Principle of Accounting - Speech or Presentation Example

Question The accounting equation s: Assets = Liabilities + Owner’s Equity As shown above, assets of a business are financed by liabilities and owner’s capital. Stated otherwise, assets are utilized to generate enough cash to pay off liabilities and the remaining is the profit for owner (added to owner’s equity). Capital may be an asset for the owner but the balance sheet is drawn for the business. The business, as a legal entity, owes the capital to owner; just as it owes bank loan to a bank. Thus, balance sheet shows the use of funds (assets) on one side and the source of funds (liabilities and owner’s equity) on the other side. Question 2 Manufacturing Business Balance Sheet As on XXX $ $ Cash at bank 2,000 Accounts receivable 11,000 Inventory 23,000 Prepayments 1,000 Current Assets 37,000 Plant and equipment 27,000 Land and buildings 80,000 Non Current Assets 107,000 Total Assets 144,000 Bank overdraft 15,000 Accrued expenses 3,000 Current Liabilities 18,000 Bank Loan – mortgage 25,000 Long term liabilities 25,000 Total Liabilities 43,000 Owner’s Capital 101,000 Total Liabilities and Owner’s Capital 144,000 Notes: Owner’s Capital = Initial Capital – Owner’s drawings + Profit for the period = $89,000 – $15,000 +$27,000 = $101,000 Accrued expenses and Bank overdraft are short term liabilities Question 3 a. Liquidity The performance in terms of liquidity can be measured through ‘current ratio’ calculation. Current Ratio = Current Assets / Current Liabilities Thus, Current Ratio (A) = 500,000 / 300,000 = 1.67:1 Current Ratio (B) = 300,000 / 100,000 = 3:1 Current Ratio (C) = 700,000 / 100,000 = 7:1 Higher current ratio indicates that the company has enough liquidity to meet its short term obligations. However, too large current ratio may be negative as this would indicate that assets are not being utilized effectively. As shown from above calculations, Company ‘C’ is performing better than the other two companies in terms of maintaining liquidity to serve its short term liabilities. b. Long Term Solvency Long term solvency is the measure of company’s ability to service its long term debts. Long term solvency is calculated through debt ratio. Debt Ratio = Total Debt / Total Assets Debt Ratio (A) = 500,000 / 1,000,000 = 0.5 (or 50%) Debt Ratio (B) = 300,000 / 1,000,000 = 0.3 (or 30%) Debt Ratio (C) = 700,000 / 1,000,000 = 0.7 (or 70%) The higher the debt ratio, the difficult it will be for the company to meet its long term obligation and hence to remain solvent in the long run. Although all three companies have debt ratio less than 1; but Company ‘B’ is performing better than the other two companies in terms of managing its long term solvency. c. Asset Mix Asset mix provides information about the percentage of each asset category in the overall asset portfolio of the company. This information assists potential investors while making decision of whether to invest in the company. Portion of current assets in total assets = Current Asset / Total Assets Portion of current assets in total assets (A) = 500,000 / 1,000,000 = 0.5 Portion of current assets in total assets (B) = 300,000 / 1,000,000 = 0.3 Portion of current assets in total assets (C) = 700,000 / 1,000,000 = 0.7 The above calculations show that 70% assets of Company ‘C’ are current assets; whereas Company ‘B’ has 30% current assets. Company ‘A’ has equal percentages for current and non-current assets. An exact interpretation is difficult to make from these results only. This is because the assets mix depends upon other factors like industry of business, need for keeping high inventories, or more fixed assets for long term productivity, and other factors. However, on the face of it, it can be said with certainty that C’s philosophy is to keep a higher percentage of liquid assets (may be cash or inventory) to be able to react to market conditions relatively quickly. However, it may also mean that ‘C’ is unable to collect its receivables (current asset) as efficiently as ‘B’; which may also lead to higher current asset mix. Regardless of the composition of current assets, Company A’s performance is midway between ‘B’ and ‘C’ (assuming same structure of current assets for ‘A’, ‘B’, and ‘C’). Question 4 (a) Cash flow from Operations Cash received from customers = Net sales + beginning debtors – ending debtors = $272,000,000 + $24,000,000 – $23,000,000 = $273,000,000 Cash paid for inventory = (Ending inventory – Beginning inventory) + (Beginning creditors – Ending creditors) = $31,000,000 – $27,000,000 + $15,000,000 – $17,000,000 = $2,000,000 Cash paid for operating expenses = Operating expenses – Depreciation = $80,000,000 – $55,000,000 = $25,000,000 Interest paid = Beginning Interest Payable – Ending Interest Payable = $4,000,000 – $5,000,000 = ($1,000,000) Cash flow from operations = Cash received from customers – Cash paid for inventory – Cash paid for operating expenses – Interest paid = $273,000,000 – $2,000,000 – $25,000,000 + $1,000,000 = $247,000,000 Hence, net cash flow from operations is $247 million. Question 4 (b) Net operating profit = $187,000,000 + $5,000,000 (adding back interest payable being a liability instead of an expense) Thus, Net operating profit = $192,000,000 Depreciation = $ 55,000,000 Increase in Inventory = ($ 4,000,000) Decrease in Debtors = $ 1,000,000 Increase in Creditors = $ 2,000,000 Increase in Interest Payable = $ 1,000,000 Net Cash Flow = $247,000,000 Thus, the net cash flow through this method is $247 million (same as before). Question 5 Chain-One Projected Sales (Units) = 60,000 Price = $165 Beginning Finished Goods Inventory = 20,000 Ending Finished Goods Inventory = 25,000 Total Units required to be produced = Ending Inventory + Sales – Beginning Inventory = 25,000 + 60,000 – 20,000 = 65,000 units Direct Material requirements to produce 65,000 units of Chain-One: Steel (@ 4 tons per unit) = 4 x 65,000 = 260,000 tons Silver (@ 2 tons per unit) = 2 x 65,000 = 130,000 tons Direct Labor requirements to produce 65,000 units of Chain-One (@ 2 hours per unit) = 2 x 65,000 = 130,000 hours Direct Labor cost (@ $12 per hour) = 12 x 130,000 = $1,560,000 Manufacturing Overhead to produce 65,000 units of Chain-One (@ $20 per direct labor hour) = 20 x 130,000 = $2,600,000 Chain-Two Projected Sales (Units) = 40,000 Price = $250 Beginning Finished Goods Inventory = 8,000 Ending Finished Goods Inventory = 9,000 Total Units required to be produced = Ending Inventory + Sales – Beginning Inventory = 9,000 + 40,000 – 8,000 = 41,000 units Direct Material requirements to produce 41,000 units of Chain-Two: Steel (@ 5 tons per unit) = 5 x 41,000 = 205,000 tons Silver (@ 3 tons per unit) = 3 x 41,000 = 123,000 tons Copper (@ 1 ton per unit) = 1 x 41,000 = 41,000 tons Direct Labor requirements to produce 41,000 units of Chain-Two (@ 3 hours per unit) = 3 x 41,000 = 123,000 hours Direct Labor cost (@ $16 per hour) = 16 x 123,000 = $1,968,000 Manufacturing Overhead to produce 41,000 units of Chain-Two (@ $20 per direct labor hour) = 20 x 123,000 = $2,460,000 a. Revenue Budget (in dollars) Revenue budget = Budget Revenue of Chain-One + Budget Revenue of Chain-Two = (60,000 units x $165 per unit) + (40,000 units x $250 per unit) = $9,900,000 + $10,000,000 Revenue budget = $19,900,000 b. Production Budget (in units) From above table, Production Budget for Chain-One = 65,000 units Production Budget for Chain-Two = 41,000 units c. Direct Material Purchases Budget (in Quantities) Steel Silver Copper Tons required for Chain-One 260,000 130,000 0 Tons required for Chain-Two 205,000 123,000 41,000 Beginning Inventory 32,000 29,000 6,000 Ending Inventory 36,000 32,000 7,000 Purchase Requirements = Ending Inventory + Tons required – Beginning Inventory Purchase Requirements 469,000 256,000 42,000 Thus, the budget for direct material purchases is: Steel = 469,000 tons Silver = 256,000 tons Copper = 42,000 tons d. Direct Material Purchases Budget (in Dollars) Direct Material Purchases Budget = Purchase price per ton x Number of tons Thus, Steel = $12 per ton x 469,000 tons = $5,628,000 Silver = $5 per ton x 256,000 tons = $1,280,000 Copper = $3 per ton x 42,000 tons = $126,000 Total budget for direct material purchases = $7,034,000 e. Direct Manufacturing Labor Budget (in dollars) Direct manufacturing labor budget = Labor cost for Chain-One + Labor cost for Chain-Two = $1,560,000 + $1,968,000 = $3,528,000 f. Budgeted Finished Goods Inventory (in dollars) Budgeted finished goods inventory is the total cost of inventory for Chain-One and Chain-Two products. Chain-One Cost to produce one unit: Direct Material = (4 tons)($12 per ton) + (2 tons)($5 per ton) = $58 Direct Labor = (2 hours per unit)($12 per hour) = $24 Manufacturing Overheads = ($20 per labor hour)(2 hours per unit) = $40 Thus, Total Cost to produce one unit of Chain-One = $122 Finished goods inventory for Chain-One = 25,000 units Thus, total inventory (in dollar) for Chain-One = (25,000) x (122) = $ 3,050,000 Chain-Two Cost to produce one unit: Direct Material = (5 tons)($12 per ton) + (3 tons)($5 per ton) + (1 ton)($3 per ton) = $78 Direct Labor = (3 hours per unit)($16 per hour) = $48 Manufacturing Overheads = ($20 per labor hour)(3 hours per unit) = $60 Total Cost to produce one unit of Chain-One = $186 Finished goods inventory for Chain-One = 95,000 units Thus, total inventory (in dollar) for Chain-One = (9,000) x (186) = $ 1,674,000 Total Inventory (in dollar) for Invermay Corporation = $ 3,050,000 + $ 1,674,000 = $ 4,724,000 Question 6 (a) Operating Lease An operating lease is one where the owner (lessor) of the property transfers the rights to use the property to lessee. The asset remains the property of the lessor; thus all risks remain with the lessor. Lessee just pays off the lease expenses and returns the property to lessor at the end of lease period. The leased property does not show on lessee’s balance sheet. Instead, the use is shown as operating expense in the income statement. Financial Lease International Accounting Standards Board defines financial lease as a lease in which at least one of the following is true: Lease life is more than 75% of the useful life of the asset The lessee gets the ownership of the leased property at the end of the lease period The lessee can buy the leased property at below market price at the end of the lease period Question 6 (b) Firms normally prefer operating lease over financial lease because of following reasons: Firms generally like to defer expenses rather than to pay them in the current period; thus they prefer operating lease. For example, Using operating lease, a firm does not have to book depreciation (which has to be booked in case of financial lease). All risks associated with ownership remain with the lessor, in case of operating lease. So for example, in case a fire breaks out in a leased building, the lessee does not have to bear the loss. The financial lease is shown on the balance sheet, along with the liability in form of present value of future lease expenses. This increases the leverage ratio. There is no such impact of operating lease. Read More