Profit Result in Increase of Companys Cash - Assignment Example

Financial Reporting Task 4 £000’s £000’s 1) Stock a/c 193 000 Cash / Bank 193 000 (As the value of stock at the end of the trading period). 2) Cash/ Bank a/c 500 000 Share capital a/c 500 000 shares @ £1 500 000 (The value of share capital with the number of shares) 3) Dividend a/c 25 000 Find dividend of 5p per share a/c 25 000 (Being the final dividend to be paid that has been declared) 4) Bank a/c 15 000 Corporation tax a/c 15 000 (Being the corporation tax charge for the year) 5) Provision for depreciation 155 250 Asset a/c (plant and equipment) 155 250 (Being the provision for depreciation forth e year on a reducing balance basis) 6) Loan interest a/c 10 000 Bank a/c 10 000 (Being the amount of loan interest deferred for the year). X PLC Profit & Loss a/c as at the end of the year £ £ Revenue 1095 000 Less: cost of sales Opening stock 160 000 Add: purchases 570 000 730 000 Less: closing stock (193 000) (537 000) 558 000 Gross profit 558 000 Less: expenses Depreciation on plant & equipment 155 250 Administrative expenses 237 000 Distribution expenses 156 000 548 250 Net profit before tax 9750 Less: corporation tax (15 000) Profit after tax before interest (5250) Less: interest (10 000) Profit after tax and interest (15250) Less: proposed dividend Final 25000 (25000) Net loss (40250) X PLC Balance sheet as at year end Fixed assets £ £ £ Plant and equipment 955 000 765 250 189 750 Current assets Inventory 193 000 Trade receivables 173 000 Bank 255 000 621 000 Less: Current liabilities Trade payables (89 000) Dividend (75 000) Corporation tax (15 000) Deferred interest on loan (10 000) (189 000) (432 000 621 750 Financed by: Ordinary share capital of 500 000 shares @ £ 1 500 000 Retained earnings 162 000 Less: profit and loss a/c (40 250) 621 750 TASK 5 REPORT Definition: In the longrun, profits result in increase of Company’s cash balance but this doesn’t help to pay out short term obligations. In the shortrun, making profit will not necessarily result in an increase in c ahs balance. Therefore we need to distinguish between cash and profits, and to determine the usefulness of information provided in balance sheet and income statements in the problem of deciding whether a company, has or will be able to generate sufficient cash to finance its operations. Cash flow in a company leads to the following items; Cash from cash in cash out cash goes: Profits → → Losses Sale of fixed assets → → Purchase of fixed assets Decrease in stock → → increase in stock Decrease in debtors → → increase in debtors Capital introduced → → drawings Received loan → → Paid loans Increase in creditors → → Decrease in creditors Dividend received → → Dividend paid Interest received → → Interest paid In our case, profit from operations before interest and tax of £1654 has overstated profits. We need to deduct interest and tax to get the real value of profit after tax and interest. An increase in inventories reduces cash balance as well as increase in trade receivables. Depreciation is an expense charged on the asset. It does not affect cash balance in the firm. An increase in trade payables increases cash inflow. This gives a balance from operations of £1377. Interest paid and income tax paid reduces cash balance too. At the end of the day, net cash from operating activities is overstated by depreciation and profit before tax and interest. A company’s performance are realistical and do not depend so much on profits earned in the period but on liquidity of cashflows International Accounting Standards 7 “provides information to users of financial statements about cashflows of a company. It provides information on ability of the company to generate cash and cash equivalents. It also indicated cash needs for the enterprise. The standards provides that cash needs for the activities, investing activities and financing activities” TASK 6 CONSOLIDATED ACCOUNTS These are accounts of two companies that are combined into one account. This happens when one firm acquires one or more other companies. This is mainly for a business combination a company acquires control of one or more enterprises. They combine into one entity as a whole therefore profit and loss accounts are combined into one. Parents / subsidiary relationship This is where one company has majority ownership of the other company. The company with majority ownership is called the parent company. It controls the operations of the other company. The subsidiary company is the smaller company or the owned company e.g. A company owns 75% of share capital of B company. A is the parent and B is the subsidiary. Minority interest This is the interest of the subsidiary company. In the example above, minority interest would be 25% of company’s ordinary share capital, preference share capital, general reserve, profit loss a/c (pre and post acquisition), Dividends proposed (both preference and ordinary) less unrealized profit. Good will £ £ Ordinary share capital 3 000 000 Net Assets acquired Ordinary share capital 1 500 000 Share premium 500 000 Retained earnings 495 000 Dividends 150 000 2 645 000 8010 X 2645 (2 116 000) Good will on acquisition 884 000 TASK 7 AB & CO PARTNERSHIP CURRENT ACCOUNTS Details Mr. Miss b Details Mr. Miss b Drawings 5609 7862 Bal b/d 1837 1543 Profit share 20893 13929 Salaries 3000 5000 Capital a/cs 20400375 1274665 Interest on capital 282.75 136.65 26012.75 20608.65 26012.75 20608.65 CAPITAL ACCOUNTS Details Mr. Miss b Details Mr. Miss b Good will - - Bal b/d 5655 2733 Good will - - Revaluation a/c - - Current a/c 20403.75 12746.65 Bal c/d 26058.75 15479.65 26058.75 15749.65 26058.75 15479.65 AB & Co profit and loss A/c Sales £ £ Less: cost of sales 110 500 Opening stock 9600 Add: purchases 45 665 55 265 Less: closing stock (7455) (47 810) Gross profit 62 690 Less: expenses Fixtures and fittings depreciation 5250 General expenses 13 768 Bank charges and interest 977 Wages 7873 (27 868) Net profit 34 822 Profit share: Mr.: 60 60/100 X 34 822 = 20893. 20 Miss b: 40 40/ 100 X 34 822 = 13928. 80 34 822.00 When there is no partnership agreement in place, the partners share profits and losses equally. That is, 50%, 50%. If they are more than two, they still share profits and losses equally. Advantages (i) Raising the capital is easier since all partners contribute to the business unlike a sole trader who may have to ask for a loan from a bank or from his family. (ii) Management of the business is done by the partners while in a sole trader; he does manage his business alone. He is overworked. (iii) Partners share responsibilities. Duties are shared therefore work is made easier and one can specialize in an area he or she understands best. In a sole trade, he does all the work. He balances his accounts, does purchasing and selling too. (iv) A partnership can be dissolved any time the partners would want. For a sole trader, he has to suffer the consequences of closing down his business alone. (v) A partnership has a wider scope of the businesses he can do. This is because of combination of efforts and also a large capital that it can raise. A sole trader can run small business and doesn’t have variety due to restriction in capital and management too. Disadvantages (i) A disagreement by one partner can lead to termination of the business in a sole trade; he has the choice to continue with his business since disagreements are with outsiders. Not any one in the business. (ii) A partner has to get consent of all partners before carrying on any activity. This delays decision making. A sole trade can easily make his own decisions. He does not have to consult. In a club and society accounts, income and expenditure account is used since they do not have a profit motive as in other business. They record income into the club and deduct all expenditure. This account is similar to the profit and loss account of any form of business. Task 8 Comparison of companies B and C Profit margin = a) Gross profit margin = Gross profit X 100 sales B = 1560 X 100 = 45.02% C= 1685 X100 = 40.02% 3465 4210 B’s ratio is higher than A. This means that B is in a better position to meet its current obligations than C b) Operating profit margin = operating profit x 100 Sales B = 685 x 100 = 19.77% C= 630 x 100 = 14.96 3465 4210 B’s ratio is higher than C. This means that Ca can meet its operating obligations more that n B. B ahs 19.77 % and C has 14.96%. A lower operating ratio is more desirable. c) Return On Capital employed: Net profit before tax x 100 or Net profit before interest and tax x 100 Total capital employed total capital employed Company = 685 x 100 Company = 630 x 100 B 3938 C 5889 = 17.39% = 11.69% When the ratio is high, it is desirable. In this case, B’s return on capital employed is better than C. This means that company B gets more returns than company C. d) Current ratio = Current Assets Current Liabilities Company = 3645 = 1.22 Company = 4764 = 1. 24 B 2990 C 3850 It is favourable when it is 3:1. However, they are almost equal for the two companies. Company C is better off since it can easily meet its current obligations by using current assets. Should the company run into liquidation, its current can be sold to cover current liabilities much better that for company B e) Gearing ratio i) Capital with fixed rated Return to capital with variable rate of return: Or Capital with fixed rate of return Total capital employed B C Company = 1 000 000 = Company = 1 000 000 3938 000 5389 000 = 25.39% = 18.56% Company C is low geared since it is between 0 – 20% and company B is medium geared since it is between 20 – 60%. When the ratio is high it is not favourable and when it is low, it is favourable. Company C’s ratio is then favourable since it is low geared. ii) Debt/ Equity ratio (i) Total debt Shareholders equity Company = 1 500 000 Company = 2 000 000 B 3938 000 C 5389 000 = 38.09% = 37.11% They are both medium geared but company C is lower than Co B. It is advisable to take company C which has a lower gear ratio in both ratios. It is favourable. f) Earning per share = profit after tax and preference dividends Number of shares issued Company = 685 000 Company = 630 000 B 1 000 000 C 1 000 000 = 68.5% = 63% Both companies have high ratios but company B is higher than C. It is favourable when the ratio is high. It will bring better results to take company B Recommendation By using the above ratios, it is important to analyse both companies in order to choose which one is better in operating ratios, company C is better than B. In return on capital employed, Company B is better than C and in current ratio, Company C is better, in gearing ratio Company C is favourable and finally in earning per share, company B is favourable. Considering the above analysis, A p/c would be advised to take Company C. Company C can meet its current obligations better than B. This puts it in a better position. The rest of the ratio that are not favourable to company C can be improved through performance. For example, return on capital employed which depends on Net profit gained before tax. When there is a high net profit the company can get a higher ROCE which is more favourable. When there is a higher performance by the company, it also gains more profits. Ratio analysis is important before investing in any company since it enables one to make comparisons between one company and another or performance of one company over a period of two years or more and even the performance of companies that fall into one industry. References Alexander, D., Britton, A. and Jorissen, A. (2005): International Financial Reporting and Analysis, Second Edition, London: Thomson Deegan, C. and Unerman, J. (2006): Financial Accounting Theory: European Edition, Maidenhead: McGraw Hill Elliott, B. and Elliott, J. (2006): Financial Accounting and Reporting, Eleventh Edition, Harlow: Prentice Hall Wood F., and Sangster, A., (1999): Business Accounting I, London, Financial Times Professional Ltd. Read More