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Kenyatta University *

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Accounting

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Nov 24, 2024

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6.29 A list of account balances for Mr Zheng’s business (Futronics) at the end of the 30 June 2017 reporting period is shown below. $’000 cash 26000 Receivables 14000 Office supplies 1200 prepaid insurance 650 Plant and equipment 125000 Accumulated depreciation — Plant and equipment 29300 Accounts payable 20600 Salaries payable 6000 Rent received in advance 12000 Share capital 75 000 Retained earnings 16000 Service revenue 178000 Rent revenue 14000 Supplies expense 17500 Rent expense 29 500 Insurance expense 2100 Depreciation expense 20650 Salaries expense 114300 Required : Produce the statement of profit or loss for the reporting period, and balance sheet at the end of the year. Negative marking will be apply to any balance sheet items included on the statement of profit or loss AND to any statement of profit or loss items included on balance sheet. Answer: Statement of Profit and Loss

Revenue Service revenue $178,000 Rent revenue $14,000 Total Revenue $192,000 Expenses Supplies expense $17,500 Rent expense $29,500 Insurance expense $2,100 Depreciation expense $20,650 Salaries expense $114,300 Total Expenses $184,050 Profit or Loss $7,950 Balance Sheet Assets Cash $26,000 Receivables $14,000 Office supplies $1,200 Prepaid insurance $650 Plant and equipment $125,000 Accumulated depreciation — Plant and equipment $29,300

Total Assets $137,550 Liabilities Accounts payable $20,600 Salaries payable $6,000 Rent received in advance $12,000 Total Liabilities $38,600 Equity Share capital $75,000 Retained earnings $16,000 Total Equity $91,000 2. Cindy Prasad runs her own business called Classy Candles, and provided the following data in relation to the business the year ended 30 June 2021: Account Amount Cash at Bank 66,300 Accounts Receivable 22,200 Inventory 25,500 Motor Vehicle 62,000 Accounts Payable 16,300 GST Payable 4,800 Loan Payable (in 2022) 45,000 Capital – C.Chen 60,000 Revenue from sale of Candles 88,000 Finance Income 5,400 Service Fees received 10,000 Cost of Sales 32,000 Wages and Salaries Expense 13,500 Insurance Expense 4,750 Rent Expense 7,200

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Advertising Expense 4,100 Utilities Expense 3,000 Motor Vehicle Expenses 1,500 Depreciation expense 8,000 Required: Based on the information given above: Prepare a Statement of Profit or Loss for Classy Candles for the year ended 30 June 2021 Note Negative marking will apply to all Balance Sheet items included in your Statement of Profit or Loss Answer: Statement of Profit and Loss Revenue Revenue from sale of Candles $88,000 Finance Income $5,400 Service Fees received $10,000 Total Revenue $103,400 Expenses Cost of Sales $32,000 Wages and Salaries Expense $13,500 Insurance Expense $4,750 Rent Expense $7,200 Advertising Expense $4,100 Utilities Expense $3,000 Motor Vehicle Expenses $1,500 Depreciation expense $8,000

Total Expenses $74,050 Profit or Loss $29,350 3. Presented below is information for Joe Snow, a sole trader for the year ending 30 June 2021: Cash balance as at 30 June 2021 68,340 Payments to employees and suppliers 291,300 Made a $20,000 Gain on land sold for $50,420 cash, original cost $30,420 ? Gst Paid 22,400 Proceeds of bank loan 33,600 Depreciation expense 13,440 Payments for property, plant and equipment 56,000 Cash balance as a 1 July 2020 51,540 Net profit 72,150 Drawings by Joe Snow 70,580 Cash Sales 180,000 Receipts from Debtors 189,700 Interest Received 8,960 Interest Paid 5,600 Cost of goods sold 220,000 Required: (a) Prepare a Statement of Cash Flows for Joe Snow for the year ending 30 June 2021 (b) Evaluate the cash performance of Joe Snow (c) Outline some cash flow warning signals (d) Describe the three sections of the statement of cash flows Negative marking will apply to any non-cash items included on your statement of cash flows Answer : Statement of Cash Flows for Joe Snow for the year ending 30 June 2021:

Cash Flows from Operating Activities Receipts Cash sales 180,000 Receipts from Debtors 189,700 Interest received 8,960 Payments Payments to employees and suppliers (291,300) Gst paid (22,400) Interest paid (5,600) Cost of goods sold (220,000) Net Cash Flows from Operating Activities (160,640) Cash Flows from Investing Activities Proceeds from sale of land 50,420 Payments for property, plant and equipment (56,000) Net Cash Flows from Investing Activities (5,580) Cash Flows from Financing Activities Proceeds of bank loan 33,600 Net Cash Flows from Financing Activities 33,600 Net Increase/(Decrease) in Cash Cash balance as at 1 July 2020 51,540 Plus: Net cash inflow from operating activities (160,640) Plus: Net cash inflow from investing activities (5,580) Plus: Net cash inflow from financing activities 33,600 Cash balance as at 30 June 2021 68,340 (b) Evaluation of the cash performance of Joe Snow: The cash performance of Joe Snow can be evaluated by considering the net increase or decrease in cash during the year. In this case, the net increase in cash is $16,800 ($68,340 - $51,540). While Joe Snow had positive cash flows from financing activities, the negative cash flows from operating and investing activities resulted in a relatively small increase in cash. This suggests that Joe Snow's cash generation from operations and investment activities may need improvement. (c) Cash flow warning signals: 1. Negative cash flows from operating activities: Negative cash flows from operating activities indicate that the business is not generating sufficient cash from its core operations. This could be a warning sign of declining sales, increasing expenses, or poor cash management.

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2. Declining cash balance: A declining cash balance over time indicates that the business is using more cash than it is generating. This could be due to excessive expenses, inadequate sales, or poor working capital management. 3. Negative cash flows from investing activities: Negative cash flows from investing activities may indicate excessive spending on assets without generating significant returns or cash inflows. It could be a warning sign of poor investment decisions or inefficient use of capital. (d) Three sections of the statement of cash flows: 1. Cash Flows from Operating Activities: This section reports the cash flows generated or used in the company's core operations. It includes cash receipts from sales, collections from debtors, payments to suppliers, employees, and other operating expenses. It helps assess the company's ability to generate cash from its day-to-day business activities. 2. Cash Flows from Investing Activities: This section reports the cash flows related to the acquisition or disposal of long-term assets and investments. It includes proceeds from the sale of assets, payments for the purchase of property, plant, and equipment, investments in other companies, and acquisitions of other businesses. It helps evaluate the company's investment decisions and capital expenditures. 3. Cash Flows from Financing Activities: This section reports the cash flows related to the company's financing activities. It includes proceeds from loans, issuance of shares, and payments of dividends, as well as repayments of debt and capital lease obligations. It helps analyze how the company raises capital and manages its financing structure.

4. Selected information for two companies competing in the catering industry have been presented below. Fine Foods Devine Current Assets 165,750 251,850 Non-Current Assets 375,000 448,500 Current Liabilities 87,900 35,250 Non-Current Liabilities 134,550 217,500 Equity 318,300 447,600 Profit 150,000 79,500 Required a. Analyse and compare the liquidity, solvency and profitability ratios of the entities. b. From your calculations in part (a), explain which entity is in a more favourable position. c. Users are interested in an entity’s future profitability, asset efficiency, liquidity and capital structure. Describe the ratios that would be of interest to users and the purpose of computing these ratios. d. When calculating days inventory, the average inventory level is compared with the cost of sales. When calculating days debtors, the average accounts receivable balance is compared with the sales revenue. Explain why the former ratio uses cost of sales whereas the latter uses sales revenue, and why averages are used instead of year end figures? e. Discuss three limitations of ratio analysis as a fundamental analysis tool. (a) Liquidity, solvency, and profitability ratios of Fine Foods and Devine: Liquidity ratios: 1. Current ratio = Current Assets / Current Liabilities  Fine Foods: 165,750 / 87,900 = 1.89

 Devine: 251,850 / 35,250 = 7.14 2. Quick ratio = (Current Assets - Inventory) / Current Liabilities  Fine Foods: (165,750 - X) / 87,900  Devine: (251,850 - X) / 35,250 Solvency ratios: 1. Debt-to-equity ratio = Total Debt / Total Equity  Fine Foods: (87,900 + 134,550) / 318,300 = 0.7  Devine: (35,250 + 217,500) / 447,600 = 0.56 Profitability ratios: 1. Gross profit margin = Gross Profit / Sales  Fine Foods: 150,000 / X  Devine: 79,500 / X (b) Based on the information provided, Devine is in a more favorable position than Fine Foods in terms of liquidity, as it has a higher current ratio and quick ratio. Devine also has a lower debt-to- equity ratio, indicating a stronger solvency position. However, without specific information on gross profit and sales, a direct comparison of profitability cannot be made. (c) Ratios that would be of interest to users for assessing an entity's future profitability, asset efficiency, liquidity, and capital structure include: 1. Profit margin ratios: Measure the company's ability to generate profits from sales. 2. Return on assets (ROA) and return on equity (ROE): Indicate the company's profitability in relation to its assets and equity, respectively.

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3. Inventory turnover ratio and days inventory outstanding: Assess the efficiency of inventory management. 4. Accounts receivable turnover ratio and days sales outstanding: Measure the efficiency of collecting accounts receivable. 5. Current ratio and quick ratio: Evaluate the liquidity position and ability to meet short- term obligations. 6. Debt-to-equity ratio: Determine the company's leverage and capital structure. The purpose of computing these ratios is to gain insights into the company's financial performance, operational efficiency, risk exposure, and ability to meet its obligations. (d) The days inventory ratio compares the average inventory level with the cost of sales because it focuses on the time it takes for inventory to be sold and turned into revenue. Cost of sales represents the direct cost associated with producing or acquiring the inventory. On the other hand, the days debtors ratio compares the average accounts receivable balance with the sales revenue because it measures the average time it takes for receivables to be collected. Sales revenue represents the actual revenue generated from the sale of goods or services. Averages are used instead of year-end figures because they provide a more representative picture of the company's performance throughout the year. Year-end figures might not capture fluctuations and changes that occur within the year, whereas averages provide a more accurate and balanced assessment. (e) Limitations of ratio analysis as a fundamental analysis tool include:

1. Limited comparability: Ratios may not be directly comparable between companies in different industries or of different sizes, as industry norms and company-specific factors can significantly influence ratios. 2. Lack of context: Ratios provide numerical information but do not explain the underlying causes or specific business circumstances affecting the results. Additional qualitative analysis is necessary to interpret the ratios correctly. 3. Reliance on historical data: Ratios are based on past financial statements, and they may not accurately reflect future performance or changes in the business environment. They should be used alongside other forecasting methods and market trends for a comprehensive analysis. 5. The following transactions were undertaken by Massenburg Personnel Services during the month of February 2022. Ignore GST. 1 st Invoiced a client for providing advice on current employment legislation, $2400. 2 nd Paid salaries to staff, $3600. 4 th Paid an annual subscription for access to an online data base of employment legislation until the end of J 5 th Received $6000 from a client for employing staff for them in January. 9 th M. Massenburg invested a further $20 000 additional capital into the business to ensure it has sufficient c 12 th Purchased new office furniture and equipment on credit for $12 500. 15 th Invoiced a client for $7000 for providing advice regarding an industrial dispute they had with their emplo 21 st Paid $720 electricity account the day the account was received. 23 rd Paid the firm’s lawyers for a bill received and recorded in January $7100. 25 th Paid for the Office furniture purchased on 12 th February 28 th M. Massenburg withdrew $1200 from the business bank account for personal use.

Prepare journal entries to record the transactions for February in the general journal. Marks will be deducted if no narrative is provided for journal entries Journal Entry for Massenburg Personnel Services in February 2022 Date Account Titles and Explanation Debit ($) Credit ($) 1st Accounts Receivable 2,400 Service Revenue 2,400 2nd Salaries Expense 3,600 Cash 3,600 4th Prepaid Expenses 250 Cash 250 5th Cash 6,000 Accounts Receivable 6,000 9th Cash 20,000 M. Massenburg, Capital 20,000 12th Office Furniture and Equipment 12,500 Accounts Payable 12,500 15th Accounts Receivable 7,000 Service Revenue 7,000 21st Utilities Expense 720 Accounts Payable 720 23rd Legal Expenses 7,100 Accounts Payable 7,100 25th Accounts Payable 12,500 Cash 12,500 28th M. Massenburg, Drawings 1,200 Cash 1,200 6. 1. Generate the adjustments needed for income, expense, asset and/or liability accounts for Board Games Pty Ltd to reflect the following transactions in the entity’s financial statement for the 12-month reporting period ended 31 December 2019 using the accrual system.

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a. The fortnightly salaries and wages bill of $8,400 for December 2019 is due to be paid on 1 January 2020. b. The entity has $60,000 of office furniture and equipment with a $10,000 residual value that it depreciates over five years on a straight-line basis. c. A client owes $3,500 for services rendered in December 2019. d. Board Games Pty Ltd’s utility services bill (water, telephone, electricity) for the quarter ended December 2019 has not yet been received. Based on previous bills, the quarterly expense is expected to be $1,800. e. Board Games Pty Ltd has a two-year subscription to a trade magazine at a cost of $1,600. The subscription was paid on 1 March 2019. f. A customer has commissioned work and paid $2,500. As at 31 December 2019, the work has not been performed. Example format for Jounral entries: Date Name of Account Debit Credit

2. Why are journals required as part of the recording process? Would not a set of ledger accounts be sufficient? 3. Discuss the difference in the role of the journal and the ledger in capturing accounting information efficiently and effectively. 4. Differentiate between financial recordkeeping in the journal and the ledger. 1. Adjustments for Board Games Pty Ltd: a. Accrued Salaries and Wages Expense: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Salaries and Wages Expense 8,400 Accrued Salaries and Wages Payable 8,400 b. Depreciation Expense: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Depreciation Expense 10,000 Accumulated Depreciation - Office Furniture and Equipment 10,000 c. Accounts Receivable: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Accounts Receivable 3,500 Service Revenue 3,500 d. Utility Expenses: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Utility Expenses 1,800 Accrued Utility Payable 1,800

e. Prepaid Expenses: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Prepaid Expenses 1,200 Subscription Expense 1,200 f. Unearned Revenue: Date Account Titles and Explanation Debit ($) Credit ($) Dec 31, 19 Unearned Revenue 2,500 Service Revenue 2,500 2. Why are journals required as part of the recording process? Would not a set of ledger accounts be sufficient? Journals are required as part of the recording process because they provide a chronological record of individual transactions. They capture the specific details of each transaction, such as dates, accounts involved, and amounts. Journals serve as the primary source of entry for recording financial activities and ensure accuracy and completeness in the recording process. A set of ledger accounts alone would not be sufficient because they provide summarized information and do not capture the specific details of each transaction. Ledgers organize and consolidate the information from the journals into individual accounts, allowing for easier analysis and preparation of financial statements. Journals and ledgers work together to provide a complete and accurate record of financial transactions. 3. Discuss the difference in the role of the journal and the ledger in capturing accounting information efficiently and effectively. The journal and the ledger play different roles in capturing accounting information:

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 Journal: The journal serves as the initial entry point for recording financial transactions. It captures transaction details in chronological order, including the date, accounts involved, and amounts debited or credited. Journals provide a comprehensive and auditable record of all financial activities and help ensure accuracy and transparency in financial reporting.  Ledger: The ledger organizes and summarizes the information from the journal entries. It consists of individual accounts such as assets, liabilities, equity, revenue, and expenses. Ledgers show the beginning and ending balances of each account and record the changes to those balances over time. Ledgers provide a consolidated view of account balances and facilitate analysis, monitoring, error detection, and preparation of financial statements. 4. Differentiate between financial recordkeeping in the journal and the ledger. Financial recordkeeping in the journal and the ledger differs as follows:  Journal: The journal is where financial transactions are initially recorded. It captures detailed transaction information in chronological order, including the date, accounts involved, and amounts debited or credited. The journal provides a complete and chronological record of individual transactions, making it easy to trace and verify specific financial activities.  Ledger: The ledger organizes and summarizes the information from the journal entries. It consists of individual accounts, such as assets, liabilities, equity, revenue, and expenses. Ledgers show the beginning and ending balances of each account and record the changes to those balances over time. The ledger provides a consolidated view of account balances,

allowing for easier analysis, monitoring, error detection, and preparation of financial statements.