Financial Accounting Practice Questions And Solutions Essay.

Question 1

Best Real Estate Agency has opened an office in Swanston Street. It generates its revenue through charging a commission (agency revenue) of 4.5% of the ultimate sale price achieved on behalf of the customer. The average monthly property sales is $700,000 and the Estate agent generates its revenue via charging a commission (agency revenue) of 4.5% of the gross property sales. Fixed monthly costs are office rent ($3,400), depreciation of office furniture ($390), electricity ($640), a multi-line telephone system ($380), computer cabling connection ($480) and salary of the office manager ($7800). Variable costs include commissions for the sales staff (50% of agency revenue), supplies and printing (10% of agency revenue), and usage costs for phone and computers (7% of agency revenue). The average property sales per month are expected to be $700,000 and the agency takes 4.5% of gross property sales, as agency revenue.

• Calculate the estate agency’s monthly break even commission / agency revenue in dollars.
• Calculate the commission / agency revenue needed to earn monthly net profit of $10,000.
• From your answer in (b) above what is the gross property sales required to generate commission / agency revenue to make a $10,000 profit above breakeven.
• When the managing partner of Best Real Estate Agency is shown your CVP calculations, he is quite dismissive. He says it is largely useless information because the reality of the real estate business is much more complex and dynamic with the model based on unrealistic assumption.   Prepare a detailed response to the managing partner, identifying model assumptions and potential use of the model.

XYZ Packaging Ltd purchased equipment for $310,750 on 1 January 2015 for use in its parcel packaging business.  XYZ’s management estimates that the equipment will be technologically obsolete in 5 years, at which time it will have a residual value of $26,000. The equipment will produce 60,000 batches of parcels in the first year, with annual production decreasing by 5,000 batches during each of the next 4 years (i.e., in the fifth year the equipment will be down to 40,000 batches of production capability).

• For each of three depreciation methods (straight-line, units-of-production, and reducing balance), prepare a depreciation schedule from acquisition showing the following balances each year for the 5 years: asset cost, depreciation expense, accumulated depreciation and asset carrying amount. For the reducing balance method, use a depreciation rate based on 45%.
• Depreciation is a concept used in accrual accounting.  Of the depreciation methods above discuss the reasons for selecting one alternative method of depreciation over another as dictated by accrual accounting and the matching principle.
• Depreciation allocates cash to eventually replace the asset once it has reached the end of its useful life. Discuss, stating whether you agree or disagree with the statement and why?

Southern Star Company is considering replacing an existing piece of machinery with a more sophisticated machine. The existing machine was purchased 3 years ago at a cost of $50,000 and is being depreciated to a zero residual value over 7 years. This machine has 4 years of usable life remaining and can currently be sold for $55,000 net.

The new machine being considered will cost $76,000 and requires an outlay of $4,000 for installation. It will be depreciated over a 4 year period to a zero value and provide the benefit of reducing cash operating costs by $10,000 per annum. (Note: Ignore Tax Implications)

• Given a required rate of return of 14% per annum on capital expenditure proposals, calculate the Net Present Value (Cost). In your own words interpret the meaning of the net present value calculated, nominating whether to continue with the old machine or replace it with the new machine. (Ignore tax implications. / show all working as part of your answer)

The management of Trucks Ltd, a transport business, wants to get a report from the accountant on the cash provided from various activities. The accountant has provide you the following information for the financial year ended 30 June 2016

Item	$
Interest paid	3,000
Dividends paid to Shareholders	20,000
Profit after tax for year ended 30/6/2016	100,000
Cash at bank at July 1, 2015	1,000,000
Depreciation for the year	50,000
Payment for Motor vehicle purchased on 28th April 2016	40,000
Loan repayments made	60,000
Taxes paid to the Tax Office	76,000
Payments to employees	100,000
Cash received from the sale of machinery	100,000
Cash sales	650,000
Dividend received	240,000
Investments in companies listed on the ASX (Australia Security Exchange)	56,000
Cash received from accounts receivable	550,000
Bad Debts expense	10,000
Payments to suppliers	500,000
Credit sales for the year	750,000
Money borrowed from Net bank	250,000
Purchase of property and land for cash	800,000

Required

• Prepare a fully classified cash flow statement for the year ended 30th June 2016 for Trucks Ltd.
• Trucks Ltd management is confused in that their Income Statement is indicating they made a net loss (negative profit) over the same period whilst reporting a positive cash inflow from operations. Assuming both reports are accurate explain to Truck management providing two possible reasons why this discrepancy could occur when comparing cash flow from operations (cash profit) with accrual accounting profit / loss.  For each cause identified highlight the impact on Assets  = Liabilities  + Owners Equity and profit versus cash flow (80 word limit)
• Given the above differences discuss which statement (Income Statement or Cash Flow from Operations) better reflects the financial performance / wealth creation for the period ending 31 December 2016. (Justify your answer with reference to accrual accounting)

The Good Men Ltd competes in the home electrical markets alongside Harvey Norman and The Good Guys. The business is in its growth phase of its business life cycle and has decided to review its performance as regard the management of its working capital. You have been asked to review their performance utilizing figures and ratios calculated over the past four years and comment on their performance taking into account benchmark figures / industry averages / budgets also detailed below. Once you have analyzed their performance provide some strategies and recommendations to assist in improving any weaknesses in working capital management identified. As part of your recommendations identify the associated potential benefits and costs of each recommendation.

Working Capital Ratios

2014 2015 2016 2017

Accounts Receivable Days 29.2 days 39.1 days 43.8 days 50.2 days

Inventory Days 32.0 days 33.5 days 36.9 days 45.6 days

Accounts Payable Days 29.6 days 30.2 days 38.2 days 53.0 days

Note: Ratios are based on assuming end year figures are the average throughout the majority of the year

Extracts from Financial Statements

Cash on hand 0.35mill 0.3mill .01mill .005mill

Sales – all on credit 15 mill 14 mill 15mill 16mill

Accounts Receivable Balance 1.2 mill 1.5 mill 1.8 mill 2.2 mill

Inventory 0.7 mill 0.78 mill 0.9 mill 1.15mill

Cost of Goods Sold 8.0 mill 8.5 mill 8.9 mill 9.3 mill

Accounts Payable 0.65mill 0.7 mill 0.95 mill 1.35 mill

Budgeted Figures

Cash on hand 0.3 mill 0.3 mill 0.31 mill 0.32 mill

Accounts Receivable Balance 1.2 mill 1.22 mill 1.28 mill 1.35 mill

Inventory Balance 0.7 mill 0.72 mill 0.78 mill 0.80 mill

Accounts Payable 0.64 mill 0.65 mill .07 mill 0.71 mill

Accounts Receivable Terms 30 days   30 days   30 days   30 days  

Accounts Payable Terms 45 days 45 days 45 days 45 days

Industry Averages

Accounts Receivable Days 30.1 days 29.6 days 30.4 days 33.1 days

Inventory Days 30 days 31 days 33 days 32.2 days

Accounts Payable Days 30 days 28.5days 17 days 15 days

Particulars	Amount ($)
Revenue	4.50%	700000
Agency Revenue	31500
Fixed costs
Office Rent	3400
depreciation of office furniture	390
electricity	640
multi-line telephone system	380
computer cabling connection	480
salary of the office manager	7800
Total fixed costs	13090
Variable costs
commissions for the sales staff	15750
supplies and printing	3150
usage costs for phone and computers	2205
Total variable costs	21105
Contribution margin %	=	(Revenue-variable cost)/revenue
	=	33%
a)
Breakeven sales	=	(Fixed costs/contribution margin %)
	=	39667
b)
Revenue required to earn net profit of $10000
Particulars		Amount ($)
Profit	=	Contribution	-
10000	=	Sales-variable costs	-
10000	=	Sales-21105	-
Sales	=	44195
c)
Revenue to make profit $10000 above breakeven
Contribution margin %	=	(Revenue-variable cost)/revenue
	=	52%
Breakeven sales	=	(Fixed costs/contribution margin %)
	=	25055
Particulars		Amount ($)
Profit	=	Contribution	-
35055		Sales-variable costs	-
35055	=	sales-21105	-
Sales	=	69250

The CVP analysis consists of three elements and the same are cost, volume (the number of units) and the profits. It is carried out for making important and noteworthy information available towards the managers of the business in respect to the products and services offered by them. The same will only be available by the people having an internal hold in the business. The past performances are assessed and analysed to get the effective structure of present and future costs and performances. Hence, the model of CVP will be effective in achieving the ultimate success required by the company.

Depreciation
Purchase cost	310750
Years	5
Residual value	26000
Straight Line method
Depreciation	(Purchase value-Residual Value)/Number of years
	56950	per year
units-of-production method
Purchase cost	310750
Residual value	26000
	284750
Depreciation per annum (per batch)	4.7458
Particulars	Year1	Year2	Year3	Year4	Year5
Total units	60000	55000	50000	45000	40000
Depreciation	284750	261020.8	237291.7	213562.5	189833.3
Diminishing value method
Purchase cost	310750
Particulars	Year1	Year2	Year3	Year4	Year5
Depreciation	139838	76910.63	105227.7	92485.03	98219.24

The accrual accounting that includes the immediate write off of the whole costs as expenses in terms of assets of long life. The spread of the cost must be done over the expected life that is done in the case of the straight line method and thus is one of the most useful methods of depreciation in undertaking the accrual system of accounting.

The depreciation process of an asset leads to a residual value that is left at the end of the period of the asset and the same is used for the determination of profits from the sale of asset. But, it is a non cash expense and it has no relation with the cash. So, we disagree with the given statement.

Old machine value
Cost	50000
Years	7
depreciation per year	7143
depreciation for 3 years	21429
Therefore,
Value at the end of 4th year	28571
Selling price	55000
Profit	26429

NPV of new machine
Particulars	Year 0	Year1	Year2	Year3	Year4
Initial cost	-76000
Installation	-4000
Total outflow	-80000
Cash inflows		10000	10000	10000	10000
PV factor	1	0.877	0.769	0.675	0.592
PV of cash flows	-80000	8770	7690	6750	5920
NPV	=	Total cash outflows	-	Total cash inflows
	=	80000	-	29130
	=	50870

The NPV is higher and positive than the obtainable profits under the operation of the old machine, there must be replacement of the old machine with new one.

The non-financial factors that should be considered in making the final investment decision other than NPV are as follows:

• Improvement in the morale and relationships among the employees, customers and the suppliers.
• Development of the abilities of business like the strengthening of the skills and experiences in new fields and systems.
• Expecting and having a plan to deal with probable risks and threats towards the company and the competitive forces.

The technique of discounting that takes into account the time value of money is known as the NPV or Net Present Value. It considers the cash flows and values that differ over the period of time. Thus, the cash flow of the estimated nature will get transformed into the present value of cash flow. The same can be referred to as the difference among the total outflows and the inflows of cash (Grob 2013).

There are various advantages and disadvantages of using the NPV method and the same are as below:

Advantages

It is the method that considers the significance of the time value of money

The calculation of the NPV takes into account the cash inflows and the outflows over the total life of the project.

Question 2

The risks and the productivity related to the project are highly prioritized.  

The method maximizes the overall value and worth of the firm.

Disadvantages 

The method computation is complex in nature

The calculation of the discount rate that is appropriate is also complex

In cases of mutually exclusive projects, the NPV method is not appropriate one

There are inaccurate answers provided in case of projects having unequal lives

Cash Flow Statement
Particulars	2016
Cash Flows from Operating Activities
Cash sales	650000
Cash received from accounts receivable	550000
Payments to suppliers	-500000
Payments to employees	-100000
Taxes paid to the Tax Office	-76000
Net Cash from Operating Activities	524000
Cash Flows from Investing Activities
Payment for Motor vehicle purchased on 28th April 2016	-40000
Investments in companies listed on the ASX (Australia Security Exchange)	-56000
Purchase of property and land for cash	-800000
Cash received from sale of machinery	100000
Dividend received	240000
Net Cash Used for Investing Activities	-556000
Cash Flows from Financing Activities
Interest paid	-3000
Dividend paid	-20000
Money borrowed from Net bank	250000
Loan repayments made	-60000
Net Cash from Financing Activities	167000
Net Increase/(Decrease) In Cash	135000
Cash In The Beginning Of Year	1000000
Cash End Of Year	1135000

The company reporting positive cash flows even after the net losses may be due to the depreciation expenses as these reduce the total income of the company without having an involvement of cash. The explanation of the same can also involve the concept of accrued accounting. An organization must record and report the expenses on their incurrence and before the payment of invoices. Thus, as per the system, the income can be reduced without having any effect on the cash of the corporation.

The income statement and cash flow statement both represents the financial positions of the company but among the two, the income statement is more effective an accurate. The income statement considers the depreciation and net losses while in the cash flow statement is set off by the other profits and incomes. Thus, for getting an efficient and accurate position of the finances, the statement of income needs to be considered.

a) The summarization of the above are as under:

The ratio is a representation of the total days in which the receivable of the company are gained and thus, the effectiveness in the maintenance of the same is important. The efficiency of the same will represent the effectiveness of the collection of the receivables from the debtors at an effective manner and time. The lesser the ratio, the better will be the collection period and thus the ratio will be perfect.

As per the above table, the budgeted ratio is approx 30days but the same is tough as the industry average has always resulted to a higher ratio and thus the collection had been slow. Only, the year 2014 had witnessed the perfect ratio as it had been less than 30days.

The ratio is a representation of the total days in which the movement of the stock takes place. The lesser the ratio, the better will be the movement of the stock within the corporation and thus the ratio will be perfect.

As per the above table, the budgeted ratio not mentioned but the ratio must be approximately near to 30days to get a perfect ratio.

The ratio is a representation of the total days in which the company will pay off the payables of the creditors. The lesser the ratio, the better will be the credit worthiness of the company.

As per the above table, the budgeted ratio is approx 45 days and the company has an average of lower than 45 days that will make the company efficient (Higgins 2012).

b) Suggestions

• The credit sales limit must be settled and improved
• There must be a review in the terms of credit. The terms of payment must depend on the customers. The longer terms must be extended towards the customers those who sell early as they would provide more profits to the organization and the terms of payment must be reduced for those who pay bills at early stages
• There must be incentives to attract the customers but the same must be maintained by the profits earned by the company.
• The credit sales must be discontinued for those having poor payment history

• The demand in the inventory must be increased and in a strategic manner
• The purchase prices must be regularly reviewed among the suppliers
• The groups of inventory must be defined in an appropriate manner
• The clients must be encouraged to order the inventory before hand

• The selection process of the vendors and suppliers must be appropriate and effective
• The master data of the supplier must be set up accurately and efficiently
• The payment terms must be reviewed and revised in a continuous manner
• The contracts with suppliers must be reviewed
• The procurement and the invoicing procedures must also be efficient (Gibson 2012).

References

Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of investment projects. Routledge.

Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now.

Gibson, C., 2012. Financial reporting and analysis. Nelson Education.

Gitman, L.J. and Zutter, C.J., 2012. Principles of managerial finance. Prentice Hall.

Grob, H.L., 2013. Capital budgeting with financial plans: an introduction. Springer-Verlag.

Healy, P.M. and Palepu, K.G., 2012. Business analysis valuation: Using financial statements. Cengage Learning.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Hofstede, G.H. ed., 2012. The game of budget control. Routledge.

Hope, J. and Fraser, R., 2013. the Budget. Budgetierung im Umbruch?, 1, p.71.

Yankovyi, O.G. and Yankovyi, V.O., 2015. Profitability management at enterprise by means of CVP-analysis. Upravlinnia bezzbytkovistiu na rivni pidpryiemstva za dopomohoiu CVP-analizu], Foreign trade: economics, finance, law. No. 1 (72), pp.12-25.