Accounting: Income Statement, Balance Sheet, Break-even Analysis

This document provides an overview of accounting concepts such as income statement and balance sheet. It also includes calculations for contribution, break-even point, and profit. Additionally, it discusses investment appraisal tools and techniques.

Accounting

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
PART-A...........................................................................................................................................1
PART-B...........................................................................................................................................6
a. calculation of contribution in order to cover fixed cost..........................................................6
b. Computing break -even and MOS in respect of units as well as value in case each of the
wall clock sold at £40..................................................................................................................7
c. Valuing profit in case the company sells 54000 units at £40.................................................8
d. Calculation of the profit through revised sales and fixed cost................................................9
e. Determining and explaining break-even model with its assumptions...................................10
PART-C.........................................................................................................................................11
a. Assessing viability of project using investment appraisal tools and techniques..................11
b. Explaining and assessing benefits and the limitation of capital budgeting tools..................13
Identifying and explaining key benefits as well as drawbacks associated with budgeting
aspects.......................................................................................................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................18

INTRODUCTION
Accounting refers to recording of the business transactions with storing, retrieving,
summarizing, sorting and communicating results in several reports for the users so that they
could assess the results and can make suitable decisions accordingly. The present study focuses
on preparation of the income statement and balance sheet of Terroy Plc which reflects its
financial performance and position in an overall industry. Furthermore, the study includes
computation of contribution per unit, break even assessment, profit evaluation and margin of
safety for Koklet Ltd in order to analyse that its operations are generating sufficient profits after
the payment fixed expenses and the variable cost. Moreover, the report highlights computation of
returns that the project will generate through application of various investment appraisal tools. It
also provides for a deeper insights towards different capital budgeting techniques with their
merits and demerits to the company.
PART-A
Income Statement
For the year ended 31 December 2018
Particulars Amount(
£)
Amount(
£)
Revenues:-
Sales(604800+154800) 759600
Other income 0
Total Revenues 759600
Expenses:-
COGS 291600
64800 356400
Depreciation 11000
1

Wages 140400
Add Outstanding wages at period end 2610 143010
Electricity Expenses 9270
Van running expenses 40320
Bad debts 1800
Rent paid 135000
Less:- prepaid rent at period end 27000 108000
Total Expenses:- 669800
Net profit before tax 89800
Less:- Tax paid 6930
Net profit after tax 82870
Balance sheet
Particulars Total Amount (£)
Liabilities
Shareholder's Equity 216000
Equity share capital 82870
Reserves and surplus
Current Liabilities
Outstanding Wages 2610
Outstanding Electricity Expenses 2430
Trade Payables 111600
Bank Overdraft 132840
Total Liabilities 548350
Fixed Assets
Delivery Van 61000
2

Current Assets
Prepaid Rent 2700
Closing Inventory 27360
Trade Receivables 77400
Prepaid Tax 1350
Cash 10800
Total Assets 548350
Working Notes
1 Total Sales
credit sales 604800
cash sales 154800
759600
2 Depreciation
Purchase Price of Van 72000
scarp value 6000
life in years 6
Depreciation 11000
3 Tax Computation
Tax up-to 31 march 2018 2880
Add:- Tax from 1 April 2018 to 31 march 2019 5400
3

Less:- prepaid tax of 3 months
(from January 2019 to 31 march 2019) 1350
6930
4 Electricity Expenses:-
Expenses paid 6840
Add:- Outstanding expenses at the end of the year 2430
9270
Working Notes
5 Reserves and surplus
Net profit after tax 82870
6 Trade Payables
Credit Purchases 583200
Less:- Payment to Trade Payables 471600
111600
7 Trade Receivables
Credit Sales 604800
Receipts from Trade Receivables 525600
Closing Trade Receivables 79200
Bad Debts 1800
Net Trade Receivables 77400
4

8 Prepaid Rent of 3 Months
Annual Rent 108000
Rent Per month 9000
Rent For 3 months 27000
9 Closing Inventory
Cost of credit sales 291600
Add:- Cost of cash sales 64800
Total Cost of sales 356400
Credit Purchases 583200
Cash Purchases 46800
Total Purchases 630000
Total Purchases 630000
Less:- Total Cost of sales 356400
Closing Inventory 273600
10 Closing Bank balance
Issue of Equity 216000
Receipts from Trade Receivables 525600
Total Receipts 741600
Less:- Rent paid 135000
Tax paid(2880+5400) 8280
Delivery van purchased 72000
5

Wages paid 140400
Electricity Expenses 6840
Payment to Trade Payables 471600
Van running expenses paid 40320
Total Payments 874440
Bank balance(cr.) 132840
11 Cash Balance
Cash Sales 154800
Less:- Cash Purchases 46800
Cash at 31 December 2018 108000
12 Closing Balance of Delivery Van
Delivery van purchased 72000
Less:- Depreciation 11000
61000
PART-B
a. calculation of contribution in order to cover fixed cost
Particulars total units produced Per unit Amount (£)
Selling price 78000 40 3120000
Variable cost 30.15 2351700
Contribution per
unit 9.85 768300
Particulars total units produced Per unit Amount (£)
Selling price 78000 40 3120000
6

Variable cost 30.15 2351700
Contribution per
unit 9.85 768300
Less: Fixed cost 319800
Profit 448500
Working note :
Material 15.75
Labour 8.85
Variable overheads 5.55
variable cost 30.15
Production 177000
Selling 142800
Fixed cost 319800
b. Computing break -even and MOS in respect of units as well as value in case each of the wall
clock sold at £40
Particulars Formula Amount (£)
Fixed cost 319800
Contribution per unit 9.85
Break even analysis
(in units) Fixed cost / contribution per unit 32467.01
Fixed cost 319800
7

Contribution margin
ratio 24.63%
Break even analysis(in
value)
Fixed cost /contribution margin
ratio 1298680.20
Budgeted sales volume 78000
Break even units 32467.01
Margin of safety(in
units)
Budgeted sales volume-Break
even units 45533.0
Budgeted sales volume 3120000
Break even sales 1298680.20
Margin of safety (in
value)
Budgeted sales volume-Break
even sales 1821319.80
Working note :
Contribution margin 9.85
Selling price 40
Contribution margin ratio 24.63%
c. Valuing profit in case the company sells 54000 units at £40
Particulars Formula Amount (£)
Selling price 54000*40 2160000
Less: Variable cost 54000*30.15 1628100
Contribution per unit 531900.00
Less: Fixed cost 319800
Profit 212100
8

d. Calculation of the profit through revised sales and fixed cost
Particulars Formula Amount (£)
Profit as per revised
selling price and units
Sales 89700*43.2 3875040
Less: Variable cost 89700*30.15 2704455
Contribution 1170585
Less: Fixed cost 454800
Profit 715785
Working note :
Old fixed cost 319800
Add: Advertising expenses 135000
revised fixed cost 454800
Old selling price 40
40*8% 3.2
Revised selling price 43.2
Old selling units 78000
78000*15% 11700
Revised selling units 89700
Interpretation- The above evaluation shows that increase in sales price, units and the
fixed cost seems to be a better option for the company as it is generating higher profits
amounting to £ 715785 as compared to the old selling price and the fixed cost resulted a profit of
£ 448500.
9

e. Determining and explaining break-even model with its assumptions
Break-even model referred as the financial tool that helps in determining the stage where
the new product and the services will counted as profitable (McGee, 2015). It plays a crucial
role in identifying practical applications of the cost functions. It refers to the function that
involves three major factors profit, sales and cost. It aims at categorising dynamic relationship
that is existed between the total cost and the sales volume of an entity. Break-even analysis also
called as the cost volume profit assessment that helps the company in knowing its operational
condition that is when the sales reaches the point equating to all the expenses that are incurred in
achieving the sales level (Hatch and et.al., 2017). The main assumptions lies with the break-even
model are as follows-
 Under this model it has been assumed that all the cost could be classified into the variable
and the fixed components.
 This model assumes that the cost behaviour is linear which means that there will be the
straight line in case if the cost data are been plotted on the graph (Assumptions of break-
even analysis, 2018).
 The sum total of the fixed cost will be remain as constant at every level of the output and
the variable cost seems to fluctuate in respect to direct proportion of the output.
 It has been estimated that product's selling price will remain as constant at each level of
sales which indicates that selling price will not change with change in the product supply.
 Price paid in respect of the input factors like wages, rent, advertisement and material etc.
will seen as constant.
 It is assumed that there will not be resulted any change in the technological methods and
in the efficiency of the machines and men.
 In this model, cost and the revenues are been compared on the basis of common activity
that is sales value of products and the total number of the units produced.
 Output and the sales volume is been assumed as the relevant factor that is affecting the
cost in at the time of application.
Break-even model helps different businesses in determining selling price that facilitates
desired profits (Morano and Tajani, 2017). It is tended to be the most useful tool for an
organization in fixing the volume of sales for covering the return generated on the capital
10

employed. This model enables in forecasting the cost and the profit as the result of the change in
the volume. This analyses provides for the suggestions to the company in making the shift in its
sales mix and also helps in making the comparison of the profitability with that of its competitors
within the industry (Uses of break-even model, 2017). Application of the break-even model
allows for evaluating the revenue and the cost at several output level. It aids the management of
the company in making suitable decisions in respect of forecasting for the long range planning
and also in maintaining the profitability (Hafizan and et.al., 2019). This analysis reveals the
strength of the business and its earning capacity without any effort or difficulty.
PART-C
a. Assessing viability of project using investment appraisal tools and techniques
On the basis of cited case situation, Smith Howe Ltd, manufacturer of window frames, is
planning to invest money in the new machine cost of £8000000. In this regard, with the motive
to evaluate viability of proposed investment several tools of capital budgeting have been applied
including payback, NPV and ARR.
Computation of cash inflow
Yea
r
Cash
inflow
(in £)
Outflo
w (in £)
Cash
surplus
(inflow
-
outflow
)
Less:
Depreciatio
n (in £)
EBIT/
EAT
(in £)
Depreciatio
n (in £)
EAT +
depreciatio
n = cash
inflow (in
£)
1
340000
0
128000
0
212000
0 1400000 720000 1400000 2120000
2
340000
0
128000
0
212000
0 1400000 720000 1400000 2120000
3
340000
0
128000
0
212000
0 1400000 720000 1400000 2120000
4
340000
0
128000
0
212000
0 1400000 720000 1400000 2120000
5
340000
0
128000
0
212000
0 1400000 720000 1400000 2120000
Calculating depreciation
Particulars Figures (in £)
Cost of new machine 8000000
11

Scrap value 1000000
Life of asset 5 years
Depreciation
(cost – scrap value) / life of asset
(8000000 – 1000000) / 5
= 1400000
Assessment of payback period
Year Cash inflow (in £) Cumulative cash inflow (in £)
1 2120000 2120000
2 2120000 4240000
3 2120000 6360000
4 2120000 8480000
5 3120000 11600000
Payback period = 3 + (8000000 – 6360000) / 2120000
= 3 + .8
= 3.8 years or 3 years and 8 months
Net present value (NPV)
Year Cash inflow (in £) PV factor @9%
Discounted cash
inflow (in £)
1 2120000 0.917 1944954
2 2120000 0.842 1784362
3 2120000 0.772 1637029
4 2120000 0.708 1501861
5 3120000 0.650 2027786
Total discounted cash
inflow 8895992
12

Less: initial investment 8000000
NPV 895992
Accounting rate of return (ARR)
Year Cash inflow (in £)
1 2120000
2 2120000
3 2120000
4 2120000
5 3120000
Average profit 2320000
Average investment 4500000
Average profit / average investment * 100
2320000 / 4500000 * 100
= 52%
Average investment = cost + scrap value / 2
= (8000000 + 1000000) / 2
= £4500000
Interpretation: By applying investment appraisal tools it has been identified that Smith
Howe Ltd will recover initial investment within the period of 3 years and 8 months. Hence, out
of 5 years, business entity will attain profit for 1 year and 4 months. In addition to this, outcome
of capital budgeting tool exhibits that NPV and ARR is £895992 & 52% respectively. By taking
into account all such aspects it can be presented that Smith Howe Ltd should accept this proposal
which proves to be more beneficial from the perspective of organizational growth. Moreover,
both NPV and ARR is positive as well as higher. Along with this, company should give
preference to the project whose payback is lower in against to the life of asset. All such aspects
clearly indicates that by investing money in the machine firm can get desired level of outcome.
b. Explaining and assessing benefits and the limitation of capital budgeting tools
In the context of business organization, investment appraisal techniques are highly
significant which helps in assessing whether proposed project will offer suitable returns or not.
13

In other words, capital budgeting tools help in assessing the viability of capital projects from
monetary perspective. The rationale behind this, attainment and maximization of profit is the
foremost objective of business unit. Hence, at the time of making evaluation and selection of
project business entity should consider benefits as well as drawbacks associated with different
tools.
Payback period- It refers to the time taken in recovering the cost that is been made in
the investment. In other words, it means the length of the time that an investment takes in
reaching to break-even point. Under this method, desirability of the investment made
directly relates to their payback period and reflects that shorter the period of payback, it
means the investment are more attractive.
Benefits Drawbacks
 Places high level of emphasis on
liquidity aspects
 Easy understandability
 Simple and easy to use
 It does not consider time value of
money concept
 Further, payback method does not
contribute in value maximizing
decisions (Advantages and
disadvantages of different capital
budgeting tools, 2019).
Net present value- This method of investment appraisal is highly significant which
assists in identifying whether proposed project will offer positive returns in the near future or
not. Hence, by subtracting initial investment from the sum of discounted cash flows returns in
the monetary terms can be assessed. According to the selection criteria firm should choose
project which offers positive as well as higher returns.
Benefits Drawbacks
 Assists business unit in identifying
whether investment will enhance firm’s
value or not.
 It presents solution by cash flows and
time value of money concept.
 It includes as estimation of appropriate
cost of capital which in turn quite
difficult
 Further, NPV method presents result in
monetary terms rather than percentage
14

 Clearly exhibits risk associated with
future cash flows referring cost of
capital.
(Investment Appraisal, 2019).
Accounting rate of return- It presents ratio of income with regards to initial investment
made. In other words, such investment appraisal tool presents average return which firm will
get from the initial investment (Advantages and disadvantages of different capital budgeting
tools, 2019). Hence, by dividing average profitability from mean investment ARR can be
calculated. In this, business entity should select project having higher ARR over other
alternatives available.
Benefits Drawbacks
 Presents result in percentage form
 Helps in evaluating alternative options
available
 Lacking time value of money concept
 Considers profitability rather than cash
flows
Identifying and explaining key benefits as well as drawbacks associated with budgeting aspects
Budget may be presented as a strategic plan which contains estimated revenue as well as
expenses pertaining to specific time period. For the purpose of strategic planning Smith Howe
Ltd is emphasizing on using budgeting tool. There are several traditional and modern budgeting
techniques available which Smith Howe Ltd can employ for making optimum utilization of
resources. Budgeting techniques mainly include incremental, cash, activity and zero based
budgeting. By employing budgeting tool business unit can do planning about future aspects
effectually. However, there are several benefits and drawbacks that associated with budgeting
tool such as:
Benefits
 Budgeting tool assists management team in doing planning about future activities.
Through this, Smith Howe Ltd can make proper estimation about future challenges and
thereby would become able to formulate strategies accordingly for meeting company’s
goals.
 Helps in creating future course of action through the means of competent plan.
15

 Provides input in relation to monitoring and controlling departmental performance.
According to this, by doing comparison of actual income as well as expenses in against to
the predetermined standards. By this, manager of Smith Howe Ltd can assess deviations
and thereby would become able to take corrective measures for improvement.
 Facilitates appropriate resource planning as well as allocation pertaining to monetary
aspects. Moreover, while preparing budget managers evaluate resource scarcity as well as
capital expenditure (Advantages and Limitations of Budgeting, 2019).
 Along with this, budgeting fosters co-ordination among all the departments. This in turn
promotes teamwork and ensures process improvement as well as to the significant level.
 In addition to this, by preparing budget manager of Smith Howe Ltd can guide personnel
of each department about money that need to be incurred in each activity.
Drawbacks
 Sometimes, budgeting may cause of de-motivation among personnel. The rationale
behind this, when firm sets unachievable targets then it may result into high
deviations or budgetary slack which in turn adversely impacts employee motivation.
 Budgeting is highly time intensive exercise which limits its significance to some
extent. Moreover, for budgeting purpose, involvement of manager at each
departmental level is highly required (Limitations of Budgeting, 2019).
 Further, it is cost exercise because extra manpower is required for setting budget in
relation to each department as well as overall organization.
In the context of Smith Howe Ltd, focus needs to be placed on the adoption of activity
based budgeting. This budgeting technique is highly suitable for manufacturing company as well
as helps in making suitable allocation of expenses and thereby facilitates appropriate cost
determination. Along with this, ABB helps Smith Howe ltd in eliminating inefficient activities
from operations and thereby assists in improving relationship with departments. Along with this,
by using ABB firm can gain competitive edge as it ensures offering products or services at
competitive prices through facilitating cost reduction.
CONCLUSION
By summing up this report, it can be concluded that by developing financial statements
Terry Joe plc can make assessment of monetary position effectually. It can be seen in the report
16

that BEP is the most effectual techniques which helps in identifying level after that firm starts to
make profit. It can be summarized from the evaluation that by generating sales of £1298680.20
Kokolet Ltd would become able to attain win-win situation. Besides this, it can be inferred that
manager of Kokolet Ltd should keep in mind assumptions associated with BEP while planning
about profitability etc. It has been articulated that Smith Howe Ltd should accept proposal and
lay emphasis on investing money in the proposed project. This in turn positively contributes in
organizational profitability as well as success. Further, it can be stated that investment appraisal
techniques are highly prominent which helps in evaluating the viability of capital projects.
17

REFERENCES
Books and Journals
Hafizan, A. M. and et.al., 2019. Cost Optimisation of a Flexible Heat Exchanger Network with
Fluctuation Probability using Break-Even Analysis. Chemical Engineering
Transactions. 76. pp.403-408.
Hatch, M. D. and et.al., 2017. The cost effectiveness of vancomycin for preventing infections
after shoulder arthroplasty: a break-even analysis. Journal of shoulder and elbow
surgery. 26(3). pp.472-477.
McGee, J., 2015. Break‐Even Analysis. Wiley Encyclopedia of Management. pp.1-1.
Morano, P. and Tajani, F., 2017. The break-even analysis applied to urban renewal investments:
a model to evaluate the share of social housing financially sustainable for private
investors. Habitat International. 59. pp.10-20.
Online
Assumptions of break-even analysis. 2018. [Online]. Available
through:<http://www.assignmentguys.com/assumptions-of-break-even-analysis/>
Uses of break-even model. 2017. [Online]. Available
through:http://www.yourarticlelibrary.com/accounting/break-even-point/break-even-point-
meaning-assumptions-uses-and-limitations/65309>
Limitations of Budgeting. 2019. [Online]. Available through:
<https://efinancemanagement.com/budgeting/limitations-of-budgeting>.
Advantages and Limitations of Budgeting. 2019. [Online]. Available through:
<https://www.businessmanagementideas.com/notes/management-notes/techniques-of-
control/benefits-and-limitations-of-budgeting/5253>.
Advantages and disadvantages of different capital budgeting tools. 2019. [Online]. Available
through: <http://educ.jmu.edu/~drakepp/principles/module6/advdistable.pdf>.
Investment Appraisal. 2019. [Online]. Available through: <http://knowledgegrab.com/learners-
zone/study-support/decision-making-financial-management/investment-decision/appraisals-
16/>.
18

19