Exam 2015, answers PDF

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ACC100 Accounting 1 Solutions and Marking Guide to Sample Exam QUESTION 1

Financial statement analysis

(20 Marks)

PART I (11 Marks) Required A. What do these ratios indicate about Big Waves’ profitability, efficiency and liquidity? (9 Marks) Three (3) marks per category. Profitability: The profit margin has increased. This may suggest that the entity has increased its selling price (due, perhaps, to increased demand) even though it is not moving inventory any faster (a very good, or lucky, position to be in indeed). Alternatively, it could be a function of lower expenses per dollar of sales. Efficiency: The entity is selling its inventory less quickly in 2016 compared with 2015; however, the debtors are taking on average 16 more days to pay. The entity may have to review its collection policy and the credit terms offered to customers. It would be useful to know the industry average in surf retail to assess how reasonable the turnover is. Liquidity: Both the current ratio and the quick asset ratio have increased in 2016. This is not necessarily a good indicator, as too much tied up in assets such as cash, inventory and debtors can represent an inefficient allocation of resources. When assessing the current ratio, an arbitrary rule of thumb is that it should be around $1.50 of current assets for every $1 of current liabilities and $0.80 of quick assets for every $1 current liabilities. The adequacy of these ratios should be assessed in conjunction with Big Waves activity cycle. B. List two (2) other sources of information that would be useful in analysing Big Waves’ business. (2 Marks) One (1) mark per example given -

Economic conditions Industry benchmarks Capital structure ratios Other ratio findings Trend, vertical or horizontal analysis Four financial statements.

PART II (9 Marks) Required A. For both the 2016 and 2015 years, complete a vertical analysis on the above data. (5 Marks) Half (0.5) mark per correct entry. 10 x 0.5 entries.

Sales/Revenue

880,000

100%

600,000

100%

Cost of sales

572,000 132,000

65% 15%

390,000 72,000

65% 12%

80,000

9%

54,000

9%

96,000

11%

84,000

14%

Selling expenses Administration expenses Profit

B. With references to the vertical analysis, comment on the profitability of Western Supplies Ltd. In your In your response include recommendations for the 2017 financial year (4 Marks) Two (2) marks for vertical analysis explanation Two (2) marks for recommendation. From the vertical analysis of Western Supplies Ltd in Part A. We can see that sales have increased in 2016 which is positive. The vertical analysis also shows that cost of sales and administrative costs have also increased in direct proportion to sales from 2015 to 2016. The area of concern is the selling expenses which have increased from 12% of sales to 15% of sales. It is this increase which has led to a decrease in profit from 14% to 11% in 2016. It is recommended that in 2017 Western Supplies Ltd passes on this increase in costs by increasing its sales price or looks at ways of reducing selling expenses in order to improve its profit.

QUESTION 2.

MANAGING THE BUSINESS

(20 MARKS)

Required A. Prepare the cash budget for Country Chic Ltd for the four quarters in 2016. (15 Marks) Country Chic Ltd Cash Budget

0.5

For the year ending 31 December 2016 March

June

Sep

Dec

Cash Receipts Loan Proceeds

-

15,000

-

-

Receipts from debtors

200,000

225,000

287,500

356,000

Total Cash Receipts

200,000

240,000

287,500

356,000

Inventory Purchases

145,000

172,500

202,500

250,000

Salaries and Wages Selling Expenses

32,500 12,500

32,500 14,700

38,000 15,900

38,000 21,000

8,600

10,400

12,600

13,500

0.25 2 1

Cash Payments

Administration Expenses Purchase Van Loan - Interest Total Cash Payments Net Cash Flow Bank Balance at the start of QTR Bank Balance at the end of QTR

375

375

304,375

322,875

2 1 1 1 0.25 1 1

16,875

33,125

1

35,000 -

-

198,600 1,400

230,100 9,900 -

24,500

25,900

35,800

18,925

25,900

35,800

18,925

52,050

Total

A. Country Chic Ltd would like to pay a dividend to its shareholders of $10,000 in the December Quarter. The company has a policy that a minimum of $10,000 must be kept in the business bank account in any one quarter. From your budget findings in Part A comment on if Country Chic has adhered to its company policy in each quarter and if the shareholder dividend can be paid. (5 Marks)

1 2 15

Suggested solution Three (3) marks for discussion on company policy Two (2) marks for discussion on shareholder dividend Country Chic Ltd has a company policy of maintaining $10,000 per quarter in the business bank account. From the cash budget for the 2016 year it is confirmed that the company policy has been maintained with the projected cash balances as follows: Country Chic Ltd Cash Budget For the year ending 31 December 2016 March Bank Balance at the end of QTR

25,900

June 35,800

Sep 18,925

Dec 52,050

In the December quarter Country Chic will be able to make its dividend payable to the shareholders without breaching the company policy regarding the bank balance. A dividend payment of $10,000 would reduce the December quarter bank balance to $42,050.

QUESTION 3.

CVP ANALYSIS

Sales (80 000 units)

(20 Marks)

$800 000

Variable manufacturing costs

160 000

Variable Selling costs

200 000

Fixed Selling and administration costs

200 000

Fixed Advertising Costs

120 000

A. Calculate sales price per unit. (2 Marks) Sales $800,000 /80,000 = $10.00 (1 Mark) Calculate the variable cost per unit. Variable Costs $160,000+200,000= $360,000 Total Variable Costs $360,000/80,000 =$4.5 (1 Mark)

B. Break-even units (4 Marks) Contribution margin per unit = $10 - $4.5 = $5.5 (1 Mark) Break-even = Fixed Costs ($320,000) (1 Mark) $5.5 =

58 182 units (2 Marks)

C. What amount of units t would give Bills Skateboards a profit of $230 000? (4 Marks) $320,000 + $230,000 (1Mark) 5.5 (1 Mark) = 100,000 units (2 Marks)

D. Management is considering two alternative cost strategies in 2016. (6 Marks) Strategy 1: reduce variable selling costs by $20 000 Variable costs =360,000-20,000=340,000 Variable costs per unit $340,000/80,000=4.25 Contribution Margin = 10 - 4.25 = 5.75 (1 Mark) Breakeven= 320,000/5.75= 55,652 (2 Marks)

Strategy 2: reduce fixed advertising costs by $50 000 Fixed costs = (320,000-50,000) =270,000 (1 Mark) Breakeven = 270,000/5.5 =49,091 (2 Marks)

E. Which strategy would you recommend to management in 2016 and why (2.5 Marks) Strategy 2 would be recommended to management as the breakeven point is considerably lower than strategy 1.

F. The weighted average contribution margin is used in break-even calculations when there are multiple products or services. It is calculated using the contribution margin per unit of each product weighted by the sales mix proportion of each product. (2 Marks)

QUESTION 4.

Funding the Business

(20 Marks)

A. Bills Café is a new business in its early development phase. Which forms of short-term finance should Bills Café try to maximise and why? (5 Marks) The form of short-term finance that should be maximised would be trade credit and wage and tax accruals. These are sources of ‘free’ finance, which are vitally important to early-stage firms which are normally short of funds. Trade credit occurs during the normal course of business and is extended without a formal agreement and is normally unsecured. Wage and tax accruals include accrued wages and PAYG withholding instalments which if timed correctly can be used as spontaneous sources of finance for a new business. B. Discuss the advantages and disadvantages of raising finance for a business via the issues of ordinary shares as opposed to financing through a bank loan (10 Marks) Ordinary shares are the main type of shares that are owned by investors. Advantages of ordinary share ownership is the limited liability and the voting rights that shareholders have. Ordinary shares have no fixed maturity date and the shares continue to exist as long as the company exists. Ordinary shares rank last in the winding up of the company and also only receive dividends after preference shareholders have been paid their dividend. From a business perspective, equity finance through shares provides the business with access to large amounts of capital without the high interest costs. Dividends may be paid if the business has sufficient cash flow. Equity finance does not have the risks associated with paying back the loan and maintaining the interest payments. Equity finance does not pose restrictions on business activities for example debt finance involves a debt covenant in place which could restrict future borrowing activities. Debt finance through loans however does have its advantages. Loans do not dilute the owner’s equity in the company as the lender does not have a claim to the equity of the business. The business only has to pay back the principal and interest. There is no claim on future profits of the business (i.e. Dividends as it the case with ordinary shares). Usually, interest expense and loan repayments are known amounts and can be budgeted for. Interest expense is also tax deductible for the business. Loan finance is much easier in terms of regulations and in setting up the loan.

C. Define factoring’ and explain the advantages and disadvantages of using it as a method of short term finance. (5 Marks).

Factoring is a form of business finance that gives the lender the right to collect the cash owing on the invoices. The factor discounts the invoices outstanding and hands over the cash to the company. It then collects the amounts outstanding. The advantages are that it does provide a form of immediate finance to the borrowing entity. The factoring company can either buy the invoices outright from the borrowing entity or it can give a loan to the borrowing entity, collect the outstanding amounts, subtract its fees, the amount outstanding and return the balance to the borrower. The disadvantages are that it is a rather expensive form of finance. The factoring fees or the discounting of the invoices can be quite high and can substantially reduce the amounts outstanding. This can have implications for the working capital of the business, particularly if the total debtors were a large proportion of the working capital....