Level of study: 5
Number of credits: 20 credits
Course the module belongs to: BA (Hons) Business Studies
Faculty: Business
Semester/Trimester of delivery: 3
Start date of the module: July 2024
Location of study: London School of Commerce
Student Name:
Student ID:
Introduction
One of the compulsory functions that all business organisations need to perform is accounting. However, accounting for business has a range of elements. For example, in accounting for business, one of the key elements is financial statement preparation. On the other hand, in accounting for business, another key element is financial ratios. In this study, there is going to be a discussion on both these aspects of accounting for business. The first part involves the preparation of an income statement and a statement of financial position for a firm, which is named AC Ltd. Moreover, discussions will also be made on the accrual or matching concept depending upon the financial statements of this company. On the other hand, the financial statement extracts of a retail company named CR plc will be used for the computation of financial ratios. Based on these financial ratios, the study will be analysing the firm’s liquidity, efficiency as well as profitability for over the 2 years 2022 and 2023.
Question 1
(a) Prepare an income statement for the year ended 31st December 2023.
In the books of AC Ltd
Income Statement for the year ending 31st December 2023
Items |
Amount (’ 000) |
Amount (’ 000) |
Sales |
|
£ 1,300 |
Cost of sales |
|
|
Opening inventory |
£ 110 |
|
Purchases |
£ 800 |
|
Closing inventory |
£ 120 |
£ 790 |
Gross profit |
|
£ 510 |
Expenses |
|
|
Selling & distribution expenses |
£ 75 |
|
Administration expenses |
£ 150 |
|
Audit fee |
£ 12 |
|
Directors’ remuneration |
£ 37 |
|
Depreciation on machinery |
£ 32 |
£ 306 |
Profit before interests and taxes (PBIT) |
|
£ 204 |
Debenture interest |
£ 13 |
|
Interest on long term bank loan |
£ - |
£ 13 |
Profit before taxes (PBT) |
|
£ 191 |
Taxation |
|
£ 40 |
Profit after taxes (PAT) |
|
£ 151 |
Dividends – Interim |
£ 20 |
|
-- Final |
£ 45 |
£ 65 |
Retained profit for the year |
|
£ 86 |
Retained profit b/f |
|
£ 81 |
Retained profit c/f |
|
£ 167 |
Working notes:
1. Cost of Sales
= Opening inventory + Purchases – Closing inventory
= 110 + 800 – 120
= 790
2. Gross Profit
= Sales – Cost of Sales
= 1300 – 790
= 510
3. Administrative Expenses
= Administrative Expenses as at 31st December 2023 – Prepaid Administrative Expenses
= 160 – 10
= 150
4. Audit fee
= Audit fee as at 31st December 2023 + Accrued Audit fee
= 10 + 2
= 12
5. Depreciation on machinery
= 20 / 100 * (Machinery at cost as at 31st December 2023 – Accumulated Depreciation as at 31st December 2023)
= 20 / 100 * (250 – 90)
= 32
6. Profit before interests and taxes (PBIT)
= Gross profit – Expenses
= 510 – (75 + 150 + 12 + 37 + 32)
= 204
7. Profit before taxes (PBT)
= Profit before interests and taxes (PBIT) – Interest Expenses
= 204 – 13
= 191
8. Profit after taxes (PAT)
= Profit before taxes (PBT) – Taxation
= 191 – 40
= 151
9. Dividends -- Final
= 10p per share
= 0.10 * 450000 shares
= 45000
10. Retained profit for the year
= Profit after taxes (PAT) – Dividends (interim + final)
= 151 – (20 + 45)
= 151 – 65
= 86
(b) Prepare a statement of financial position as at 31st December, 2023.
In the books of AC Ltd
Statement of Financial Position as on 31st December 2023
Items |
Cost (’ 000) |
Accumulated Depreciation (’ 000) |
NBV (’ 000) |
Non-current assets |
|
|
|
Land & buildings |
£ 624 |
£ - |
£ 624 |
Machinery |
£ 250 |
£ 122 |
£ 128 |
|
|
|
£ 752 |
Current assets |
|
|
|
Inventory |
£ 120 |
|
|
Receivables |
£ 100 |
|
|
Prepayment |
£ 10 |
|
|
Cash and Bank |
£ 16 |
|
£ 246 |
Total assets |
|
|
£ 998 |
|
|
|
|
Share capital |
|
|
|
£1 Ordinary shares |
|
|
£ 450 |
Reserves |
|
|
|
Retained profit |
|
|
£ 167 |
Shareholders’ funds |
|
|
£ 617 |
Non-current liabilities |
|
|
|
7% Debentures |
£ 200 |
|
|
Long-term bank loan |
£ - |
|
£ 200 |
Current liabilities |
|
|
|
Accruals |
£ 2 |
|
|
Proposed dividends |
£ 45 |
|
|
Bank overdraft |
£ 24 |
|
|
Payables |
£ 70 |
|
|
Taxation |
£ 40 |
|
£ 181 |
Shareholders’ funds & liabilities |
|
|
£ 998 |
Working notes:
1. Non-current assets
= Land & buildings + Machinery
= 624 + 128
= 752
2. Current assets
= Inventory + Receivables + Prepayment + Cash and Bank
= 120 + 100 + 10 + 16
= 246
3. Shareholders’ funds
= Share Capital + Reserves
= 450 + 167
= 617
4. Non-current liabilities
= 7% Debentures + Long-term bank loan
= 200 + 0
= 200
5. Current liabilities
= Accruals + Proposed dividends + Bank overdraft + Payables + Taxation
= 2 + 45 + 24 + 70 + 40
= 181
6. Shareholders’ funds & liabilities
= Shareholders’ funds + Non-current liabilities – Current liabilities
= 617 + 200 + 181
= 998
(c) Explain, using 3 examples, the Accruals (or Matching) Concept in relation to financial statements of AC Ltd.
In the field of financial accounting, there are different types of concepts or principles present. As defined by Schroeder, Clark and Cathey (2022), accounting concepts are the primary assumptions, ideas and conditions, which form the basis to record as well as report the financial transactions taking place in a company. These concepts are of great significance in terms of ascertaining that financial statements are developed uniformly and consistently, thereby making them more useful and reliable for making decisions. However, accounting concepts are of different sorts. One of the primary concepts existing in accounting is the accrual concept. As stated by Atrill and McLaney (2018), the accrual concept of accounting is a concept, which governs how a business organisation records its cash or credit transactions. This concept depends on the idea that companies need to recognise their income and expenses whenever they are secured or spent even if payment has not been made for the transactions. In the context of accounting, the matching concept is also one of the most significant concepts.
As stated by Kimmel, Weygandt and Kieso (2020), the matching principle states that a business needs to record all its expenses during the same period in which it has secured related revenue. This means that all companies must report their expenses during the same period in which their sales revenues have been obtained for those expenses. An application of both these accounting concepts and principles can be identified in the financial statement preparation for AC Ltd. For example, in AC Ltd, sales have been reported during the creation of the income statement of the company. However, sales have not been reported as credit sales or cash sales. The total sales made in the company are reported in the same period in which the sales transactions have been made irrespective of payments received for sales.
Another example of the application of the accrual concept can be seen from the costs and expenses of AC Ltd. The reduction of advance payment of administrative expenses while addition of accrued audit fees are examples of the application of the accrual concept. This proves that the company prepares its financial statements based on the transactions taking place for an accounting period instead of considering only cash exchange. The reduction of advance payment of administrative expenses while addition of accrued audit fees are example are also an example of the matching principle applied for the financial statements of AC Ltd. This is because the accounting treatments made for these two expenses of the company prove that it reports its expenses in the same period during which revenues have been secured for those expenses.
Question 2
(a) Calculate profitability, liquidity and efficiency ratios for the 2 years.
The financial statements prepared and reported in a company turn out being the primary source of its financial information (Atrill and McLaney, 2019). However, to interpret a company’s performance and financial health from its financial statements, calculation of ratios is one of the most important metrics. According to Drury (2017), the fractions that are calculated from the figures that are disclosed in a firm’s financial statements are referred to as financial ratios. In the section below, detailed calculations have been presented on the three different categories of ratios for CR plc –
Financial ratios |
Formula |
2023 |
2022 |
Profitability ratios |
|
|
|
|
Gross profit / Net sales turnover * 100 |
830.4 – 646.2 / 830.4 * 100 = 22.18208 = 22.18% |
746.5 – 577.8 / 746.5 * 100 = 22.59879 = 22.6% |
|
Net profit (Profit after taxes) / Net sales turnover * 100 |
83.4 / 830.4 * 100 = 10.04335 = 10.04% |
87.6 / 746.5 * 100 = 11.73476 = 11.73% |
Liquidity ratios |
|
|
|
|
Total current assets / Total current debts |
417.5 / 346.2 = 1.20595 = 1.21: 1 |
291.6 / 234.2 = 1.24509 = 1.25: 1 |
|
Total current assets – Stock in hand / Total current debts |
417.5 – 102.7 / 346.2 = 0.909301 = 0.91: 1 |
291.6 – 87 / 234.2 = 0.873612 = 0.87: 1 |
Efficiency ratios |
|
|
|
|
Inventories / Cost of Sales * Total number of working days |
102.7 / 646.2 * 365 days = 58913 = 58.01 days |
87 / 577.8 * 365 days = 54.95846 = 54.96 days |
|
Trade receivables (or debtors) / Net sales turnover * Total number of working days |
43.2 / 830.4 * 365 days = 18.98844 = 18.99 days |
48.4 / 746.5 * 365 days = 23.6651 = 23.67 days |
|
Trade payables (or creditors) / Cost of Sales * Total number of working days |
346.2 / 646.2 * 365 days = 195.5478 = 195.55 days |
234.2 / 577.8 * 365 days = 147.9457 = 147.95 days |
(b) Analyse the financial performance of CR plc over the 2 years using the ratios calculated in 2(a).
In the ratios calculated above for CR plc, there are three main aspects of financial performance evaluated. As defined by Thomas and Ward (2019), the profitability ratios are the category of financial ratios, which help in the determination of the percentage of profit, which a company has been able to secure from its sales and other aspects. An evaluation of this category of ratios calculated for CR plc show that there been a marginal decrease in the company’s gross profit ratio from 2022 to 2023. A similar decrease can be seen even in its net profit ratio. On the other hand, the liquidity ratios are the category of financial ratios, which help in the determination of the capacity of a company through which it can meet all its short-term dues and debts (Markonah, Salim and Franciska, 2020). An evaluation of this category of ratios computed for CR plc show that the current ratio of the company has experienced a marginal decrease. Conversely, the quick ratio of the company shows a marginal increase from 2022 to 2023. However, despite this increase, stability cannot be seen in the company’s liquidity.
Similarly, the efficiency ratios are the category of financial ratios, which help in the determination of the effectiveness with which a company is able to manage its assets as well as its debts (Hasmiana and Pintor, 2022). An evaluation of this category of ratios computed for CR plc show that the inventory turnover days of the company have increased from 2022 to 2023. A similar increase can be seen in the trade receivable days and trade payable days of the company during this period. These increases are an indication of the depletion taking place in the operational efficiency of the company from 2022 to 2023. As a result, the ratios calculated for CR plc help in determining that on an overall basis, the performance of this company has depleted during the past two accounting years.
Conclusion
Therefore, the findings of this study help to conclude that accounting is an important element in all businesses. This is because it not only assists businesses in terms of preparing its financial statements to report its financial performance but also helps in the measurement of its financial performance. The way in which an income statement and a statement of financial position can be developed could be identified. Moreover, the financial statements of AC Ltd helped in identifying the relevance of the accounting concepts, for example, the accrual concept. The ratios calculated for CR plc helped in determining that on an overall basis, the performance of this company has depleted from 2022 to 2023. This depletion can not only be identified in terms of profitability but also based on efficiency and liquidity. To enhance the performance of the comapny, CR plc is recommended on reduction of prices, emphasise on marketing and manage short-term debts. Moreover, controlling credit on overall performance is also recommended to ensure the improvement of the company’s performance.
Bibliography
Atrill, P. and McLaney, E. (2018) Accounting and Finance for Non-specialists 11th Ed., Pearson.
Atrill, P. and McLaney, E. (2019) Financial accounting for decision makers. 9th ed. Harlow: Pearson.
Drury, C. (2017) Management and Cost Accounting, 10th Ed., Cengage Learning EMEA
Hasmiana, M. and Pintor, S. (2022) The effect of financial risk, capital structure, banking liquidity on profitability: Operational efficiency as intervening variables in Persero bank and private commercial banks. ratio, 5(1).
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