends paid
=$56,750/$9,300 = 6.10 times.

Cash Budget:
A budget is a quantitative expression of a business plan to measure the actual performance and
achievements of individuals, departments and organizations. The term budget and buddgetory
control are used interchangeably.
Advantages
1) The budget sets goals for the operational departments to achieve.
2) They force management to plan forward for the business by foreseeing and planning for shifting
circumstances.
3) Budgets act as benchmarks by which future performance can be measured.
4) As managers create budgets for their own departments, they may assign specific managers the duty
of sticking to the budget, making the budget a component of accounting for responsibility.
5) Managers and key staff get psychologically involved and driven to meet the goals set as a result of
their participation in budget setting.
6) Budgets offer a formal declaration of adherence to a well-thought-out strategy for the effective
management of current business operations.
7) Budget preparation aids in coordinating the actions of the
11) A proper budgetry control system assist in delegation of authority and assignment of
responsibility.

Disadvantages or Limitations
1) Because using a budgetary control system is neither inexpensive nor straightforward, it must be
compared to the advantages it offers.
2) Forecasts serve as the foundation for budgets, but despite the use of multiple statistical and other
approaches, forecasting is not a precise science. A budgetory control system's effectiveness mostly
depends on how well and precisely forecasts are created.

3) Using a budgetary management system can occasionally lead to disputes amongst the participating
departments since some departments may engage in conflicting activities to meet budgetary goals.

behaviour that appears to boost their performance but could be harmful to others. Departments may
therefore hold one another accountable when goals are not met.

4) Budgets are frequently imposed on managers against their will, which may demotivate them to
meet the targets set forth in the budget.
5) A strong budgetary control system is a tool for management; it cannot take the place of competent
leadership. Because of this, the entire organisation must work effectively to implement the budgetary
control system.
6) Budgets are occasionally based on easily realisable ideas, which may result in management
complacency or poor performance.

7) Budgets may become obsolete if they are not updated or modified to account for changing
circumstances.

8) Goals are frequently created for the very short term, and managers tend to focus on them, which
may be detrimental to the organization's long-term success.
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