Advantages and Disadvantages of Operating a Business in a Firm's Structure - Math Problem Example

ACCOUNTING College Name What are the advantages and disadvantages of operating a business in a company structure? ADVANTAGES Liabilities are limited to the shares of the company Raising capital is done from shares making it easy The business will continue even after the death of the owners There is professionalism in the services they receive It is much easier to get financing as a company because of the available assets that can be used as collateral. A company is very attractive to a lot of investors and this makes it possible to have many shareholders in it. An owner of the business can also join and work as an employee and this will give him a chance to be reimbursed in form of salaries and many other ways. Those who have shares can transfer their shares freely A company is a going concern and will only stop its operations if owners decide to dissolve it. DISADVANTAGES Gains in the company are shared among many holders. There is double taxation There are a lot of requirements when starting making it hard to start Decision making is a very slow process because of the many people that are involved in making the decision. It does cost a lot to incorporate a company There is a lot of paperwork involved in a company’s incorporation Those that are officers in the new company awaiting incorporation must make known their whole identity up to their addresses while shareholders need not do that A company can be dissolved either voluntarily or be dissolved involuntarily Do you think Duncan and/or Lisa should be liable for overlooking the tax liabilities for the company? Why or why not? They are liable because they are directors of the company and it is their responsibility as directors to be good stewards of the wealth of shareholders and to ensure that the company runs well and get higher returns. Shareholders may sue the two directors because of negligence in performing their duties as stewards of the wealth of shareholders. As concerning this case taken to court by the Australian Taxation Office, the person that should be sued is the company and not the two directors. Though they never conducted their duties of taking keen notice of their tax liability, they themselves are not the persons to be taken to court but the company. What responsibilities do you think Duncan and Lisa have as directors of the company? Investing shareholders wealth in profitable ventures. Directors are also endowed with the obligation to give their shareholders a report of the company’s performance. They have the responsibility of planning the future of the company strategically to ensure it is successful. It is their responsibility to deal with corporate governance and also act upon their social responsibility as a corporate to ensure a peaceful coexistence with its environment. It is the responsibility of directors to monitor those people that they have delegated duties unto. They have the duty to hold meetings and to ensure that, by the end of the meeting, every agenda that was meant to be looked into has been attended to. Case Study 2 – Consideration of ethics and corporate social responsibility ‘This is probably the biggest environmental disaster we’ve ever faced in this country. It’s certainly the biggest oil spill and we’re responding with the biggest environmental response.’ Carol Browner, director of the White House Office of Energy and Climate Change Policy, was speaking on NBC’s Meet the Press about the situation in the Gulf of Mexico following the accident on a drilling rig, Deepwater Horizon, that was being used by oil giant BP What is BP’s corporate social responsibility in relation to this situation? BP has the obligation of ensuring that the environment mess made in which it is operating in is kept clean and not cause any pollution. Having caused this spill, they have the responsibility of making sure they cater for the damages that have been experienced by their environment. Along with this, they are also obliged to help bring the oil spill situation to a halt by helping in clearing the area through financing. What actions has the company taken? Do you think this is enough? Why/ why not? The company is paying out dividend to shareholders who represent a major part of the economy. Many of the Americans have put their investments in BP and it has become a great company. What BP has done is not enough because the consequence as a result of this spill is being felt afar. Bp should pay so as to compensate Americans for this oil spill that it has and also pay all the damages that have occurred especially along their beautiful coastline. Experts say that the cost needed to be able to clean up the mess that has been caused is too high such that even Bp cannot manage to cater for. This is an explanation as to why reasons why Bp has not managed to do a lot. If they are pushed to act on the financial state they are in, the pensioners might be risking losing all their investments because instead of investing the wealth of shareholders to other profitable opportunities they will have to pay up to clear the mess caused. Case Study 3 Treatment of asset and reporting business transactions (text case 4.4) Bodie, the managing director of a public company, successfully negotiates (without any payment to the company) to keep his luxury car upon being dismissed for poor performance. The car is valued at $165 000. Doyle, the company accountant, leaves the value of the vehicle on the company’s balance sheet so as to leave the accounting equation in balance. Other benefits for this course of action are to make the assets of the company look good and to continue the tax deduction benefits the car has given the company. Case Study 3 Treatment of asset and reporting business transactions (text case 4.4) Bodie, the managing director of a public company, successfully negotiates (without any payment to the company) to keep his luxury car upon being dismissed for poor performance. The car is valued at $165 000. Doyle, the company accountant, leaves the value of the vehicle on the company’s balance sheet so as to leave the accounting equation in balance. Other benefits for this course of action are to make the assets of the company look good and to continue the tax deduction benefits the car has given the company. Has Doyle done anything wrong here? Yes because the act that was done was a fraud to the company because the assets are inclusive of this car whereas in the real sense the vehicle is not amongst the assets of the company. The financial statements of this company are misrepresentative of the actual financial state of the company. Who are the stakeholders in such circumstances and how could each be affected by Doyle’s decision? The stakeholders in this company include: Shareholders- the shares they have are reflecting a price higher what it actually is. If any dividend is declared, the amounts shareholders will get will have suffered a deduction on the depreciation that is being portrayed as the depreciation for the car already. The wealth the shareholders have is actually not what they think they have because they have been robbed off a car. Directors- the directors have the chief responsibility of keeping good custody the wealth of shareholders and because the car reflected in the financial statement is not there in actual sense, the shareholders have every right to sue the directors for not fulfilling their duties of custody of the wealth the shareholders have entrusted them with. Creditors- if the car that has been given out by the accountant was collateral then the creditors might be at a risk of losing their pay if the company defaults. If the car was bought on credit terms and then given out at no cost, then the company still risks having a bad credit worth because they have given out an asset that was a liability to them and had not cleared the obligation bestowed upon them to pay up the remaining amount the vehicle was owing. Accountant- as an employee of this company who is a qualified accountant, it is the duty of Doyle to ensure that he gives sound financial services to this company and because the service delivered was contrary to the conduct of a prudent accountant, this accountant is at risk of losing this job. Potential shareholders- investors in the market might consider this company for investment purposes and invest hugely because of the financial state of affair that the financial accounts represent. After investing in this firm, they might suffer losses after discovering that the accounts published were misleading and in the process sue the management of this company for the falsified information that they used to make critical financial decisions. What advice would you give Doyle over her concern regarding the accounting equation issue? Doyle’s concern over the equation is that both the assets and the liabilities equal the owners’ equity. This is she has refused to remove the car from the assets on the balance sheet and all other benefits accruing to this car are still being enjoyed by the company. The problem that she is trying to manage of having a balanced equation by not without removing the car is in essence creating a worse problem. These financial statements are no longer reflecting a true and fair position of this company because of an overstated assets amount and an understated asset cash or debtors depending on how the car would have been paid. Having an equation that is not balanced might have not been a significant issue as having financial statements that are materially misstated. These financial statements that are misstated may be used by stakeholders to make financial decisions that might result to a huge loss. Go to the Australian Taxation office website and click on the ‘Businesses’ tab. Then click on the ‘Tax topics A-Z’ subheading. Click on ‘deductions’ under the ‘D-E’ heading and describe the basic rules contained in the ‘income tax deductions for small business’ guide. The basic rules are: Every small business should calculate the income it has that is assessable. This means that anyone owning a small business should carry out calculations pertaining to his business and be able to know the income from his business that is chargeable to tax. This is done by looking at the documents of purchasing and selling and also the profit the business has made. These businesses ought to be able to calculate and know the deductions that are allowable to them. These are those costs or expenses that they can deduct from the income they have made so that they can come to the actual figure that is assessable for tax purposes. A small business should also claim those deductions that are common to their kind of business. This deduction might be as a result of the kind of business that they are operating in that they are entitled to. It is also important for any small business to be able to comprehend the credits and also those tax offsets that may be availed to them so now they can benefit from them. Without proper understanding of the credits available and the tax offsets, a business might incur more than they ought to have been incurred and also miss a chance to get credits. Every year, all the small businesses are required to file an income tax return. This should be done without failure and having all relevant documents supporting or are evidence of the kind of returns made. A small business should also ensure they gain access to those publications that enlighten them on the basics on taxation for small businesses and update themselves on turn of events in taxation. Case Study 4 – Preparation, reconciliation and evaluation of statement of cash flows (text, problem 7.7) Comparative balance sheets as at 31 December 2009 and 2010 for Chartowers Ltd are shown below. Chartowers Ltd Balance Sheet as at 31 December Assets 2010 2009 Cash 11 372 3 554 Accounts receivable 4835 8 529 Inventory 22 034 15 637 Prepaid expenses 1 421 2 132 Property, plant and equipment 63 972 49 755 Less Accumulated depreciation $ (18 480) $ (14 215) TOTAL ASSETS 85154 65392 Liabilities and equity 2010 2009 Accounts payable 7 108 10 490 Debentures 12 794 35 000 Paid-up capital (ordinary shares, par value $1) 35 000 19 902 Retained earnings 30 252 TOTAL 85154 65392 Sales for 2010 were $180 000, and net income after tax was $16 350. Cost of sales was $136 456. Dividends of $6 000 were declared and paid during the year. Interest earned and received was $2 340, and interest incurred and paid was $1654. Tax expense for the period was $3 000 and this was paid in the period. Other expenses (including depreciation) were $24 880. Property, plant and equipment were purchased for cash. 2010 Sales 180,000 Less: cost (136,456) Gross profit 43,544 Depreciation (4,265) Other expenses (20,615) Interest earned 2, 340 Interest paid (1,654) PBIT 19,350 Tax (3,000) PAT 16,350 Dividend (6 000) NET PROFIT 10,350 Required: Prepare a statement of cash flows for Chartowers Ltd for 2010. Chartowers Ltd. Cash flows statement For the year 2010 Cash flow from operating activities $ $ $ Net income 16,350 Depreciation 4,265 Increase in inventory (6,397) Decrease in accounts receivable 3,694 Decrease in prepaid 711 Decrease in accounts payable (3,382) Net cash provided by operating activities 15241 Cash flow from investment activities Purchase of property plant and equipment (14,217) Net cash from investment activities (14,217) Cash flow from financing activities Decrease in debenture (22,206) Increase in retained earnings 19,902 Paid up capital 15,098 Dividend (6,000) Net cash from financing activities 6,794 Net increase/(decrease) in cash 7,818 Prepare a reconciliation of cash flows from operating activities and operating profit after tax for Chartowers Ltd Chartowers Ltd. Reconciliation of cash flows Net increase/(decrease) in cash 7,818 Cash at the beginning 3,554 Cash at the end of period 11,372 Complete an evaluation of the statement of cash flows of Chartowers Ltd. $ Net cash provided by operating activities 15241 Net cash from investment activities (14,217) Net cash from financing activities 6,794 Net increase/(decrease) in cash 7,818 Cash at the beginning 3,554 Cash at the end of period 11,372 Case study 5 – Analyzing profitability, liquidity and financial stability (text problem 8.10) Joe’s Ceramics and Tiling completed an expansion program in 2008. It now lays floor and wall tiles, as well as operating a tiling retail outlet. The following information has been obtained from the entity’s financial statements: Joe’s Ceramics and Tiling Income statements for the 12 months ended 30 June 2010 $000 % 2009 $000 % Sales revenue 3200 100 1800 100 Cost of sales 2080 65 1080 60 Gross profit 1120 35 720 40 Expenses Selling 480 15 288 16 Administrative 160 5 162 9 Interest 256 8 90 5 Total expenses 896 28 540 30 Profit before tax 224 7 180 10 Income tax 112 3.5 90 5 Profit after tax 112 3.5 90 5 Joe’s Ceramics and Tiling balance sheets as at 30 June are as follows: Joe’s Ceramics and Tiling Balance sheet as at 30 June 2010 $000 2009 $000 Current Assets Cash 40 30 Accounts receivable 330 270 Inventory 500 370 Total current assets 870 670 Furniture and equipment 2 690 2 050 Total assets 3 560 2 720 Liabilities Bank overdraft 320 500 Accounts payable 440 280 Other current liabilities 380 940 Total current liabilities 1140 1 720 10% Debentures (due 2012) 1 800 400 Total liabilities 2 940 2 120 Net assets 620 600 Shareholders’ equity Paid-up capital 400 400 Retained earnings 220 200 Total equity 620 600 Required: Write a report commenting on the profitability, liquidity and financial stability of Joe’s Ceramics and Tiling, and your views on whether the expansion program has been financially successful. Provide details of any ratios calculated to support your analysis. A report on profitability, liquidity and financial stability Profitability One of the measures of profitability is the gross profit margin. The profit margin at the end of the year was much lower compared to that of the previous year. The percentage shows that the amount that remained at the beginning of the year after subtracting the costs incurred has reduced evidently from 40% to 35%. Operating profit margin is also used for profitability analysis. This is a good highlight of how a firm can ensure its cost of production is low. In 2009, the margin was at 19% but is now at 7% meaning the ability of this firm to ensure that all costs are lower is weakening as it evident with the decrease in the year end margin. The other ratio is the net profit margin that determines the net profit available for each of the net sale that has been made. Compared to previous year, it shows that the net income for each net sale has lowered. Return on Assets is also used to determine how much income is generated by the assets. (earnings after tax/total assets) 2010 2009 112/3 560=0.31 90/2 720=0.33 Though not a big margin, it is evident that the assets return is going down Return on Equity is used to determine how much income has been generated for each share for the shareholders. (earnings after tax/Owners equity) 2010 2009 112/400=0.28 90/400=0.225 This shows that the return on the equity belonging to shareholders has increased in the year. It is evident that generally, the profitability of this company is decreasing. Liquidity Liquidity ratio measures a company’s to meet its obligation in the short term as they fall due. This is measured through current ratio and quick ratio. The current ratio checks if the company’s current assets are sufficient enough to meet the current liabilities. (current assets/current liabilities) 2010 2009 870/1140=0.76 670/1 720=0.39 Their ability of this firm to meet current liabilities has improved though low. The quick ratio is used to measure how fast a company is in a position to meet its current obligation after getting rid of the asset that is least liquid which is inventory. ((current assets-inventory)/current liabilities) 2010 2009 (870-500)/1140=0.32 (670-370)/1720=0.17 The capacity to meet their current liabilities as they mature has improved. Financial stability Debt ratio is used here and it calculates the debt that a company is operating on and how capable it is to repay this debt. This is what is used to assess the stability of a company financially. Debt to total assets: (debt/ total assets) this will show what percentage of the assets is being financed by debts. 2010 2009 1 800/3560=0.51 400/2720=0.15 This indicates that half the assets are now being financed by debt which is a big reason to worry because of the move from a 15% to 51% debt financing. Times interest earned ratio :( Earnings before interest and tax/ interest expense). This ratio shows the margin of safety of a company in its capacity to repay interest using its operating income of this current period. 2010 2009 (1120-896+256)/256=1.875 (720-540+90)/90=3 The ability to pay the interest expense has gone down as is evident. According to the analysis on liquidity, profitability and financial stability, this firm is retrogressing from its initial financial strength. Read More