Accounting for Business

This document provides study material and solved assignments on Accounting for Business. It covers topics such as current ratio, quick ratio, accounts receivable turnover, and inventory turnover. It also discusses the short term liquidity position and operational efficiency of a company. Additionally, it classifies financial items as income and revenue, evaluates potential borrowers for loan extension, and considers the impact of outstanding liabilities on business valuation. Finally, it compares non-fixed assets for making a buying decision.

ACCOUNTING FOR BUSINESS
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PART A
a) 1) Current Ratio – This is reflective of the current liquidity and the ease with which the
company can settle the outstanding current liabilities.
Formula used
Working
2) Quick Ratio: This is also reflective of the current liquidity but provides a more stringent
measure of the same as inventory is excluded from the list of liquid assets used for settling
the current liabilities.
Short Formula used
Working
3) Accounts Receivable Turnover – This is reflective of operational efficiency and in
particular the ease with which the company recovers outstanding cash from debtors created
on account of credit sales.
Formula used
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Working
4) Inventory Turnover – This is reflective of operational efficiency and in particular the ease
with which the company converts outstanding inventory into sales to customers.
Formula used
Working
b) The short term liquidity position of the company is represented with the use of current and
quick ratio, Comparing the current ratio in 2019 with the corresponding figure in 2018, it
is apparent that there is sizable drop which implies worsening liquidity position. But, there
is also a positive trend as the current ration in 2019 is higher than corresponding value in
2018. However, the actual ratios in 2019 do not reflect any liquidity threat in the near term
as enough coverage is available for meeting the current liabilities (Watson and Head,
2015).
The operational efficiency of the company is represented with the use of turnover ratios. In
context of both turnover ratios computed for the company, 2019 indicates a marked
improvement over the performance in 2018. But despite this stellar improvement, the
operational performance of the company poses grave risks to working capital. This is
because the credit period as stated by the company is 30 days but the average collection
period in 2019 continues to be higher. Also, the days required to turn inventory into sales
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are far higher than the industry average which would imply additional costs in storage,
handling and obsolescence, thus adversely impacting profitability (Ehrhardt and Brigham,
2014).
PART B
Income may be defined as economic benefit with the underlying reporting entity may derive
on the basis of various modes such as increase in asset, decrease in liability, any cash inflow
provided this cash has not been given by shareholders for exchange of equity. Further, it is
highlighted by AASB 118 that any income whose source is the core business activity would
result in revenue being produced (AASB, 2014). Considering the definition for the income
and revenue, the suitable classification of financial items is provided below.
1) Sale of software ($ 25 million proceeds)
Classification: It is income and also revenue.
Explanation: There is cash inflow which leads to economic benefit for Green Apple and the
same is not in exchange of shares but rather the key product of the company. Also, the selling
of software is the main business activity that Green Apple is engaged in which leads to
income being termed revenue.
2) Update downloads ($ 3 million proceeds)
Classification: It is income and also revenue.
Explanation: There is cash inflow which leads to economic benefit for Green Apple and the
same is not in exchange of shares but rather the key product of the company. Also, the selling
of software is the main business activity that Green Apple is engaged in which leads to
income being termed revenue.
3) Interest income ($ 50,000 proceeds)
Classification: It is income but not revenue.
Explanation: There is cash inflow which leads to economic benefit for Green Apple and this
is not to be paid back and therefore is income. However, the company does not have
investing as one of the business activities and hence the income is not revenue.
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4) Liability settlement ($2,000 proceeds)
Classification: It is income but not revenue.
Explanation: The cash outflow is reduced on account of the discount in liability settlement.
This increases the net cash inflow and hence recognised as income. However, the impact of
this is seen in the expenses related to the business and thereby recognition is not as revenues.
5) Share proceeds ($ 5 million)
Classification: It is neither income nor revenue.
Explanation: The proceeds from shareholders are in exchange of the shares and thus the
proceeds are not income. As the proceeds do not qualify as income, these cannot be termed as
revenue for Green Apple.
PART C
a) The duration of intended loan is only six months. Thus, the major consideration for
extending loan is the underlying short term liquidity situation associated with the
potential borrowers. Hence, the current ratio for both the potential borrowers is indicated
as follows (Petty et. al., 2016).
It is quite clear from the results obtained the current liquidity situation of XYZ company is
quite robust. In contrast, ABC company is in the midst of credit crunch and lending to such
company is highly risky. Hence, lending should be done to XYZ company with regards to a
six month loan.
b) There are plans to sell the two businesses under the assumption that the existing
liabilities would have to be dealt with by the buyer only. This would result in lower
valuation for business where outstanding liability are higher provided the other aspects
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are comparable for the two companies under sale. The total extent of current outstanding
liabilities for ABC company stand at $ 52,800 and the current cash balance is only $
2,400. This indicates high net debt. A contrasting position is witnessed for XYZ since
the net debt is significantly lower. Considering this, it makes sense to pay a higher
amount for XYZ company (Damodaran, 2015).
c) A changed term and condition is that the new buyer will not assume the outstanding
liabilities associated with the underlying company that is bought. This would result in
change in decision made above as it makes more business sense to require ABC under
the new terms and conditions. This is primarily because of the comparison of the non-
fixed assets which indicate that ABC has a higher capacity when compared with XYZ.
This makes ABC a more lucrative buy in the present scenario.
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References
AASB (2014) AASB 118 – Revenue, [Online] Available at
https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_%20COMPapr07_07-
07.pdf [Accessed May 25 2019]
Damodaran, A. (2015) Applied corporate finance: A user’s manual. 3rd ed. New York:
Wiley, John & Sons, pp. 167-168
Ehrhardt, M. C. and Brigham, E. F. (2014).Corporate Finance: A Focused Approach. 6th ed.
London: South- Western College Publisher, pp. 123
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2016)
Financial Management, Principles and Applications. 6th ed. NSW: Pearson Education, French
Forest Australia, pp. 216
Watson. D., and Head, A., (2015) Corporate Finance – Principles and Practice.6th ed.
London: Pearson, p. 145
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