Accounting Fundamentals: Income Statement, Financial Position, Ratios, and Performance Analysis

This article covers the preparation of income statement and statement of financial position for Wales Plc, calculation of ratios for Sweet Plc, and analysis of its profitability, liquidity, market, solvency, and efficiency performance. The article also explains the reason behind balanced financial statements. The subject is Accounting and the course code is not mentioned. The article is relevant for students pursuing accounting courses in any college or university.

ACCOUNTING
FUNDAMENTALS

Table of Contents
Question 1......................................................................................................................................3
a) Preparation of Income Statement for the year ended 31st December 2021 for Wales Plc and
Statement of financial position at that date.....................................................................................3
b) Reason behind balanced financial statement..........................................................................4
Question 2......................................................................................................................................4
a) Calculation of following ratio for Sweet Plc for 2021 and 2020.............................................4
b) Comment on the profitability, liquidity, market, solvency and Efficiency performance of sweet
plc...................................................................................................................................................5
References.....................................................................................................................................7

Question 1
a) Preparation of Income Statement for the year ended 31st December 2021 for Wales Plc
and Statement of financial position at that date
Income Statement
for the year ended 31st December 2021
Particulars Details Amount
Sales Revenue 800000
Less Cost of Sales excluding goods sold to
customer yet not recorded 578650 - 980 577670
Gross Profit 222330
Less Operating Cost
Administration expenses 30000
Interest paid 2000
Directors’ remuneration 5000
Distribution cost 28000
Sales commission 3000
Total operating cost 68000
Net income before interest and tax 154330
Less Interest expenses 0
Net income before tax 154330
Less Corporation tax 100000
Net income 54330
Less Preference dividend paid 30000
Net income available for equity shareholders 24330
Statement of financial position as at 31st December 2021
Particulars
Detail
s
Amoun
t
ASSETS
Non-current assets
Plant and Equipment 632730
Current liabilities
Inventory
33060
0
Trade receivable + goods sold to customer not yet recorded
(170125 + 980)
17110
5
Cash and bank 76250
Total Current liability 577955
Total assets
121068
5
EQUITY AND LIABILITIES
Current liabilities
Trade payable
17135
5
Tax payable
10000
0
Sales commission payable 3000

Total current liability 274355
Non-current liability
4% Debentures 100000
Net assets 836330
Equity
£1 Ordinary Shares 400000
10% £1 preference shares 300000
Retained profit at 1st January 2021
13200
0
Less ordinary dividend paid 20000
Add Net profit of year 24330
Retained profit at 31st December 2021 136330
Total equity 836330
b) Reason behind balanced financial statement
The financial statement should always balance because of the double entry system
and concept of financial reporting framework. The double entry bookkeeping is the
method of bookkeeping which state that every transaction has two effect one on debit
side and other on credit side. The debit side of transaction should always equal to the
credit side of the transaction (Sangster and Rossi, 2018). Thus, it can be said that the
financial statement always balances if the accountant prepares the financial statement
following double entry bookkeeping method. Also, the double entry is based on
accounting concept assets = liabilities + owner’s equity. The transactions are recorded in
term of debit and credit under this concept that’s why financial statement always balance.
Question 2
a) Calculation of following ratio for Sweet Plc for 2021 and 2020
Particulars Formula 2021 2020
Net profit 431 366
Total assets 9736 10087
Total current liability 2511 3046
Capital employed
Total assets - Total current
liability 7225 7041
Return on capital employed
Net profit / Capital
employed *100 6% 5%
Net profit 431 366
Total equity 3088 2912
Return on equity
Net profit / total equity *
100 14% 13%
Net profit 431 366
Outstanding shares 600 600
Earnings per share
Net profit / outstanding
shares 0.72 0.61
Net profit 431 366
Net sales 6738 6441
Net profit margin Net profit / Net sales * 100 6% 6%
Net Sales 6738 6441

Total assets 9736 10087
Asset turnover Net sales / Total assets 0.69 0.64
Inventory 708 659
Cost of sales 3235 3096
Stock holding days
Inventory / Cost of sales *
365 days 80 78
Trade receivables 1249 1287
Net sales 6738 6441
Debtors’ collection period
Trade receivables / Net
Sales * 365 days 68 73
Current assets 2303 2355
Current liabilities 2511 3046
Current ratio
Current assets / Current
liabilities 0.92 0.77
Total debt 6648 7175
Total equity 3088 2912
Gearing ratio Total debt / Total equity 2.15 2.46
Interest expenses 226 181
Earnings before interest and
expenses 805 699
Interest cover ratio
Earnings before interest
and tax / Interest expenses 0.28 0.26
b) Comment on the profitability, liquidity, market, solvency and Efficiency performance
of sweet plc
Profitability performance: On the basis of above table, it is identified that return
on capital employed of Sweet Plc has increased in current year to 6%. The return on
equity and profit margin is also increased in the current year (Easton and et.al., 2018).
This indicate that the profitability performance of sweet plc is good and improving year
by year.
Liquidity performance: The current ratio of Sweet Plc has increased in current
year i.e., 0.92 but it is not meeting the ideal and standard ratio 2:1. This means that in
order to meet the standard, the management of company improve its current ratio. For
this, the company can sell its outdated assets, allow discount to debtors for early payment
or paying due of supplier on time (Palepu and et.al., 2020). Basically, the liquidity
performance of company is improving from previous year but to meet targets the
company need to adopt strategies.
Market performance: The earning per share of the company in year 2021 has
increased to 0.72 as compared to previous year. This means that the market position of
sweet plc is good and improving because they provide high return to shareholders.
Solvency performance: The gearing ratio of sweet plc has decreased in current
year to 2.14 but this meets the standard ratio of 2 while on the other hand, interest cover
ratio has increased to 0.28 in the current year. The ability of company to pay manage a
stable balance between debt and equity is good (Husna and Satria, 2019). The coverage
of interest to EBIT is also good which means the overall solvency performance of sweet
plc is good.
Efficiency performance: The asset turnover ratio has increased to 0.69 in current
year. Also, the debtor collection period of sweet plc in the current year has decreased to
68 days. This means that the company ability to collect the amount from its debtors is
improving in the current year (Erfani and Vasigh, 2018). On the other hand, the stock
holding days of sweet plc has increased to 80 days in current year. This means that the
ability to sale its stock as soon as possible is decreasing year by year of sweet plc. So, in
order to improve the same, the management of sweet plc need to adopt proper strategy.
The management of sweet plc need to offer discounts to its customer on its product so

that customer can buy more and more goods of company. This further leads to higher
sales and decreased stock holding days.

References
Books and Journals
Sangster, A. and Rossi, F., 2018. Benedetto Cotrugli on double entry bookkeeping. De
Computis-Revista española de historia de la contabilidad. 15(2). pp.22-38.
Easton, P. D. and et.al., 2018. Financial statement analysis & valuation. Boston, MA:
Cambridge Business Publishers.
Palepu, K.G. and et.al., 2020. Business analysis and valuation: Using financial
statements. Cengage AU.
Husna, A. and Satria, I., 2019. Effects of return on asset, debt to asset ratio, current ratio,
firm size, and dividend payout ratio on firm value. International Journal of
Economics and Financial Issues. 9(5). p.50.
Erfani, G. R. and Vasigh, B., 2018. The impact of the global financial crisis on
profitability of the banking industry: a comparative analysis. Economies. 6(4).
p.66.