Financial Statement Analysis Issues - Assignment Example

ACG 11 Accounting for Business SP4 2015 Assignment 2 80 Marks - Weighting 20% Due 8:00pm SA time (ACDT) on Wednesday 10th February 2016 Here are the details for assignment 2. There are five (5) multipart questions in this assignment. Please aim to complete the assignment a few days before the due date to allow for any unforeseen circumstances such as illness, family issues, work commitments etc. You may submit the assignment early if you have other commitments around the due date. The due date and time is stated in the unit outline, on the unit website and above. Please note it is your responsibility to ensure you factor in any time difference between Adelaide (South Australia) and your location when submitting your assignment. Please note that following important instructions relating to the assignment format and submission: 1. You mustcomplete your assignment using the assignment Word document provided. 2. Do not convert this document into any other format (.docx or .doc are the only permissible file formats than can be uploaded). 3. You can only submit this one file. 4. Do not ‘embed’ other files (Excel for example) as pictures within the assignment Word document 5. You cannot scan hand written responses and submit.  All assignments must be word processed.  6. Remember to fill out the assignment coversheet which is the second page of assignment Word document. 7. All assignments must be lodged via Learnonline page (link located on same page as assignment).  8. Assignments submitted via e-mail (or any other method) will NOT be accepted. 9. Make sure that you upload the correct file. If you discover (after the due date) that you have uploaded a draft version or the wrong file completely, you will not be allowed to submit a second file. IMPORTANT - Failure to follow these instructions may result in your assignment not being marked, and you will receive a zero grade. Please note that this is an individual piece of assessment. Pay particular attention to the student declaration which forms a part of the cover sheet. You must type your name and the date in the appropriate field in this declaration. Best of luck with your assignment. Assignment Cover Sheet for OUA Students An Assignment Cover Sheet needs to be included at the front of each assignment submitted. Address details Full name: Address: Postcode: Personal details UniSA Student ID: UniSA Email: @mymail.unisa.edu.au Assignment details Unit code: Unit name: Assignment no. Due date: Extension due date (if applicable): Student Declaration I declare the work contained in this assignment is my own, except where acknowledgement of sources is made. I authorise the University to test any work submitted by me, using text comparison software, for instances of plagiarism. I understand that this will involve the University or its contractor copying my work and storing it on a database to be used in future to test work submitted by others. I understand that I can obtain further information on this matter at http://w3.unisa.edu.au/ltu/integrity/default.asp Note: The attachment of this statement on any electronically submitted assignments will be deemed to have the same authority as a signed statement. Student Signature: Date: LODGING YOUR ASSIGNMENT Please note: All text based assessment tasks should be submitted electronically using Learnonline If submitting your assignment in hard copy you should complete and attach this Assignment Cover Sheet. Please check your UnitOutline for submission details. OFFICE USE ONLY Date received: Received by: Academic staff member: Assessment/grade: Date recorded and dispatched to student: Recorded and dispatched by: Developing knowledge and skills in the assignment During the study period, you have been developing: technical and theoretical knowledge and the ability to integrate that knowledge, judgement skills, and application skills. Your studies of accrual accounting are a good example of the knowledge and skills that you have been developing. You developed technical knowledge of accrual accounting from topic 4 onwards. You developed theoretical knowledge of some accounting concepts which interact with accrual accounting and you integrated both areas of knowledge. You also exercised and demonstrated judgement, and critically applied your knowledge and skills when determining if adjusting entries were necessary. This is an example of the knowledge and skills which are learning outcomes of Bachelor accounting and business programs. Learning outcomes are what graduates are expected to know, understand and be able to do as a result of learning. Importantly, business and the professions were consulted during the design of the learning outcomes. Thus, they give us vital insights into the knowledge and skills that business and the professions want graduates to possess. This assignment is designed to further develop your knowledge and skills. Theoretical and technical knowledge, and the skill to integrate these interrelated areas of knowledge, is highly valued by the employers of graduates. Employers of graduates also value: the skill to be able to exercise judgement under supervision to solve routine accounting problems, and the ability to critically apply theoretical and technical knowledge and skills to solve routine accounting problems. Please keep these learning outcomes in mind as you work on the assignment and remember that this knowledge and skills are important to employers. Communication skills. The assignment is also designed to develop your communication skills. The importance of communication skills in the professions and careers in business cannot be underestimated. While the ability to justify and communicate accounting advice and ideas is a learning outcome of graduates of Bachelor accounting programs, communication skills are equally valuable in all Bachelor business programs. Indeed, communication skills consistently rank as the most or one of the most important skills that employers consider when they employ graduates. The following three aspects of your written communication skills development will also be assessed in this assignment to a maximum of 15 marks: Paraphrasing, Being relevant and the art of selection, and An introduction to writing for a professional business audience. Please refer to the resource ‘Written Communication Skills in AFB’ on the course Learnonline page. It has information about the three aspects of your written communication skills development and links to accompanying resources that will assist you develop your skills. Parts of An introduction to writing for a professional business audience are particularly relevant to your work on Question 3 in the assignment. As you use the resources and apply them in your assignment, remember that the finest communicators are constantly developing their skills, based on experience and observing other communicators. Nonetheless, your studies is the perfect time to start working on these skills and appreciating their importance in business careers and the professions. Sources: Hancock, P., Freeman, M. and Associates. (2010), Graduate Careers Australia (graduatecareers.com.au) and Achievement Matters (achievementmatters.com.au). QUESTION 1: Financial Reporting Worksheet (17 marks) Chewie’sToy Shop, whose financial year ends on 30 June, had the following balances in its ledger at 30 June 2015. CHEWIES TOY SHOP TRIAL BALANCE AS AT 30 JUNE 2015 Debit ($) Credit ($) Cash at Bank 134 928 Accounts Receivable 221 308 Inventory 187 200 Prepaid Insurance 6 552 Office Supplies on hand 4 368 Furniture & Fittings 53 040 Accumulated Depreciation – Furniture & Fittings 15 912 Delivery Van 62 400 Accumulated Depreciation – Delivery Van 24 960 Accounts Payable 39936 Loan Payable (long term) 156 000 C Mayhew – Capital 88 296 C Mayhew – Drawings 37 440 Sales Revenue 1 200000 Sales Returns and Allowances 10172 Cost of Sales 549 744 Discount received 11 284 Freight inwards 12 480 Sales Salary Expense 80 104 Delivery Expense 35 336 Advertising Expense 35 880 Rent Expense 26 044 Office Salaries Expense 57 000 Electricity Expense 13 344 Discount Allowed 9 048 1 536 388 1 536 388 The owner of Chewie’s Toy Shop has emailed you the following list of account information and asked you make the relevant adjustments on the worksheetfor the year ended 30 June 2015: (1) Sales Salaries which are payable but not recorded as at 30 June are $4 700. (2) The Furniture and Fittings is expected to have a useful life of eight years and have a $200 scrap value (calculate and record the depreciation expense for the year) (3) $280 of the recorded sales represent payments for toys which will not be delivered until 4 July 2015. (4) The Delivery Van is expected to have a useful life of nine years and have a $795 scrap value (calculate and record the depreciation expense for the year). (5) The bank has approved an overdraft facility for $15 000 for Chewie’s Toy shop. (6) The Office Supplies on hand at 30 June 2015 was $2 300. (7) $1 324 of the prepaid insurance expense had expired by the end of the year. REQUIRED: a. Using the transactions provided above complete the worksheet provided. (17 marks) CHEWIESTOYSHOP Worksheet for the year ended 30 June 2015 Unadjusted trial balance Adjustments Adjusted trial balance Income Statement Balance Sheet Account Title Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash at Bank 134 928 15000 149 928 149 928 Accounts Receivable 221 308 221 308 221 308 Inventory 187 200 187 200 187 200 Prepaid Insurance 6 552 1324 5 228 5 228 Office Supplies on Hand 4 368 4368 4 368 Furniture &Fittings 53 040 2300 50 740 50 740 Accum. Depr. – Furn & Fittings 15 912 6605 22 517 22 517 Delivery Equipment 62 400 62 400 62 400 Accum. Depr. – Delivery Equip. 24 960 6845 31 805 31 805 Prepaid Income 280 280 280 Accounts Payable 39 936 39936 39 936 Sales salary payable 4700 4 700 4700 Bank overdraft 15000 15 000 15 000 Loan Payable 156 000 156 000 156 000 C Mayhew, Capital 88 296 88 296 88296 C Mayhew, Drawings 37 440 37 440 37 440 Sales 1 200 000 280 1 199 720 1 199 720 Sales Returns & Allows. 10 172 10 172 10 172 Cost of Sales 549 744 549 744 549 744 Discount Received 11 284 11 284 11 284 Freight In 12 480 12 480 12 480 Sales Salaries Expense 80 104 4700 84 804 84 804 Delivery Expense 35 336 35 336 35 336 Advertising Expense 35 880 35 880 35 880 Office Supplies Expense 2300 2300 2 300 Rent Expense 26 044 26 044 26 044 Office Salaries Expense 57 000 57 000 5 700 Electricity Expense 13 344 13 344 13 344 Insurance 1324 1324 1 324 Discount Allowed 9 048 9 048 9 048 Depreciation (Furniture and Fittings) 6605 6605 6 605 Depreciation Delivery Van 6845 6845 6 845 $1 536 388 $1 536 388 1 569 538 1 569 538 Profit 411 378 QUESTION 2: Financial Statement (18 marks) Woody prepared the following Trial Balance for The Force and Co Chocolates at year end, but he realises it is not in the correct order. REQUIRED: Prepare a fully classified Income Statement using the Trial Balance provided for the period in question. The Force and CoChocolates Trial Balance As at 30 June 2015 Debit ($) Credit ($) Cash on Hand 9 200 Accounts Receivable 31 000 Inventory (30 June 2015) 32 000 Prepaid Shop Rent 12 000 Display Cabinets 73 000 Accum. Deprec. - Display Cabinets 27 600 Bank Overdraft 1 000 Accounts Payable 1 600 L. Skywalker, Capital (1 July 2014) 133 600 L. Skywalker, Drawings 12 500 Sales 269 750 Sales Returns & Allowances 1 200 Discount Received 1 000 Cost of sales 128 000 Sales Staff Salaries 45 200 Advertising 1 500 Discount Allowed 240 Freight Outwards 360 Sundry Administration 1 800 Interest 1 000 Council Rates 1 400 Administrative Salaries 28 000 Shop Rent 44 000 Stock Shortage 1 000 Doubtful Debts Expense 930 Allowance for Doubtful Debts 930 Accrued Sales Staff Salaries 3 200 Accrued Income 550 Deprec. Expense – Display Cabinets 13 800 438680 438680 ** A stocktake at the end of the period determined inventory on hand to be $31000 Answer on following page The Force and Co Chocolates Income Statement As at 30 June 2015 $ ‘000 $ ‘000 Sales 269 750 Sales returns (1 200) 268 550 Less Cost of sales (128 000) Gross Profit 140 550 Less Operating Expenses Selling Expenses Sales Staff Salaries 45 200 Advertising 1 500 Freight Outward 360 Total Selling Expenses (47060) Administrative Expenses Shop Rent 44 000 Administrative Salaries 28 000 Sundry Administration 1 800 Council rates 1400 Total Administrative Expenses (75200) Other Operating Expenses Discount allowed 240 Depreciation-Display Cabinet 13 800 Doubtful debts 930 Total Other Operating Expenses (14 970) Income From operations 3 320 Less Other Expenses Interest 1 000 Stock Shortage 1 000 Total Other Income 2 000 (2 000) 1 320 Other Income Discount Received 1 000 Net Income 2 320 QUESTION 3: Financial Report Analysis (19 marks) The following information relates to the business of Lightsabre Electronics. A shareholder would like some detailed feedback about the profitability and financial structure of the business at 30 June 2015. 30 June 2015 30 June 2014 Revenues (sales and services on credit) 580 000 575 000 Interest Expense 23 000 26 500 Income Tax Expense 44 600 53 000 Total Assets 540 000 555 000 Profit (after income tax) 52 500 56 100 Preference Share Capital 62 000 62 000 Ordinary Share Capital 110 000 100 000 Total Liabilities 300 000 330 000 REQUIRED: A. Calculate the following ratios for 2015: 1. Return on Ordinary Equity 2. Return on Total Assets (7 marks) B. In your own words explain what the following ratios show in relation to the company’s profitability and financial stability: 30 June 2015 30 June 2014 Profit Margin 9.1% 9.8% Debt Ratio 55.6% 59.5% Times Interest Earned 5.2 times 5.1 times (6 marks) C. In your own words, discuss three (3) general limitations of financial statement analysis (6 marks) Answer on following pages QUESTION 3 Part A Return on Ordinary Equity =Net income/ Shareholder equity (Ordinary) =$52 500/$110 000 =0.477 Return on Total Assets =Net Income/ Average Total Assets $52 500/ ((540 000+ 555 000) /2) =0.0959*100 =9.59% Part B The Profit margin measures the percentage of sales that is left after expenses have been paid which in turn shows how effectively a company is running its operations. In the scenario above the profit margin decreased from 9.8% in 2014 to 9.1% in 2015 which means that either their sales decreased and/or its expenses increased. It is therefore less profitable than before. The debt ratio measures the financial stability of a company by measuring its ability to pay off its liabilities using its assets. A company is more stable the lower its debt ratio is. The company’s debt ratio improved (decreased) from 59.5% in 2014 to 55.6% in 2015. It is therefore more financially stable. Times Interest earned measures financial stability by measuring the capacity for income to be used to pay off interest expenses. The more times the company can pay off its interest with its income the more financially stable it is. The company’s stability increased by 0.1 times from 2014 (5.1 times) to 2015 (5.2 times). This marks an increase in financial stability as well. QUESTION 3 (cont) Part C Financial Statement analysis ignores qualitative factors which are also useful in decision making. Such factors include quality of management and its relations with employees and customers. Such factors also affect the financial statements but are not visible on them. Financial Statement analysis uses historical information which is also a limitation in itself. Such information is of little value when planning. This may lead to the users assuming that future performance will mimic historical performance which may not be necessarily true. Financial Statement analysis does not allow for accurate comparison because of the different standards used by companies. The slightest differences such as provisions for debt and depreciation and inventory recording methods can alter the financial statements drastically. Therefore, financial statement analysis is more useful when comparing the company to its precious performance than to other companies in the industry. QUESTION 4: Accounting Concepts (10 marks) Pele Ton is the owner of MAMIL’S R US, a cycling shop. Pele does not understand why he cannot expense the entire cost of a computer purchased on 1 June 2015 in the income statement for the year ended 30 June 2015. (i). Explain the correct treatment for recording the computer to Pele, and why he cannot simply expense the entire cost. Refer to any appropriate accounting assumptions and/or definitions in your response (3 marks) (ii). Pele is under the impression that the $1 800 listed in his Balance Sheet (see below) represents the current market value or replacement price for the computer. Explain the meaning of the amounts in the balance sheet extract below (Note: You are not being asked to explain the calculation of the numbers, but rather what these numbers represent) (4 marks) MAMIL’S R US Balance sheet extract as at 30 June 2015 Computer $2 000 Less Accumulated Depreciation 200 $1 800 (iii). Pelehas been informed by his accountant that he needs to include depreciation expense as an adjusting entry in the preparation of his financial statements. Explain to Pele the importance of adjusting entries by using the relevant accounting concepts and alsoindicatethe effect on his financial statements if this adjusting entry is not included. (3 marks) Question 4 I. Mr.Pele, the reason you cannot expense the entire cost of the new computer is because it defies the matching principle. This principles requires that we report expenses in the same period in which its revenue is earned. A payment such as rent can be expensed because you are paying for the same month in which you received its benefit. However, it is unlikely that after the end of the year you will want to throw away your computer. Since it is useful for a longer period we must estimate how long the computer is useful for and distribute the payments throughout its useful life. Therefore, during purchase: Dr.Fixed Asset Cr. Cash or creditor At the end of the period: Dr. Depreciation Expense Cr. Accumulated Depreciation II. The $1800 that is seen on the balance sheet is the net book value of the asset not its market value. The net book value is based on the historical value of the asset ($2000) minus the estimated loss in value due to its use (estimated to be $200). The market value is the asset’s current price point which could be higher or lower than the net book value depending on factors such as supply and demand. III. Adjusting entries are made so that financial statements reflect all revenues that have been earned and all expenses that have been incurred during a period. This is in line with the matching principle. If the depreciation expense is not included in the adjustment of entries then the financial position would be over stated while net profit for the period would be inflated. QUESTION 5: Statement of Cash Flows (16 marks) You are provided the following financial information for Darkside Constructions, a company specialising in the production of moon-sized Imperial battle stations: DARKSIDE CONTRUCTIONS COMPARATIVE BALANCE SHEETS AS AT 30th JUNE 2015 2014 $'000's $’000's Current Assets Cash on Hand 35 12 Cash at Bank 209 98 Accounts Receivable (net) 58 54 Inventory 310 330 Prepaid Expenses 35 647 33 527 Non-Current Assets Planet destroying Laser 840 760 less Acc. Depreciation 440 400 408 352 Buildings 80 180 Total Assets 1 127 1 059 Current Liabilities Bank Overdraft 20 - Accounts Payable 64 80 Accrued Stormtroopers wages 63 89 Loan 12 159 - 169 Non-Current Liabilities Loan 18 - Total Liabilities 177 169 Net Assets 950 890 Equity D. Vader, Capital 950 890 (continued over page) DARKSIDE CONSTRUCTIONS INCOME STATEMENT FOR THE YEAR ENDED 30th JUNE 2015 $'000's Net Sales 1 990 COS 1 300 Less: Discount received 5 1 295 Gross Profit: 695 Other Revenue: Gain on sale of building 60 Interest received 8 763 Expenses: Selling & Admin Expense 517 Doubtful Debts Expense 9 Interest Expense 12 538 Profit 225 Additional Information: Selling & Admin Expense includes depreciation expense of $32,000. The owner, D. Vader, contributed $20,000 during the year A new planet destroying laser was purchased by extending the loan, and paying the balance in cash A building which had originally cost $100,000 was sold for $160,000 cash, making the business a gain of $60,000 REQUIRED: Answer this question on the pro forma provided a. Using the template provided below, prepare a statement of cash flows. Show all calculations on the pro forma. [12 marks] b. The owner of Darkside Constructions can’t understand why the cash flow from operations is so different to the profit figure. As he has a tendency to react quite badly to negative news, carefully explain to Mr Vader at least two of the factors causing this difference. [2 marks] c. Explain what information is provided by a Statement of Cash Flow that is not provided by the other General Purpose Financial Reports (Income Statement, Statement of Changes in Equity & Balance Sheet)? [2 marks] DARKSIDE CONSTRUCTIONS Cash Flow Statement FOR THE YEAR ENDED 30th JUNE 2015 $’000 $’000 Cash Flows from Operating Activities Receipts from customers 1986 Payments to suppliers & employees (1322) Cash generated by operations 664 Interest received 8 Interest paid (12) 660 660 Cash Flows from Investing Activities Proceeds from sale of buildings 160 Payment for Laser (50) 110 110 770 Cash Flows from Financing Activities Contribution by owner 20 Drawings 0 20 20 Net increase / decrease in cash held 790 Cash at the beginning of the year 110 Cash at the end of the year 900 ALL WORKINGS MUST BE PRESENTED BELOW OR THE CASHFLOW STATEMENT WILL RECEIVE NO MARKS Receipt from customer =Sales – Increase/decrease in accounts receivables =$1 990 000 + ($54 000-$58 000) =$1 986 000 Payment to suppliers Cost of sales + (End Inventory –Beginning Inventory) + (Beginning Accounts Payable- Ending Accounts Payable) =$1300000 + ($310000-$330000) + ($80000-$64000) =$1 296 000 Payment to Employees =Salaries + (Beginning Salaries payable-End Salaries Payable) = $0+ ($89 000 - $63 000) =$26 000 Payment to suppliers and Employees =$1 296 000+ $26 000 =$1 322 000 Interest Paid =Interest Expense + (Beginning Interest payable-Ending Interest Payable) =$12 000 + (0) Proceeds from sale of building=selling price Payment for Laser =Value of laser – Loan Extension value Loan Extension value= value of new loan =$18 000+$12000 =$30 000 Value of Laser= Beginning value of laser-End value of laser =$840 000 -$760 000 =$80 000 Cash payment =$80 000 – $30 000 =$50 000 Cash at beginning of the year =Cash at hand (2014) +Cash at bank (2014) =$12 000 + $98 000 =$110 000 Question 4b The cash flow from operations is different from the profit figure because there is a time gap between when sales was recorded and when actual payments are made. The cash flow from operations may be high because credit sales from previous periods were paid in this period. Since the sales are not from the current period, they will not reflect in the income statement. The profit is also lower because non-cash items such as depreciation must be deducted from revenue. These items do not reduce the cash that a company generates and are therefore added back when calculating cash low. [2 marks] Question 4c A statement of cash flows provides information about how much cash and cash equivalents are entering and leaving a company. Unlike the income statement and balance sheet, it does not include the amount of cash and cash equivalents that will come and go in future for example from credit sales and purchases. Instead, the statement of cash flows breaks down where cash came from and where it was spent.This allows user of financial information to gauge a company’s ability to meet its obligations when they are due. [2 marks] Reference List Horngren, Charles T.; Datar, Srikant M.; Foster, George (2006), Cost Accounting: A Managerial Emphasis (12th ed.), New Jersey: Pearson Prentice Hall. Needles, Belverd E.; Powers, Marian, 2013, Principles of Financial Accounting. Financial Accounting Series, 12 ed, Cengage Learning. Weber, Richard P., and Stevenson W.C., 1981. Evaluations of Accounting Journal and Department Quality. The Accounting Review 56, pp. 596–612. Read More