Accounting for Business

Accounting for Business

SECTION 1 (A)

SECTION 1 (B)

REPORT ANALYSING THE PERFORMANCE AND FINANCIAL HEALTH OF THE TWO COMPANIES

This analysis will compare the two companies using each of the ratios calculated and give a general view of the financial health and performance of each company.

Return on equity

The ROE of Thrifty Ltd is higher than Cheapo’s. This is the ratio of net income to average common stockholder’s equity. A higher return of equity invested is favourable to the stockholders. In relation to this ratio, Thrifty is a better company to invest.

Return on capital employed

This is a measure of the returns that a company achieves from the capital employed. When comparing companies using this ratio, it is required that numbers for both profit and capital are to be comparable. This involves closely analyzing their accounting policies and adjusting, where required. For instance, differences in the revaluation or depreciation policies that change the amount of capital employed. Thrifty has a better return on capital employed and, hence, it is favourable.

Operating profit margin

This is a profitability ratio that Measures the operating efficiency of a company. This margin analyses the company’s ability to turn its sales into net operating income. Thrifty has a better operating efficiency; hence it is more favourable to invest.

Asset turn

This is the return on the assets of the company. It is considered as an overall measure of profitability. This ratio measures the amounts of net income generated for each asset the company has. ROA is a blend of the asset turnover ratio and profit margin ratio. A higher asset turn is favourable and, therefore, Thrifty is much favourable.

Current ratio

It is also known as the working capital ratio, which is the difference between current assets and current liabilities. It measures the company’s ability to pay its current obligations or liabilities, using current assets (Drury, 2005). The two companies under analysis have similar abilities to repay their current obligations using current assets.

Quick ratio/acid test

The conventional rule of thumb for this ratio has been 1:1. A lower ratio requires further analysis of the trade receivables. This helps to understand how often the company turns receivables to cash. It also indicates that the company needs to access cash from a financial institution in order to pay its obligations. Thrifty limited is still more favourable.

Trade receivable days

Trade receivable days calculate the number of days it takes to collect the average trade receivables balance from debtors. It evaluates the effectiveness of a company’s credit policies. Meigs & Meigs (1990) notes those receivable days are favourable when they are greater than a company’s credit term period. Both companies have similar trade receivable days.

Payable days

It takes Thrifty limited a shorter time to pay for its credit purchases than Cheapo. Therefore, it is much more favourable.

Inventory days

This is the day’s sales on hand. It is a disparity of the inventory turnover and measures the number of day’s sales are being carried in inventory. Cheapo holds sales in inventory for more days that Thrifty, hence it is less favourable.

Gearing

The two companies have similar ratios of external funding to capital employed.

EPS, P/E, Dividend cover: These are the shareholder’s ratios. Cheapo has a higher EPS, price earnings ratio, and dividend cover, compared to Thrifty limited. Considering the shareholder’s interests, the most favourable company to invest is Cheapo.

SECTION 2

(a)    Revenue is not recognized at the point of sale:

In buy back agreements, where a company sells a product to the customer and agrees to buy it back in the future. Another instance falls on returns.

Not yet earned:

Deferred revenue like advance cash for goods or services to be delivered later. This    revenue is only recognized when the matching obligations are incurred.

Not yet realized:

This is in the case of accrued revenue, where goods or services are delivered, at which the income item is earned, and cash for them is to be received in a later period. (100 words) 2.

(b)   The income statement shows revenues, expenses, losses, gains, and the net loss or profit for a given period. It is comparable to a moving picture, as it gives the operations of the company in a given period. The balance sheet, on the other hand, is like a snap shot. It gives a summary of the company’s financial position, showing assets, liabilities, and equity. In other words, an income statement reflects a period of time, whereas a balance sheet reflects a single moment in time. (84 words)    

(c)    Reporting higher revenues reflect higher profits. Lowering expenses is a scheme to reduce the obligations to the gross profit, hence reporting higher net income. The income statement is usually required by the financiers and shareholders. At this point, managers may want to manipulate it to give a good picture of the company’s operations. (56 words)     

(d)   Cash dividends are the payments, made to shareholders by a company. It is paid out of surplus or profit. The surplus money can either be reinvested or distributed. It is profit after all interests and taxes. Expenses, on the other hand, are the economic costs, incurred by a business to carry out operations hence earn revenue (Horngren, 2006) (57 Words)

(e)    Retained earnings are the amount retained from the net income by a company and not distributed as dividends. They are usually cumulative losses offsetting earnings. It is taken as just a residual claim and not a pot of gold. It covers dividends and net losses of the business. They are also used to improve sales turnover and profit margins. Ideally, the amounts of retained earnings are always in use. (70 words)

(f)     A cash basis income statement is easy to implement as it involves just tracking the cash flow and provides an accurate depiction of cash activities. It is, however, disadvantaged because it does not recognize trade as receivables and payables.  As a result, a company could be earning a profit when it is actually losing money. Accrual basis is better, as it shows the income and debts more accurately. The two methods have drawbacks and advantages. The method chosen should always be reviewed to fully understand the firm’s performance .This Kinney & Raiborn (2012) is to ensure that there is enough cash at hand for running business operations .(100 Words)

(g)     I do not agree. There are errors that do not affect the trial balance. These include errors of principle, errors of omission, and errors of commission, reversal of entries errors, compensating errors, errors of original entries, transposition errors, among others. Taking such errors into consideration, the trial balance will still balance, but the errors still exist.(55 Words)

SECTION 3 (A)

P/L- Profit/loss

CM – Contribution margin

SECTION 3(B)

Fixed costs are usually viewed as irrelevant costs in making decisions on various options to implement. According to Weygandt, Kieso, & Kimmel, (2005), relevant costs are defined as costs that are appropriate to aid the management in decision making. They include future costs, incremental costs, and cash flows. Irrelevant costs include the common costs, which are identical, sunk costs, and committed costs.

In this case, there has been some adjustment in the individual costs, which adjust the fixed cost, hence altering the stated operating loss.

Proposal 1 reduces the selling price by 10% and, hence, produces an operating loss of 1.95 million.

Proposal 2 increases the variable cost by 10% and, hence, produces an operating loss of 1.204 million.

Proposal 3 increases R & D budget by 10% and, hence, produces an operating loss of 0.84 million.

Proposal 4 decreases the administration cost by 10% and, hence, produces an operating loss of 0.59 million.

Proposal 5 increases the selling price by 10% and, hence, produces an operating profit of 0.61 million.

Proposal 6 increases the advertising cost by 10% and, hence, produces an operating loss of 0.79 million.

There seems to be a break even in option 5 when the company actually makes a profit after a series of losses. Therefore, the most immediate and practicable option recommended to the board of directors is option 5. (212 words)