Accounting and finance - Essay Example

Question Balance sheet of Florence plc as of 31st March, is as follows: Florence plc Fixed assets 325 Investment In Rusty 300 In Dougal 80 Inventory 125 Cash 45 Receivables 60 Payables -120 Bank Loan 0 Total 815 Share capital 500 Accumulated profits 315 Total 815 a) Consolidated Balance Sheet After consideration of notes, the balance sheet of Florence plc has to be revised so that it reflects the true picture of the company. Therefore a consolidated and a revised balance sheet of the company is as follows: Florence plc Fixed assets 325 Investment In Rusty 266 In Dougal 80 Inventory 125 Cash 45 Receivables 151 Payables -120 Bank Loan 0 Impairment Total 872 Share capital 500 Accumulated profits 372 Total 872 It can be seen that the total worth of the company has increased from 815,000 to 866,000. b) Effect on Income Statement of Florence Group Note 1: As the fixed assets of Rusty Ltd in which Florence Group has invested has been found to be overvalued and therefore it has been revised by 30,000.

This change would reduce the profits of the firm and therefore the profit and loss statement would be reduced by 24,000 as Florence Group has acquired 80% of the shares of Rusty. Note 2: As the good will of Rusty Ltd. has been impaired by 10,000 therefore it will have a negative influence on Florence Group. Florence Group has acquired 80% of the shares of Rusty therefore it will have to record a loss of 8,000 in its income statement. Note 3: As Florence group has sold goods to Rusty with a mark up 40% then this would improve the profits of the company.

The total value of inventory is 100,000 and therefore the mark up at 40% means a profit of 40,000. So, this would enhance the profits of the company by 40,000. Note 4: Rusty Dougal Total Shares 300 100 Accumulated Profits 20 140 Shares acquired 80% 25% Addition to RE 16 35 Question #2 The balance sheet of Purple plc as at 31st March 2011 is as follows: Fixed assets 480 Investments In Pink 600 In Yellow 100 In Green 550 Inventory 170 Cash 80 Receivables 110 Payables -120 Bank Loan 0 Total 1970 Share capital 800 RE 1170 Total 1970 a) Consolidated balance sheet Fixed assets 480 Investments In Pink 480 In Yellow 100 In Green 538 Inventory 170 Cash 80 Receivables 360 Payables -120 Bank Loan 0 Impairment Total 2088 Share capital 800 RE 1288 Total 2088 b) Effect on Income Statement of Purple Ltd Note 3: As the value of fixed assets of Pink ltd is found to be inflated therefore its value has been reduced by 160,000.

Therefore it would have a negative impact on Purple Ltd. Purple has acquired 75% of the shares of the company; therefore it would have to revise its investment and report a loss in the profit and loss statement of 120,000. Similarly, the value of fixed assets of Green Ltd has been inflated by 50,000 and with 80% of the shares acquired by Purple, the company needs to revise its investment by 40,000. Therefore a loss of 40,000 has to be reported by Purple. Note 4: As Purple sold its inventory to Pink, and for this, it earned a mark up of 50% on 500,000.

Therefore a total profit of 250,000 has been earned by the company and it will improve its profit and loss statement. Note 5: As the good will of Green ltd has been revised by 15,000 and with Purple holding 80% of the shares of the company. Purple would need to report an impairment loss of 12,000. Why management may seek off balance sheet investment? Of late, there has been an increasing use of off balance sheet investment by different firms around the world. off balance sheet allows firms to invest and the fluctuations in the investment are not included in the balance sheet and therefore the value or worth of the firm is not disturbed.

Therefore, one of the reasons that encourage management to invest using off balance sheet technique is that the fluctuations do not hurt the worth or balance sheet of the company. Other important reason that encourages management to use off-balance sheet financing is that the credit risk is transferred. For instance, when banks give loans they record it in the balance sheet and therefore the risk will be taken by the bank. However while using securitisation, firms would not record in the balance sheet and the credit risk will be transferred.

Economic substance should take precedence over legal form: Financial statements need to represent the true value of the firm and true value of the transactions that have occurred during the period. In order to represent the true value of the transactions, faithful representation of transactions is required in a way that it represents the true economic substance or value instead of legal form and this concept has been named as the Substance Over Form. According to Substance Over Form, when the value or substance of the transaction is not the same as the legal form then such transactions should be reported considering the economic value of the transaction.

The main reason for this is that the financial statements should represent the true value of the transactions.