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BSB110 ACCOUNTING

SOLUTIONS TO REVISION QUESTIONS FOR FINAL EXAM

QUESTION 1
(a) Gatton Gardeners Cash Flow Statement
For the year ended 30 June 2007
Inflow
(Outflow)
Cash flows from operating activities
Receipts from customers
Payments to suppliers & employees
Net cash provided by operations
Cash flows from investing activities
Purchase of equipment
Purchase of land
Net cash used in investing activities
Cash flows from financing activities
Capital contributed
Increase in mortgage
Drawings
Net cash used in financing activities
Net (decrease) in cash held
Cash at beginning of year
Cash at end of year

241000
(221000)
20000
(3000)
(10000)
(13000)
3000
30000
(40200)
(7200)
(200)
5200
5000

(b) --cash is not related to profitprofit of $1600 and cash decreased by $200
--profit is based on accrual accounting measured as revenue earned less expenses incurred
not cash in or cash out
--need to be clear about difference between cash balance and profit
--best way to explain to Gary is via the Cash Flow Statement
--the cash provided by operating activities ie. Related to profit activities is $20,000 ie. the
cash inflows from profit activities is much greater than the accrual profit of $1600.
--need to explain how cash decreasedhe invested in additional assets equipment and land
total of $13,000
--he withdrew $40,200 and this is the major contributor to decline in cash balancethis
amount does not affect profit but does affect cash balance
--he increased the mortgage and did contribute additional capital but only to the extent of total
of $33,000
--so overall the major factor causing the decrease in cash is the drawings he made

BSB110 2014 revision solutions

QUESTION 2
(a)

Kody Anthony
Cash Flow Statement for the year ended 30 June 2006

Cash Flows from Operating Activities:

Receipts from customers
Payments to suppliers and employees
Net Cash provided by Operating Activities

39,300
(35,700)

Cash Flows from Investing Activities:

Payment for land
Payment for plant and equipment
Net Cash used in Investing Activities

(15,000)
(3,300)

Cash Flows from Financing Activities:

Capital contributions
Proceeds from Long-term loan
Drawings
Net Cash provided by Financing Activities

9,000
12,000
(3,600)

3,600

(18,300)

17,400

Net increase in cash held

2,700

Cash held at the beginning of the financial year

Cash held at the end of the financial year

(1,200)
$1,500

(b) See Lecture Notes

QUESTION 3
(a)
Albert Clarence
Cash Flow Statement for the financial year ended 30 June 2005
Cash flows from operating activities
Receipts from customers
41470
Payments to suppliers and employees
(23085)
Net cash provided by operating activities
18385
Cash flows from investing activities
Payments for purchase of office furniture
(13600)
Payments for purchase of delivery vehicles
(26835)
Net cash used in investing activities
(40435)
Cash flows from financing activities
Increase in borrowings
11640
Capital contributed
15000
Drawings
(7535)
Net cash provided by financing activities
19105
Net (decrease) in cash held
(2945)
Cash at beginning of year
260
Cash at end of year
$(2685)
(b)

BSB110 2014 revision solutions

Net profit = Accrual basis accounting $6030.

Ie. Revenue EARNED less expenses INCURRRED. Not just cash items but includes all
accruals, prepayments, and credit transactions
Cash flows = only cash items included
Net decrease in cash = $2945
Net profit is related to cash flows from operations
But cash flows from operations does not include: depreciation, Bad debts expense,
Prepaid expenses, Accrued expenses, Credit transactions
ONLY CASH
Cash profit
Cash is used for other purposes besides profit, ie. Investing and Financing
Investing = purchase and sale of non current assets
Financing = liabilities and equity
For Albert,
- cash used in investing
$40435
- net cash inflow from financing
$19105
-net cash provided from ops
$18385
Main reason why cash decreased was the Investing activities
QUESTION 4
(a)

Louisa Hannah
Cash Flow Statement for the year ended 30 June 2006

Cash flows from operating activities

Receipts from customers
5980
Payments to suppliers
(3420)
Net cash provided by operating activities
Cash flows from investing activities
Purchase of office equipment
(2100)
Purchase of delivery vehicles
(1550)
Net cash used in investing activities
Cash flows from financing activities
Proceeds from borrowings
1600
Capital contributed
1000
Drawings
(1230)
Net cash provided by financing activities
Net increase (decrease) in cash held
Cash at beginning of year
Cash at end of year
(b)

2560

(3650)

1370
________________
280
______(100)_____
______$180______

Can a company have a good net profit and little cash generated from operations in the
same year? Provide an explanation including examples to justify your answer.
Yes net profit based on accrual accounting - if large amounts of sales on credit but
little amount of collections from customers
Also if payments to suppliers is greater then purchases on credit
Then there will be little cash generated from operations but large profit
Cash flow Statement based on CASH flowsnot accrual accounting.

BSB110 2014 revision solutions

QUESTION 5
(1)
Date

INVENTORY CARDAVERAGE COST

Explanation
Un
it

Jan 1

Balance

Mar 3

Purchase 5

Apr 9

Sold 6

May10
Aug 22

Purchase 6
Sold 4

Purchases
Unit
Total
Cost
Cost

1608

Cost of Goods Sold

Un Unit Total
it
Cost Cost

1620

1500

6000

1560

14040

9360

1560

4680

6400

9
5

1600
1600

14400
8000

8040
6

Un
it

Balance
Unit
Total
Cost
Cost

1560

9720
4

1600

Total

$15760

Ending Inventory = $ .....8000...........

Cost of Goods Sold = $ ...15760.........
(2)
Date

Explanation

Jan 1

Balance

Mar 3

Purchase

Apr 9

May
10
Aug
22

INVENTORY CARD--FIFO
Purchases
Cost of Goods Sold
Unit Unit
Total
Unit Unit
Total
Cost
Cost
Cost
Cost
5

1608

8040

Sales--6

Purchase

1620

1500

6000

1608

3216

9720

Sales4

TOTAL

17760

1608

4824

1620

1620

Balance
Unit
Total
Cost
Cost
1500 6000

1500

6000

1608

8040

1608

4824

1608

4824

1620

9720

1620

8100

Unit

15660

Ending Inventory = $8100

Cost of Goods Sold = $15660
(3) The calculations are different because we have used two different inventory costing
methods for the inventory cardsFIFO and Average Cost
Note that in this question, inventory purchase price (cost) rose during the month.
The effect of this is dependent on the Inventory Costing method used
--FIFO ending inventory (asset) is higher than Average Cost
--FIFO Cost of Goods Sold (expense) is lower than Average Cost
--thus FIFO profit is higher than Average Cost.
The opposite effects would occur if inventory purchase price fell during the period

BSB110 2014 revision solutions

(4) The best valuation of inventory depends on what management wants to achieve and its
goals for the firm.
Because, the costing method used affects assets and profits
Management must choose the most appropriate method
Depending on the type of inventory that the firm is selling
This then in an important decision for Management
The items affected by the inventory costing method are:
*COGS
*Gross Profit
*Net Profit
*Inventory in the Balance Sheet and
*Owners Equity (as net profit is affected)
--The specific unit cost method assigns each inventory item its particular cost. The specific
unit cost method is used for inventory items that are individually identifiable, like jewels and
motor vehicles.
--The average cost method assigns the weighted-average cost of inventory available during
the period to ending inventory and cost of goods sold.
--Under the first-in, first-out (FIFO) method, the first inventory costs incurred during the
period are assigned to cost of goods sold. The latest unit costs are assigned to ending
inventory. When prices are rising, FIFO produces the highest reported profit.
--Under the last-in, first-out (LIFO) method, the last inventory costs incurred during the period
are the first to be assigned to cost of goods sold. The earliest unit costs of the period are
assigned to ending inventory. When prices are rising, LIFO produces the lowest
reported profit.
In general: FIFO results in the ending inventory being valued at the most current cost. The
earliest costs of the period are assigned to cost of goods sold, leaving the last (that is, the most
current) costs for ending inventory. LIFO results in the cost of goods sold amount being
valued at the last (the most current) cost.
QUESTION 6
Date
Apr 1
2

10

18

22

Explanation

(1) Inventory Card--FIFO

Purchases
Cost of Goods Sold
Unit
Unit
Total Unit
Unit
Total
Cost
Cost
Cost
Cost

Balance
Purchase

12

225

2700

Sales--10

Purchase

Sales--16

Sales--4

14

230

220

1540

225

675

3220

220

1540

12

225

2700

225

2025

225

2025

14

230

3220

Unit

225

2025

230

1610

230

1610

230

920

230

690

TOTAL
Ending Inventory = $ 690

Balance
Unit
Total
Cost
Cost
220
1540

6770
Cost of Goods Sold = $ 6770

BSB110 2014 revision solutions

Date
Apr 1

Explanation

(2) Inventory CardAverage Cost

Purchases
Cost of Goods Sold
Unit Unit Total Unit Unit
Total
Cost Cost
Cost
Cost

Balance

Purchase

Sales--10

7
12

225

2700

19
10

10

Purchase

18

Sales--16

16

22

Sales--4

14

230

14/4
(b)
11/3

16/3

5228.42

227.3
226

681.97

227.32 3637.16
26

909.29

2008.42

1591.26

6778.03

Highest profit for April is the method with the LOWEST cost of goods sold = FIFO.

1,400
1,400

Accounts PayableGolden Ltd

Inventory

250

Accounts PayableGolden Ltd

Cash

1,150

250
1,150

Accounts ReceivableP. Scott

Sales

900

Cost of Goods Sold

Inventory

300

Sales Returns and Allowances

Accounts ReceivableP. Scott

150

Inventory
Cost of Goods Sold
21/3

4240

Cost of Goods Sold = $6778.03

QUESTION 7
(a)
5/4
Inventory
Accounts PayableGolden Ltd
10/4

223.1
579

23

5920

Ending Inventory = $681.97

223.15 2231.58
79

3220

TOTAL

(3)

Unit

Balance
Unit Total
Cost Cost
220
1540

Cash

900
300
150
50
50
750

Accounts Receivable

750

BSB110 2014 revision solutions

(c) 1. Sales - Sales Returns & Allowances = Net Sales = $21,500 - $165 = $21,335
2. Net Sales - Cost of Goods Sold = Gross Profit = $21,335 - $15,975 = $5,360
3. Gross Profit - Operating Expenses = Net Profit = $5,360 - $1,650 = $3,710
QUESTION 8
(EXTRACT) CASH RECEIPTS
JOURNAL
Total to date
56,431

Total to date

NSF

(540)

Bank Charges

Note Receivable

2,650

Interest earned

(EXTRACT) CASH PAYMENTS JOURNAL

68,798
35

74

TOTAL

$58,615

TOTAL

$68,833

CASH AT BANK ACCOUNT

Balance
Date

PR

1 Oct

Bal

31 Oct

CRJ

31 Oct

CPJ

Debit

Credit

Debit

Credit

2,287
58,615

60,902
68,833

7,931

Bank Reconciliation at 31October

Balance as per Bank Statement 31 October--credit

6,484 CR

Add deposits in transit

2,937
9,421

Less Outstanding cheques

18,432
9011 o/d

Less Bank error on cheque no. 424

1080

Agrees with balance as per ledger cash account--credit

7,931 CR

BSB110 2014 revision solutions

QUESTION 9
Cash Receipts Journal
Total to date
Bill Receivable
NSF

$
4778
650
(100)
$5328

Cash Payments Journal

Total to date
Bank charges

CASH AT BANK A/C

DEBIT
CREDIT
April 1 Balance
April 30 CRJ
CPJ

$
3896
25
$3921

BALANCE
13641
18969
15048

5328
3921

Bank Reconciliation
As at 30 April
Balance as per Bank Statement 30 April
Add outstanding deposit

15405 CR
570
15975
100
15875

less bank error on Chq no. 828

less Unpresented cheques:
No. 818
369
827
248
830
210
Balance as per Cash at Bank A/C in ledger 30 April

827
$15048 DR

QUESTION 10
CREDIT SALES
April $15600
May $14500
June $12800
July $16100
August $11200
TOTAL

Schedule of Cash Collections

JULY
AUGUST
1560
5800
1450
6400
5120
8050
$13760

$14620

SEPTEMBER
1280
6440
5600
$13320

BSB110 2014 revision solutions

QUESTION 11
Hannah's Hair Fashions--Cash Budget for May
Cash balance at 1 May
775
Add receipts
Collections from customers
60% of May sales 2200
1320
40% of April sales 1760
704
Cash available
2799
Less payments
Purchases
70% of May 1320
924
30% of April 1020
306
Rates
Rent
Wages
New equipment
Total payments
Cash balance at 31 May
(ii)

270
150
550
180
2380
$419

If Hannah wants to maintain a cash balance of $600 she will need to CONTRIBUTE
additional cash of ($600 419) = $181

QUESTION 12
(a)
Cash Receipts Journal
Total to date
Dividend received
NSF

Cash Payments Journal

Total to date
Fee
Int. on O/D

387
100
(22)
$465

CASH AT BANK A/C

DEBIT
CREDIT
May 31 Balance
June 30 CRJ
CPJ

465
551

Bank Reconciliation As at 30 June

Balance as per Bank Statement 30 June
Add Unpresented cheques
No. 7392
200
7407
21
7411
135
less Deposits not yet credited
less Bank error Chq No 7412
Agrees balance as per ledger 30 June

17
16

$
459
10
82
$551

BALANCE
3742 CR
3277 CR
3828 CR

3532DR

356
3888
33
3855
27
$3828 CR

BSB110 2014 revision solutions

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(b) Bank Rec is an EXTERNAL, INDEPENDENT check of cash recordsvery

strong control as it is TOTAL separation of custodianship and record keeping
YES__DEFIN ITELY WORTH DOINGas need to find items that Bank knows about and
the firm does not e.g. bill receivable collected; bank charges; NSF cheques ; direct debits
--need to confirm that all cheques have been presented and all deposits make INTACT
--in this questiondeposit of the 8th June has not yet been made at the bank
--need to check to see what has happenedcould be an indication of very big FRAUD
perhaps
--therefore Bank RecsEXCELLENT form of internal control

(c)

Country Motors Ltd

Collections from Customers

Credit Sales (70% of total sales)
June
36 400
July
38 500
Aug
40 600
September
42 000

September
(5%) 1820
(15%) 5775
(80%) 32480

October
(5%) 1925
(15%) 6090
(80%) 33600
$41615

$40075
Schedule of Cash Receipts
September
18 000
40075
$58075

Cash Sales (30%)

Collection from Customers
Interest
Total

QUESTION 13
(a)
Cost = 160000 RV = 20000 Depreciable Amount = 140000
Straight line

140000
4
for 2000
for 2001

Reducing balance =

for 2000
for 2001

Units of production = per unit

for 2000 = 80000 x 70c
for 2001 = 60000 x 70c

October
18 600
41615
2 000
$62215

EUL = 4 years

= 35000 p.a.
= 35000
= 35000
=
=
=
=

40% of 160000
64000
40% of 96000
38400

140000
= 200000 = 70c/unit
= $56000
= $42000

Total depreciation exp = $140000 under all methods as total exp

= Total depreciable amount
The different methods merely allocate that total depreciable amount in a
different way
(b)
land
$450000 (not depreciable)
bldgs $675000
plant $82400

BSB110 2014 revision solutions

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Depreciation under HC accounting

= ALLOCATION of COST of asset over its useful life
attempts to measure the decline in service potential of the asset
decline caused by wear and tear
technical obsolescence
commercial obsolescence
in fact = allocation of depreciable amount
LAND not depreciated as its service potential does not
Depreciation is NOT a valuation technique, i.e. does not show in VALUE
Depreciation is NOT a measure of current worth of asset
the fact that L & B can be sold for $1,500,000 is IRRELEVANT
must still depreciate bldgs regardless of current value
same for plant dep difference between cost and market value
Depreciation does NOT create cash reserves
depreciation cash, nothing to do with cash
a BOOK entry to allocate cost and show the EXPENSE of using the asset
QUESTION 14
(a)
(i)
Straight lineuniform charges over the life of an assetequal amounts each year
depreciation is a function of time
--ideal for buildings
(ii)
Reducing Balanceaccelerated depreciation i.e. greater depreciation in early years as
compared to later years when smaller depreciation
--ideal for assets which are used a lot in early years and then not so much in later
yearsequipment which deteriorates quickly
--or computer equipment which suffers from technical and commercial obsolescence
and thus greater depreciation in early years of life
(iii)
units of productiondepreciation is a function of USErequires extra record
keeping to measure the production output (or usage) of the asset
--ideal for assets whose usage can be measured easily e.g. machines which produce
units; or e.g. motor vehiclesuse kilometres travelled
(b)
Note: cost of asset = 15,000 + 600 + 400 = $16,000
Year
30/6/99
30/6/00
Note:

Reducing Balance
Depn
Book value
4800
11200
3360
7840

Depn
3750
3750

Straight Line
Book Value
12250
8500

Depn
3750
3000

Units of Use
Book Value
12250
9250

RB = 30% of 16000; 30% of 11200

Straight Line = (16000 -1000) / 4 = 3750 per year
Units of use:
Depreciation per unit = (16000 -1000) / 360000 = 0.041666 per unit
Depreciation year 1 = 0.041666 x 90000 units = 3750 (round to nearest dollar)
Depreciation year 2 = 0.041666 x 72000 units = 3000 (round to nearest dollar)

(c)
1. Alex says price of truck NOW = price of truck 1 year ago
BUT depreciation does NOT equal market price or decrease in market
Price, hence, Alex is WRONG. Depreciation is not a valuation technique.
2. Alex says in 2nd year VALUE will drop---WRONG again.

BSB110 2014 revision solutions

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Depreciation is not a valuation technique.

3. Alex says cash obtained from depreciation.
WRONG, as depreciation does not equal cash
Depreciation is a book entry and has nothing to do with cash.
Depreciation does not put aside funds or create any funds for replacement
Depreciation simply decreases profits and decreases assets
4. What depreciation is = allocation of the depreciable cost of the asset over the assets
useful lifeto show that the asset has been used to produce revenue.
Matching revenues and expenses.
Depreciable cost = cost less residual value.
QUESTION 15
(a) Book value of asset=cost less accumulated depreciation
Depreciation is simply an ALLOCATION of the cost of the asset over the useful life
--depreciation is NOT a valuation technique i.e. selling price is NOT what book value equals
--depreciation is NOT a measure of efficiency or value of asset i.e. efficient value of asset is
not what book value equals
NBBook Value is also written down value
The production manager and the managing director are BOTH WRONG IN THEIR
ARGUMENTS
(b) (i)

Year 1
2
3
4

Straight line
Depreciation
Carrying
amount
7500
32500
7500
25000
7500
17500
7500
10000

Reducing balance 37.5%

Depreciation
Carrying
amount
15000
25000
9375
15625
5625
10000
-----10000

Units of Production
Depreciation
Carrying
amount
8250
31750
9000
22750
6750
16000
6000
10000

Workings

Straight line = (40000 10000) /4 = 7500 p.a.

Units of Production = (40000-10000)/200000 =15 cents per klm
(ii)
Depreciation DOES affect ANNUAL profit figuresdifferent deprn expense
depending on the method usedsee table above to illustrate
--the higher the deprn exp, the lower the profit for the year
--over the life of the asset, the total deprn expense is the same regardless of the
method usedthe total deprn exp must always equal the depreciable amount==cost
less residual valuesee the table abovefor all methods, the total deprn expense is
$30,000
--accounting is concerned with periodic profitaccounting period convention
therefore the choice of a depreciation method is critical to profit determination

BSB110 2014 revision solutions

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QUESTION 16
Sales Budget - 2nd Quarter
1st month
2nd month
3rd month
$4,200
$5,400
$7,200
Multiply number of units by unit cost.

Total
$16,800

Purchases, Cost of Goods Sold, and Inventory Budget

+
=
1
2
3

4
5

1st month
$2,100
1,080
3,180
6004
$2,580

Cost of Goods Sold1

Desired Ending Inventory2
Subtotal
Beginning Inventory3
Purchases

2nd month
$2,700
1,440
4,140
1,080
$3,060

3rd month
$3,600
1,2005
4,800
1,440
$3,360

Cost of Goods Sold is 50% of budgeted sales: $3/$6 = 50%

Desired Ending Inventory is 40% of the following months Cost of Goods Sold.
Beginning Inventory is 40% of current months Cost of Goods Sold (or simply last
months Ending Inventory!)
Beginning Inventory is 200 units $3 ea = $600
The next months projected Cost of Goods Sold = 1,000 units $3 ea = $3,000; Ending
Inventory = 40% $3,000 = $1,200

QUESTION 17
(a)

(i)

contribution margin = sales variable costs

= $20 - $9.50 = $10.50

(ii)

breakeven (units)

=
fixed expenses / contribution margin
=
$15,000 / $10.50 = 1,428.5714 units
=
1,429 units (rounded to nearest unit)
Breakeven (dollars) = breakeven (units) x selling price per unit
= 1,429 x $20
= $28,580

(iii) NEW contribution margin = sales variable costs

= $20 - $10 = $10
NEW breakeven (units) =

fixed expenses / contribution margin

= $15,000 / $10
= 1,500 units
NEW breakeven (dollars) = breakeven (units) x selling price per unit
= 1,500 x $20
= $30,000
Contribution Margin Income Statement
Sales (2,000 x $20)
Less Variable expenses (2,000 x $10)
Contribution margin
Less Fixed costs
Net profit

40,000
20,000
20,000
15,000
5,000

BSB110 2014 revision solutions

Total
$8,400
1,200
9,600
600
$9,000

14

Check calculation: if sell 2,000 balls then that is 500 above the break even point. Every sale
above the break even point earns the CM per unit in profit. 500 x $10 = $5000 = profit as
per the profit and loss statement.
QUESTION 18

Cayden Kent

a. Contribution margin per unit:

Sale price......................................
Variable expenses..................................
Contribution margin per unit....................
b. Break even sales
in units

Fixed expenses
Contribution margin per unit
$1200
$6
200 meals

=
=
=

c. Breakeven sales in $

d.
Sales revenue (200 $9)
Less Variable expenses (200 $3)
Contribution margin
Less Fixed expenses
Profit
e. Target sales in units

9
3
$6

200 x $9

= $1800
$1800
600
1200
1200
$ 0

Fixed expenses + Profit

Contribution margin
1200 + 900
=
$6
= 350 meals
Target sales in $
= 350 x $9
= $3150
To earn target profit of $900, Cayden Kent must sell 350 meals.
=

f. Verify this by preparing a Contribution Margin format Income Statement

Sales (350 x $9)
3150
Less Variable expenses (350x $3)
1050
Contribution Margin (7875 x $40)
2100
Less Fixed expenses
1200
Net profit
$900
QUESTION 19
Sales
Less: Variable Expenses
Cost of Goods Sold
Marketing Expense
General Expense
Contribution Margin
Less: Fixed Expenses
Marketing Expense

$280,000
$120,000
24,500
35,000

179,500
100,500

10,500

BSB110 2014 revision solutions

15

General Expense
Net Profit

35,000

45,500
$ 55,000

BSB110 2014 revision solutions

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QUESTION 20
(a)

Clarence Enterprises
Purchases, Cost of Goods Sold and Inventory Budget
August

September

Total

Cost of Goods Sold

68000

62400

130400

+ ending Inv. **

42440

49160

49160

110440

111560

179560

- Beginning Inv

69000

42440

69000

Total Purchases

41440

69120

110560

** ending inventory = 5000 plus 60% of the budgeted cost of good sold for the
following month
August = 5000 + 60% of 62400
September = 5000 + 60% of (80% of 92000)
(b)
Budgeted Income Statement
for the month of September
Sales

78000

Less cost of Goods Sold

62400

Gross Profit

15600

Less operating expenses

15000

Net Profit

600

QUESTION 21
(a)
Liquidity = ability to pay debts in short term
Current Ratio = amount of CA available to pay CL --Rule of thumb is 2:1.
For 2000 good just above rule of thumb
--Improved since 1999 = good
Acid Test Ratio = amount of very liquid assets available to pay CL
--A mere stringent test of liquidity--Rule of thumb is 1:1.
For 2000 good just above rule of thumb
--Improved since 1999 = good
Inventory T/O very industry dependent
no information here as to what industry, difficult to comment higher the better
increased since 1999= good
at 3.75 times not a fruit shop which should have T/O of roughly 185 times
approximately
must be selling slow moving items that have long shelf life

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A/Cs Rec T/O increased since 1999 good higher better

convert to average collection period and compare to average credit period

365

6.98 52.29 days

if credit period is 30 days then this is good.
Financial Stability = ability to pay debts in long term
ability to service debts from current profits
Debt Ratio = decreased since 1999 good the lower the better
above 70% is not good in Australia
- 60% is good level and secure
need to look at decreasing the debt and increasing the OE in equity structure
Times Interest Earned = ability to pay interest out of profits
coverage of interest--3 or 4 times is safe. 2000 figure = good
has increased since 1999 good
Profitability ability of business to generate profits-- overall good
rate of return on net sales = 6% in 2000, a large increase from 1999 good
= sales are producing dollars.
rate of return on total assets = 16.70% in 2000 tripled from 1999 excellent
the assets are working efficiently
management is using assets in a good combination
(b) Other information:
-- industry averages
horizontal analysis of the 2 years given
trend analysis of past 3 or 4 years data
common size financial statements
any info about the firm management or directors reports etc.
cash flow statement
Any relevant piece of data.
QUESTION 22
Profitability Analysis:

The profit ratio measures the profit per dollar of sales. Profitability has fallen sharply
from 15.00% in 1998 to 6.67% in 1999 as indicated by the profit ratio. In other words,
for every dollar of sales, the company is only earning 6.67 cents. This is of major
concern.

The rate of return on net assets measures the return earned by management through
activities; shows the success a company has in using its assets to earn a profit. This ratio
has also dropped from 15.52% to 9.04% indicating that the ability of the assets to
generate profits has declined. This, too, is of major concern.
Liquidity Analysis:

The current ratio measures the company's ability to satisfy its obligations in the shortterm. The company's current ratio has fallen from 7.00 times to 2.33 times, indicating
that it is finding it more difficult to pay its debts as and when they fall due. This is an
area of concern, although 2.33 times is satisfactory - a rule of thumb is usually 2:1.

The quick ratio tells us whether the company could pay all of its current liabilities if
they became due and payable immediately. The company's quick ratio has fallen

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dramatically from 4.00 times to 1.11 times. This is an area of concern, although 1.11
times is satisfactory - a rule of thumb is usually 1:1.
The inventory turnover ratio is a measure of the adequacy of inventory and how
efficiently it is being managed. Inventory turnover has increased slightly between 1998
and 1999. The higher the turnover, the better, as it means that inventory is being turned
over more frequently. Steps should be taken to try to increase this.

Financial Stability Analysis:

The debt ratio measures the proportion of the company's assets financed by debt. The
debt ratio is a measure of the relationship between total liabilities and total assets. The
company's debt position has deteriorated dramatically between 1998 and 1999. In 1998
only 9.09% of the entity was debt financed, whereas in 1999, this amount has increased
to 35.14%. Upon further investigation, a long term loan of $24,000 was taken out to
purchase non-current assets. This is a perfectly acceptable strategy. Also, the ratio is
well below 50% so there is no need for alarm at this stage.
QUESTION 23
(i)
PROFITABILITY shows the ability of the firm to earn profits
Profit Margin has improved from 97 to 98. Shows the % of each $ of
sales that is profit.
LIQUIDITY shows the ability of the firm to pay its debts in the short term
Current ratio current assets to current liabilities has decreased from 97
to 98. Rule of thumb is usually 2:1; was OK for 97 at 2.3:1 and has
declined in 98 to below the 2:1 benchmark. But beware of Rules of Thumb
as they are only averages and should look at the industry. Also the more
liquid the firm, the less profitable. As liquid assets are not usually
profitable.
Quick ratio more stringent test of liquidity only "quick" assets included in
numerator rule of thumb 1:1; OK for 97 and then decreased to 0.67:1. Not
too bad though.
Inventory T/O measures number of times inventory is turned over during
year. Has decreased from 97 to 98. Industry dependent.
Receivables T/O measures how quickly the cash is received from
receivables has decreased. Compare to average credit period of 30
days.
FINANCIAL STABILITY shows the ability of the firm to survive in long run
security
Debt Ratio shows % of assets funded by outside debt. In Australia, 60%
is the maximum preferred Rose Wines very stable with only 30%+ then
increase to 34.3% therefore very secure.
(ii)

Profitability Rate of Return of Assets measures return that assets produced

Liquidity Receivables Collection Period convert receivables T/O to Days
Inventory T/O period covert inventory T/O to Days
Financial Stability - Times interest earned shows how well net profit covers interest
expense commitment

(iii)

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would expect this to be the case

ie. profit margin increased and current ratio decreased
profitability versus liquidity
liquid assets are generally not profitable eg. cash at bank earns very low interest, prepaid
expenses earn no interest, the more liquid the assets the less profitable the firm and
vice versa
here--less liquid increased profits

(iv)
would expect this to be the case
ie. profit margin increased and inventory T/O decreased
profitability versus liquidity
they usually move in opposite directions
though an increased inventory T/O would likely lead to increased profits as selling more
but perhaps cost of sales is too high to allow for much increase in profits
(v) Other info
(vi)

= Industry averages, Past years data, Trend analysis

Info re: economic climate , Investor's preference for risk and returns
Changing dep'n method affects dep'n exp and accumulated dep'n net assets

affects net profit and Total Assets

all ratios which include there two items will be affected
NOT LIQUIDITY ratios.
PROFITABILITY
FINANCIAL STABILITY

Profit margin
Rate of return on assets
Times Interest Earned
Debt Ratio

QUESTION 24
(a)
Inventory T/O increase means good newsinventory was sold more quickly therefore better
liquiditymore sales alsowould also expect this would lead to higher potential profits
Receivables T/O increase means good newscollected money from customers more quickly
quicker cash collectionbetter liquidityless problems with bad debts perhapsthis does
not affect profitability
BUT net profit decreasedtherefore COGS must have been increased at a GREATER rate
than sales OR operating expenses have increased at a greater rate than sales
Overall any kind of expense must have risen at a greater rate than the increased turnover
(b) PART (i) FOR THIS SECTION NEED TO LOOK JUST AT THE RATIOS GIVEN
CANNOT DO COMPLETE DISCUSSION BECAUSE OF THE LACK OF DATA AND
THE LIMITATIONS AS PER SECTIONS (ii) and (iii)
PROFITABILITY
Ability of firm to generate profits
Profit Margin=the return on sales
Has decreased from 10% to 7% --on the face of itnot a good signbut at least profits are
being earned

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Return on Assets=measures the efficiency of the assets

Decreased from 15% to 11%--not good to have a decreasebut profits are being earned
Overall profitability is OK for 19X9 but the decreases are a cause for concern
LIQUIDITY
Ability of firm to pay its short term debts as they fall due
Current Ratio = current assets compared to current liabilities
Decreased from X8 to X9 was 2:1=rule of thumb
Beware use of the Rule of Thumbtoo much liquidity can lead to decreased profitability
Quick Ratio = more stringent test of liquidityrule of thumb here is 1:1firm quick ratio
has DECREASED cause for concern
Both these measures are STATIC measures of liquidityfor a more complete analysis look at
Receivables collection period and Inventory T/O
Receivables collection period = no. of days to collect accounts receivablecompare to
credit period for firmusual credit period is 30 daysthis firm was doing well at 30 days
and has now DECLINED to 45 daystaking longer to collect receivablesleads to
decreasing cash balancescould lead to BAD DEBTS
Inventory T/O = no. of times inventory is turned over during the yearmore times the better
higher T/O would lead to higher liquidityhas DECREASED in this case form 33 times to
28 timesthe firm must not be selling perishablesfruit shop T/O would be 60 or greater
timesMercedes Benz retailer T/O around 15 times approx
OVERALL, all liquidity ratios have worsened
FINANCIAL STABILITY
Ability of firm to survive in the futurelong term liquidity
Debt Ratio = % of assets funded by debt as opposed to equityaverage in Aust approx 60%
The more debt in a firmthe higher interest expense and the lower the profits and the more
debt repayments
Has increasedBAD newsfrom .64 up to .72 above Aust Averagemore debt to service
and repay
Times Interest Earnedability of profits to cover interest expenserule of thumb around 3
or 4 times
--has DECLINED from 2 down to 1.7area of concern
OVERALL financial stability has worsened.
FOR THE FIRM OVERALL ALL AREAS HAVE WORSENED FROM X8 TO X9
(ii)
NONOT ENOUGH INFORMATION TO MAKE A DECSION
OTHER INFO NEEDED;
--industry averages
--past years data to see if the decline is a trend
--trend analysis
--info re the economic climate
--the friends preference for risk and return
(iii) LIMITATIONS
--based on past data
--based on historical cost measurement
--based on year-end data
--limited disclosures by certain companies
--entities may not be comparable

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e.g. different industries

different accounting methods
different sizes
--must consider info in other reports
--existence of extraordinary items can cause problems in the analysis

BSB110 2014 revision solutions