This document provides study material and solved assignments on Accounting for Business. It covers topics such as current ratio, quick ratio, accounts receivable turnover, inventory turnover, and revenue recognition according to AASB 118. It also discusses the impact of liquidity on loan decisions and business valuation.
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PART A a)1) Current Ratio – The short term liquidity is captured using this ratio which presents an overview with regards to availability of current assets for meeting the current liabilities of the reporting entity. 2) Quick Ratio: The short term liquidity is captured using this ratio which presents an overview with regards to availability of liquid current assets (excluding inventory) for meeting the current liabilities of the reporting entity. 3) Accounts Receivable Turnover – The operational performance is captured using this ratio which focuses on the time required for the firm to convert the credit sales into cash collection from such customers. 2
4) Inventory Turnover – The operational performance is captured using this ratio which focuses on the time required for the firm to convert the outstanding inventory into sales. b)The short term liquidity performance of the company has taken a hit in 2019 as compared to the previous year i.e. 2018 which is apparent from the lowering current ratio despite some improvement in liquid ratio. A deteriorated liquidity position is reflected from the lowering of current ratio and liquid ratio. Even though there has been a sizable dip in the current ratio which is witnessed in 2019, the current liquidity position of the company does not raise any concern as the current ratio continues to be above 2 while the quick ratio is almost 1 (Lasher, 2017). Taking the turnover ratios into consideration and comparing the 2018 and 2019 performance, it is evident that an overall improvement in operational performance is evident for the year 2019 as compared to the previous year. However, despite this improvement, it is noteworthy 3
that the company’s operational performance still is significantly poor in comparison to the industry. This is primarily reflected from the inventory turnover days which continue to be very high in comparison to the industry average. The receivables turnover days for the company despite improvement in 2019 continue to be on average higher than the credit period made available by the company (Berk et. al., 2016). PART B AASB 118 offers the definition of revenue as that income which the underlying reporting entity tends to earn from main business activities. In this regards, it is noteworthy that income would arise when the reporting entity derives an economic benefit. Typical examples would include cash inflow (especially from customers but not shareholders), asset increase or liability decrease (AASB, 2014). The reporting entity is Green Apple which is essentially a software company. 1)Through the sale of the anti-virus software, Green Apple would derive economic benefit on account of cash inflows from buyers. Therefore this amount would be termed as income. Also, it is noteworthy that for Green Apple, selling of software is a primary activity related to the business and hence the proceeds contribute to revenue. 2)Through the download of updates, Green Apple would derive economic benefit on account of cash inflows from buyers. Therefore this amount would be termed as income. Also, it is noteworthy that for Green Apple, selling of software is a primary activity related to the business and hence the proceeds contribute to revenue. 3)Through the interest earned on investments, Green Apple would derive economic benefit on account of cash inflows as interest income. Therefore this amount would be termed as income. Also, it is noteworthy that for Green Apple, indulging in investments is not the primary business objective owing to which the proceeds would not contribute to revenue. 4)Green Apple is deriving economic benefit here as the actual expense in discharging of liability is $2,000 lower than otherwise envisaged. This is on account of the discount which would have a positive impact on the company’s income. This is therefore income but not revenue as it relates to the expense aspect of the business. 5)The proceeds obtained from the shareholders do not lead to any economic benefit as the giventransactionisessentiallyanexchangewherebyformoneyputinbythe 4
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shareholders, incremental shares are provided. As a result, the proceed are not classified as income and also not revenue. PART C a)The tenure of the intended loan $ 6,000 is only six months. Thus, for a lender, the liquidity of the company in the near term is of significance while long term liquidity does not hold much importance. In this regards, to make a prudent choice, it makes sense to compute the current ratio for the two prospective borrower which has been done as shown below (Damodaran, 2015). It is evident that Current ratio (XYZ) > Company (ABC). Further, the dismal current ratio of ABC hints at difficulty at meeting even the current outstanding liabilities and hence loan would be extended to XYZ. b)It is imperative to note that the purchaser of the business does not just assume the assets of the acquired company but also the outstanding liabilities. These payments would need to be made for discharging of these liabilities which could be a matter of consideration for determining the valuation. For the given case, the following two aspects are pivotal in terms of valuation (Brealey, Myers and Allen, 2014). Considering the poor current ratio of ABC, it is evident that the new buyer would need to infuse liquidity on immediate basis so as to keep the business operational. It is likely that these funds would be in the form of equity. The net debt on the books of ABC is significantly higher in comparison to the corresponding value for XYZ. Taking a cue from the above two aspects, it would be concluded that XYZ would command higher valuation when compared to ABC. c)A crucial change announced by the existing promoters is that they would discharge the existing liabilities in the business and thereby the buyer of the business does not need to 5
be concerned in this regards. With this condition in place, the decision would now be altered. This is because, the comparison parameter would now be the total assets where it is evident that ABC has the advantage as the total assets for this company are higher than the corresponding total for XYZ. Hence, it would be fair to conclude that ABC would command a higher valuation than XY under the altered scenario (Petty et. al., 2016). 6
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 31 2019] Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N. (2016)Fundamentals of corporate finance. London: Pearson Higher Education Brealey, R.A., Myers, S.C. and Allen, F. (2014)Principles of corporate finance. 2nd ed. New York: McGraw-Hill Inc Damodaran, A. (2015)Applied corporate finance: A user’s manual. 3rd ed. New York: Wiley, John & Sons Lasher, W. R., (2017)Practical Financial Management.5th ed. London:South- Western College Publisher 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 7