Accounting for Business

This document provides an overview of accounting for business, including measures of liquidity and operational efficiency. It discusses the current ratio, quick ratio, accounts receivable turnover, and inventory turnover. It also explores the classification of revenue and income. Additionally, it compares the short term liquidity of two companies for a loan extension. References are included.

ACCOUNTING FOR BUSINESS
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PART A
a) 1) Current Ratio – This is a measure of liquidity in the short term and provides an estimate
of the ability of company to settle the current liabilities by relying on current assets.
2) Quick Ratio: Short term liquidity is also measured through this ratio which outlines the
ability to settle current liabilities based on liquid current assets only.
3) Accounts Receivable Turnover – It measures an aspect of operational efficiency i.e. the
time within which on average the company would realise cash on the credit sales made.
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4) Inventory Turnover – It measures an aspect of operational efficiency i.e. the time within
which on average the company would realise sale from the purchased inventory.
b) Liquidity – Two measures aim to represent short term liquidity for the company namely
current ratio and quick ratio. The current ratio of the company has shown significant dip in
2019 which implies worsening liquidity position. However, the same is not indicated in
quick ratio where marginal improvement in2019 is registered over the 2018 levels.
Currently there is no concern as despite the fall in the current ratio, the two ratios for 2019
are quire healthy and do not hint at any cash crunch but any more fall going forward
might change this conclusion (Watson and Head, 2015).
Operational Efficiency – On both counts i.e. inventory turnover and receivables turnover,
the company in 2019 has made significant strides. This is apparent from the significant fall
in inventory turnover days and receivable collection days that have been registered in 2019
when compared with corresponding values in 2018 (Damodaran, 2015). However, still the
operational efficiency of the company continues to remain inferior. The inventory turnover
days in 2019 (176 days) is substantially larger than the corresponding industry average
(104 days). Also, the average collection days for receivables continues to exceed 30 days
despite the official credit period of 30 days provided to creditors. The company needs to
make rapid strides in these aspect or it would not be able to compete with peers owing to
high working capital requirements (Ehrhardt and Brigham, 2014).
PART B
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Revenue and income are both defined in AASB 118. In accordance with this, income refers
to any economic benefit that the report entity would realise on account of cash inflows that
would lead to asset increase, decrease in liability. However, it is imperative that any cash
inflows from the shareholders would not be realised as income as it is given in exchange of
shares of the reporting entity. Income that is the result of conducting primary (main) business
activities would be referred to as revenue (AASB, 2014). In wake of this definitions, the
following financial items can be appropriately classified.
1) Anti-virus software sale –The company gets cash inflows from customers and hence
receives economic benefit on account of the sale. Thereby the proceeds would be
categorised as income. Considering that the company is in business of selling software,
the given is directly attributed to the main business activity and hence revenue.
2) Sale from updates download – In this instance also, the cash inflows would arise from
customers in exchange of the downloading of the update for particular software. Thereby
the proceeds would be categorised as income. Considering that the company is in
business of selling software, the given is directly attributed to the main business activity
and hence revenue.
3) Interest income – The interest payment results in actual cash inflow in the company
(Green Apple) and this amount does not need to repaid. Hence, company derives
economic benefit and the proceeds are categorised as income. The company has not been
incorporated to undertake the activity of investing in money market and thus this does not
constitute as primary business activity. Hence, the proceeds do not amount to revenue.
4) Discount related to liability settlement - The given transaction has resulted in lesser cash
outflow for settling an outstanding liability. This discount thereby results in economic
benefit to the company and hence aids the overall income. Clearly, the nature of the
transaction is that it leads to lowering of expenses and does not alter the revenues.
5) Share issue related proceeds – As clearly stated in the definition of income, the cash
provided by shareholders is in exchange of shares and thereby this does not result in
income for the company. For a proceed amount to be considered as revenue, the primary
condition is that it ought to be income which is not fulfilled here. Hence, the share sale
proceeds are neither income nor revenue.
PART C
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a) The loan has to be extended for a short duration of six months. As a result, the criterion
to decide as to which company is superior rests on the short term liquidity of these
companies. One of the key measures of the same is current ratio which is computed
below (Brealey, Myers and Allen,2014).
The comparison between the above ratios makes it evident that while XYZ is in a very
comfortable short term liquidity position, ABC is experiencing severe shortage of funds and
faces potential default. Thus, loan would be given to XYZ company.
b) The information provided indicates that the liabilities currently present in the business
would need to be discharged by the purchaser. In such a scenario, higher valuation
would be accorded to a business where the associated liabilities are lesser provided the
other comparable factors such as cash balance and nature of business is similar. In case
of ABC company, the total quantum of current liabilities amount to $ 52,800 while the
bank balance is a paltry $2,400. Also taking the current liquidity position of ABC into
consideration, it is correct to conclude that the new owner would need to infuse
incremental equity to keep the company going concern (Petty et. al., 2016). Liability is
much smaller for XYZ company and also the associated liability position is quite healthy.
Thus, higher valuations would be paid for XYZ company.
c) Unlike previous scenario, now the new owner would not have to settle the existing
liability since it would be undertaken by the present owner. Now, a higher valuation
would be given to ABC company which may be attributed to the larger asset base in
comparison got XYZ company. This higher non-current asset base would imply a greater
operating capacity for ABC leading to greater valuation (Damodaran, 2015).
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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 22 2019]
Brealey, R.A., Myers, S.C. and Allen, F. (2014) Principles of corporate finance. 2nd ed. New
York: McGraw-Hill Inc, pp. 178
Damodaran, A. (2015) Applied corporate finance: A user’s manual. 3rd ed. New York:
Wiley, John & Sons, pp. 156-157
Ehrhardt, M. C. and Brigham, E. F. (2014).Corporate Finance: A Focused Approach. 6th ed.
London: South- Western College Publisher, pp. 134
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. 189
Watson. D., and Head, A., (2015) Corporate Finance – Principles and Practice.6th ed.
London: Pearson, p. 111
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