Accounting Fundamentals: Ratios, Financial Statements, User Groups

This document covers accounting fundamentals including the calculation of ratios, analysis of financial statements, and different user groups of financial statements. It provides insights into the advantages and disadvantages of financial reporting. The document also includes income statements, statement of position, and examples of ratio calculations. The subject is Accounting and the course code is not mentioned. The document type is not mentioned and the assignment type is not mentioned. The college/university is not mentioned.

ACCOUNTING
FUNDAMENTALS

Table of Content
QUESTION 1..................................................................................................................................3
Question 2........................................................................................................................................4
a. calculation of ratios..................................................................................................................4
b. Analyzing the results...............................................................................................................5
QUESTION 3..................................................................................................................................7
(a).................................................................................................................................................7
(b).................................................................................................................................................8
(c).................................................................................................................................................8
REFERENCES..............................................................................................................................10

QUESTION 1
Income statement for the year ended 31st December 2019
Particulars £’000 £’000
Sales
30,30
0
Cost of sales
16,22
0
Add: depreciation on plant 2,560
18,78
0
Gross profit
11,52
0
Revaluation income (land) 5000
Administration expenses 2920
Add: Bad debts written off 240
Add: Discount on account receivables 160
Add: Depreciation on building 320
Add: Outstanding insurance fees 500 4140
Distribution expenses 2160
Debenture interest paid 240
Dividends paid 560
Tax paid 1600
Net profit 7,820
Statement of position as at 31st December 2019
Liabilities £’000 Assets £’000
Share capital 29000 Bank 320
Retained profit 8380 Land at cost 20000
Share premium 5000 Buildings at cost 16000
Net profit 7,820
Less: Accumulated depreciation
(4260 + 320) 4580 11420
12% debentures 2024 4000 Plant at cost 25600
Outstanding insurance fees 500
Less: Accumulated depreciation
(4960 + 2560) 7520 18080
Trade payables 4480
Trade receivables (8240-240-
160) 7840
Income tax liability 1600 Inventory 3120
Total liabilities 60780 Total assets 60780
Working note
Building cost 16000

Depreciation (2% * 16000) 320
Plant cost 25600
Depreciation (10% * 25600) 2560

Question 2
a. calculation of ratios
Particulars Formula
Amoun
t
2018 2019
Earnings before interest and taxes 29.7 23
Total assets 293.8 286.1
Current liabilities 148.4 151
Capital employed Total assets-Current liabilities 145.4 135.1
Return on capital
employed
Earnings before interest and taxes/Capital
employed 20% 17%
Net income 18.3 12.9
Shareholders equity or funds 80.3 93.2
Return on equity Net income/Shareholders equity 23% 14%
Net income 18.3 12.9
Average outstanding shares 17.8 17.8
Earning per share Net income/Average outstanding shares 1.03 0.72
Gross profit 186.9 191.8
Net sales 486.8 501.3
Gross profit ratio Gross profit/Net sales*100 38% 38%
Net sales 486.8 501.3
Average total assets 293.8 286.1
Asset turnover ratio Net sales/Average inventory 1.66 1.75
Cost of goods sold 299.9 309.5
Inventory 41.1 38.8
Stock holding period Cost of goods sold/Inventory 7.3 8.0
Debtors 114.7 114.9
Sales 486.8 501.3
Debtors collection
period Debtors/Sales*365 86.0 83.7
Current assets 156.5 153.9

Current liabilities 148.4 151
Current ratio Current assets/ Current liabilities 1.05 1.02
Debt (Long term funds) 65.1 41.9
Equity (owners fund) 17.8 17.8
gearing ratio Debt/Equity 0.27 0.42
Earnings before interest and taxes 29.7 23
Interest expense 3.5 0.2
Interest coverage
ratio
Earnings before interest and taxes/Interest
expense 8.49 115.00
b. Analyzing the results
Return on capital employed- It is referred as the financial ratio which could be used for
analyzing capital efficiency & profitability of the company. This ratio helps in understanding the
manner in which the firm is generating earnings from the use of its capital. It is computed by
dividing the EBIT with that of capital employed. The analysis shows that the ROCE of Jerry plc
resulted as 20% in the year 2018 and 17% in 2019. This reflects that the ratio of company in
declining over the years with the change of 3% due to decrease in the earnings and increased
current obligations with fall in total assets (Murad and et.al., 2019). It means that an entity is not
making effective usage of its capital in order to generate profits. Therefore, an organization
needs to focus on improving its ROCE by increasing value of its assets and earnings through
charging high price and increasing sales.
Return on equity- It means as the ratio that measure return rate that an owner of the
shareholders equity receives on their respective shareholdings. It reveals the best way in which
an enterprise could generate return on investment which it is receiving from their shareholders. It
is calculated by dividing net income by shareholders funds. The assessment indicates that the
ratio is decreasing from 23% to 14% from 2018-2019. This ratio is declining because the net
profit of the company is decreasing and shareholders’ funds are increasing. It clearly shows that
Jerry plc is not earning enough money through its equity and this leads to decrease in the
shareholders wealth as it results to decreasing in the price of shares in an overall industry or the
market. Thus, the firm must have to take corrective action like increasing profitability and
improving performance so that value of equity increases.
EPS- It seems as an essential financial condition that indicates profits of the firms. It is
been computed through dividing net profits of the firm with that of its total outstanding shares. It
means as the tool which is used by market participant on frequent basis for gauging profitability
of an entity prior to buying their shares (Dong and et.al., 2020). As the evaluation shows that
EPS of an entity is declining 1.03 from 0.72, which means that company is earning very less on

its per share value. This is because the net income of Jerry Plc is decreasing with no change in its
average shares. Therefore, the firm should take appropriate measures for improving its earnings
per share by earnings increased profitability.
Gross profit ratio- It refers to the metric that an analyst uses for analyzing financial
condition of company through computing an amount of the money that is left over the sales of
product after reducing COGS. The ratio is calculated by dividing gross profits by that of the net
sales for assessing operational performance of the company. The results show that the GP ratio
remains as stable in both the years that are 38% in 2018 and 2019. This is because the GP and
sales of Jerry Plc is increasing with very little margin so that ratio does not change from one
period to other (Ardalan, 2017). This in turn shows that company is seeking for improving its
operational efficiency by increasing sales and ensuring control over its cost. The firm would e
taking measures for increasing its GP margin by making optimum use of its resources.
Asset turnover ratio- It referred as ratio that reflects the value present between company’
revenue and asset value. It deemed as an indicator of efficiency through which an entity is
deploying its own assets for producing or generating revenue. It is considered as the determinant
of an enterprise performance in entire market and industry. Higher the ATR, more efficient a
firm is in generating the revenue from that of its assets. However, lower ratio reflects inefficient
use of assets in generating revenue. The analysis depicts that ATR of Jerry Plc is increasing
which clearly depicts that an organization is generating higher sales by making use of its assets
in an effective & efficient manner. This shows that efficiency position of the company is
becoming better from one accounting period to other.
Inventory holding period- It means as ratio that shows an average time that an entity
takes in turning its inventory into the sales including the goods that are WIP. It is determined by
dividing cost of sales with that of inventory or goods. Lower holding period is preferred because
it reflects that inventory remains for a shorter duration in the premises and very less time is taken
in clearing off the goods (Alladio and et.al., 2017). However, higher ITR shows that company is
holding its inventory for a long term period at the workplace. The analysis shows that ITR days
is increasing with little value which means that an entity seeks for increasing its holding period
in terms of inventory.
Average collection period- This ratio signifies the time period taken by the firm to
receive its payments that is been owed by their clients in form of the trade receivables. An entity
compute it’s ACP in ensuring that it has sufficient cash with which it could meet its finance
related obligations in an effective way. It is expressed by dividing the trade receivables by that of
sales for assessing the days in which the firm collects its receipts. The results reflects that debtors
receivable period is declining over the years which clearly shows that company is seeking for
reducing the period of collection through receiving the amount due within 83 days rather 86
days.

Current ratio- It means as the liquidity ratio that measures an ability of the company in
paying its short term liabilities with the cash generated from their current assets. It tells the
investors the manner in which firm could maximize its current assets on balance sheet for
satisfying other payables and current debt (Wen and Zhu, 2019). It is calculated by dividing
current assets with that of the short run obligations in order to understand the liquidity position of
Jerry Plc. Higher the CR, better is the liquidity condition of an enterprise and vice versa. The CR
ratio of Jerry Plc is seen as stable in both the accounting periods as the value remains as 1.05 and
1.02. This clearly states that an entity is not making optimum but adequate use of the assets. It
has not attained ideal liquid position because of decrease in current assets and increase in short
term obligations. Therefore in order to attain optimal or ideal position, the firm must have to take
corrective measures such as collecting the receivables on time and making payment to the
creditors within the specified time frame.
Gearing ratio- This means as financial ratio which compares owners funds to the debt that
is been borrowed by firm. It seems as measure of the financial leverage which demonstrates a
degree towards which operations of an entity is funded by the equity capital over debt financing.
It is determined by dividing debt with equity for analyzing the amount of borrowed funds.
Greater is the D/E ratio; poor is the leverage position of firm as it shows that company is having
higher borrowed money as compared to equities (Pesaran and et.al., 2018). As the D/E ratio of
Jerry Plc is increasing from one period to other, this clearly shows that it has borrowed large
amount of funds in comparison to its owned funds.
Interest coverage ratio- It is the measure of an entity’s ability in meeting its interest
related payments. It equates to the earnings before interest and the taxes for the time period that
is of one year dividing it by finance cost for same period (Messerlian and Gaskins, 2017). The
ICR of Jerry Plc is showing an increasing trend which means that leverage position of the firm is
becoming good as its ability in paying off its interest obligation is increasing.
QUESTION 3
(a)
Three different user groups of financial statements are stated below.
Owners and investors: The stockholders of the companies require the financial data in
order to to assist them with settling on decisions on how to manage their ventures (portions of
stock), for example hold, sell, or purchase more. The prospective investors of the company need
data to survey the organization's potential for progress and gainfulness. Similarly, entrepreneurs
need financial data to decide whether the business is gainful and whether to proceed, improve or
drop it.
Management: In small companies, the board may incorporate the proprietors. In large
associations, the board members are of hired professional who are endowed with the duty of

operating the business or a piece of the business (Preda, 2019). They go about as an agent of the
proprietors. The managers, regardless of whether proprietors or employed, routinely face
monetary choices such as - How much supplies will we buy? Do we have enough money? What
amount did we make a year ago? Did we meet our objectives? Every one of those, and numerous
different inquiries and business choices, require examination of financial information.
Trade creditors:Just like lenders, exchange leasers or providers are keen on the
organization's capacity to pay commitments when they become due. They are in any case
particularly keen on the organization's liquidity – its capacity to meet up with its short-term
commitments.
(b)
Advantages and disadvantages of financial reporting
Advantages Disadvantages
 It provides various types of decision-
making tools which assist the users
of the information in taking right
decision. For preparer of the reports,
it becomes important in knowing the
actual financial picture of the
company which is used in taking
relevant decisions (Matuszyk and
Rymkiewicz, 2018).
 The financial reports are being used
by the government authorities in
evaluating whether the company is
working complying with the
required regulations or not.The
preparer can take advantage of the
same and clearly state in its reports
all the regulations it has followed
which will create a positive and
good image in the eyes of law.
 The reports are being prepared
considering various policies and
regulations of which the users are
might be aware of which leads to
wrong decision making on their part.
Also, the preparer is required to gain
knowledge of each regulations and
its impact on the financial position
and performance of the company
which is very difficult.
 In case of any problem or mistake in
the preparation of the reports, the
users might consider it true and
based on it , takes decisions and on
knowing the same, the preparer is
held liable for the mistake and the
loss that might have incurred to the
users.

(c)
Limitations of financial statements
 Financial statements don't uncover the current worth of the organization. At first, items
recorded at their cost. The worth of assets and obligations changes with time. This leads
to misleading figures.
 The figures of assets that shows up in the statements relies upon the principles of the
individual who manages it (Velte and Stawinoga, 2017). For instance, the technique for
depreciation, method of amortization and so on, relies upon the individual judgment of
the accounting.
 In the event that the circumstance of expansion the rate is moderately high, the measures
of advantages and liabilities to be decided sheet will show up excessively low, as we can't
modify it for swelling. This for the most part applies to long haul resources.
 On the off chance that an organization needs to contrast the outcomes of its organization
with other organizations, their financial summaries might not be generally similar, in
light of the fact that various organizations utilize diverse accounting practices.

REFERENCES
Books and journal
Alladio, E. and et.al., 2017. Direct and indirect alcohol biomarkers data collected in hair
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Ardalan, K., 2017. Advancing the Interpretation of the Du Pont Equation. Journal of Modern
Accounting and Auditing. 13(7). pp.294-298.
Dong, G. and et.al., 2020. The win ratio: on interpretation and handling of ties. Statistics in
Biopharmaceutical Research. 12(1). pp.99-106.
Matuszyk, I. and Rymkiewicz, B., 2018. Integrated Reporting as a Tool for Communicating with
Stakeholders–Advantages and Disadvantages. In E3S Web of Conferences (Vol. 35, p.
06004). EDP Sciences.
Messerlian, C. and Gaskins, A. J., 2017. Epidemiologic approaches for studying assisted
reproductive technologies: design, methods, analysis, and interpretation. Current
epidemiology reports. 4(2). pp.124-132.
Murad, M. H. and et.al., 2019. When continuous outcomes are measured using different scales:
guide for meta-analysis and interpretation. Bmj. 364.
Pesaran, B. and et.al., 2018. Investigating large-scale brain dynamics using field potential
recordings: analysis and interpretation. Nature neuroscience. 21(7). pp.903-919.
Preda, I., 2019. The Information Content Of Audit Opinion For Users Of Financial
Statements. Oradea Journal of Business and Economics. 4(2). pp.102-111.
Velte, P. and Stawinoga, M., 2017. Integrated reporting: The current state of empirical research,
limitations and future research implications. Journal of Management Control, 28(3),
pp.275-320.
Wen, H. and Zhu, T., 2019. Interpretation of Financial Statements.