Accounts: Profit & Loss, Financial Position, Depreciation, Ratios, Payback & NPV Methods

This article covers the computation of profit & loss statement, statement of financial position, depreciation using straight line and sum of digit methods, computation of ratios such as current ratio, debt equity ratio, return on equity, and gross profit ratio. It also includes the advantages and limitations of payback and net present value methods and advice to the director.

Accounts

TABLE OF CONTENTS
Q1. ...................................................................................................................................................3
a) Statement of profit & loss for the year ended September 2019...............................................3
b) Statement of financial position for the year 2019....................................................................3
Q2. ...................................................................................................................................................4
a) Calculation of depreciation using Straight line method...........................................................4
b) Computation of depreciation using Sum of digit method........................................................5
c) Arguments made for and against two methods........................................................................5
Q3.....................................................................................................................................................7
a) Computation of current ratio with its measure and interpretation for 2018 & 2019 year.......7
b) Calculation of debt equity ratio with measure and interpretation for the period 2018 & 2019
......................................................................................................................................................7
c) Determination of return on equity with its measures and interpretation.................................8
d) Calculation of gross profit ratio by considering its measures and interpretation for period
2018 & 2019................................................................................................................................8
e) Two users of financial statement.............................................................................................9
Q4. ...................................................................................................................................................9
a) Access of following projects using two methods:...................................................................9
b) Pay back period method..........................................................................................................9
c) Net present value method......................................................................................................10
b) Advise to the director............................................................................................................11
c) Advantages and limitations of two methods.........................................................................11
REFERENCES..............................................................................................................................13

Q1.
a) Statement of profit & loss for the year ended September 2019
Particulars As at 30-09-2019
Income:
Revenue from operations 120000
Less: Return inwards 5000
Total revenue from operations 115000
COGS:
Opening inventory 850
Add: Purchases 90000
Add: Direct expenses:
Wages and salaries 14264
Less: Closing inventory 11500
Total COGS 93614
Gross profit 21386
Other expenses:
Rent 920
Discount allowed 1440
Light and heat 940
General expenses 5520
Insurance 405
Depreciation of motor van 265
Total of other expenses: 9490
Net profit 11896

b) Statement of financial position for the year 2019
Particulars Amount
Equity & liability:
Capital 70220
Less: Drawings 5461
Total of capital after drawings treatment 64759
Add: Net profit 11896
Total of equity & liability 76655
Current liabilities:
Trade payables 9200
Total of current liabilities: 9200
Total liabilities 85855
Non-current assets:
Plant and machinery at cost 31625
Office furniture and fittings at cost 19780
Motor van at cost 2650
Less: Depreciation 265
Motor van at cost after depreciation 2385
Total of non-current assets 53790
Current assets:
Trade receivables 16100
Inventories 11500

Cash at bank 4465
Total of current assets: 32065
Total assets 85855
Q2.
a) Calculation of depreciation using Straight line method
Formula: (Cost – residual value)/estimated useful life
Total of depreciation 800
Years Cost
Annual
depreciation
Accumulated
depreciation
Book
value
(in £) (in £) (in £) (in £)
1 3000 800 800 2200
2 3000 800 1600 1400
3 3000 800 2400 600
b) Computation of depreciation using Sum of digit method
Sum of year digits= year 1+ year 2+ year 3
Total of sum of year digit 6

Amount to be depreciated= Cost – residual value
Cost of the catering freezer 3000
Residual value 600
Total of amount to be depreciated 2400
Years
Amount to be
depreciated
Depreciation
factor
Depreciation
expense
(in £)
1 2400 0.50 1200
2 1200 0.33 400
3 800 0.17 133.33
c) Arguments made for and against two methods
Straight line method :
 Arguments made for Straight line method of depreciation:
1) Simplicity: SLM is the simplest method for calculating depreciation and any normal
person can understand this method easily.
2) Asset are written off completely: Under straight line method depreciation is charged on
the cost of assets at constant rate over its estimated useful life i.e., charging takes place
till assets value comes to zero (Kumaat., Paendong and Lintong, 2021).
3) Suitable for small business: This method of depreciation is appropriate for small entity
because it is the easiest and simplest way to determine value of net assets for those
structure who has small business size.
 Arguments made against Straight line method of depreciation:
1) Considered to be illogical: This way of computing depreciation value seems to be
illogical because charge is applied on original cost of asset irrespective of its declination
every year.

2) Puts pressure on final year: As the assets comes to its end of estimated life it demands
more repairs and maintenance in comparison of initial years. During final period this
method puts pressure because depreciation charged is equal for whole tenure.
No provision of replacement: Under this method there is no provision for substitution as entity
retains the asset for charging depreciation and using it to perform business regular operations for
the whole estimated life. Therefore, firm need another sources of fund for replacing their assets.
Sum of digit method:
 Arguments made for Sum of digit method of depreciation:
1) Practical method: Helps the user to adjust the cost of assets with its utilization each year
over the estimated life of an asset which means that this method is practical and
productive in early stages.
2) Maintains balance between depreciation and repair cost: This method helps to
maintain equilibrium between depreciation and maintenance cost because the charge is
higher in its initial stage and needs less repair expense (Sum of Years Digits Method of
Depreciation, 2021). Subsequently, as assets get old they demand high maintenance cost
with charging less depreciation. Hence, in this way, this method maintains balance.
3) Ensures earnings don't get distorted: By maintaining proper balance between
depreciation charged and assets repair and maintenance cost, they also take care that
firm's earnings don't get distorted.
 Arguments made against sum of year digit method:
1) Charge more depreciation: Under this method during its initial years depreciation
charged on assets is high as compared to later periods which leads to lower profits in
starting tenure and high revenue during following years.
2) Difficult to understand: This method of depreciation is tough to understand and
calculate in comparison with straight line, written down value & other ways.
Q3.
a) Computation of current ratio with its measure and interpretation for 2018 & 2019 year
Particulars Formula
Amount for the
period 2019
Amount for the
period 2018

Current assets /
current liabilities
Current ratio
Current assets 10354 10118
Current liabilities 3615 5420
Total of current ratio 2.864 1.867
 Current ratio measures the liquidity of company i.e., whether company is able to pay
their current liabilities with its current assets or not. Moreover, in 2019 ratio derived is
2.864 as compared with 1.867 during 2018 which reflects that the firm's ability to meet
their short term obligations has improved.
b) Calculation of debt equity ratio with measure and interpretation for the period 2018 & 2019
Particulars Formula
Amount for the
period 2019
Amount for the
period 2018
Debt to equity ratio
Total debt / Total
equity
Current liabilities 3615 5420
Non-current liabilities 6400 7000
Total equity 12800 11590
Total of debt to equity ratio 0.782 1.072

 This ratio reflects the portion of equity and debt which company is using to fund its
assets. By looking at firm's ratio in the given case, it shows that firm's debt to equity
ratio has gone down in comparison to 2018 where it becomes 0.782 in 2019 from 1.072
during 2018. Therefore, financial risk for the company has reduced in 2019.
c) Determination of return on equity with its measures and interpretation
Particulars Formula
Amount for the
period 2019
Amount for the
period 2018
Return on equity ratio
Net income /
Shareholders equity
Net income
(revenue – cost of
sales – total
expenses) 3033 2025
Shareholders equity 12800 11590
Total of return on equity 23.70% 17.47%
 Return on equity shows that whether the company is handling shareholders money
properly or not. Through a computation of such ratio we have seen that percentage is
increased by 6.23% in year 2019 i.e., it gives 23.70% from 17.47%. accordingly, it can
be said that the company's efficiency in using its shareholder's equity has improved.
d) Calculation of gross profit ratio by considering its measures and interpretation for period 2018
& 2019
Particulars Formula
Amount for the
period 2019
Amount for the
period 2018

Gross profit ratio
Gross profit / net
sales
Gross profit
(revenue – cost of
sales) 12188 10695
Net sales 18200 16481
Total of gross profit ratio 66.97% 64.89%
 Gross profit ratio reflects the profitability of company i.e., how efficiently firm is
performing and generating good earnings over a particular period. Moreover, the above
quoted calculation has improved in 2019 i.e., entity is producing 66.97% profit from its
operations by comparing it with result generated during 2018 i.e., of 64.89%.
e) Two users of financial statement
1) Government: The stated authority uses such information to know whether firm has paid
appropriate amount of tax or not.
2) Investors: They will require financial statements to know the firms position and for
understanding a performance of their investment.
Q4.
a) Assessement of following projects using two methods:
b) Pay back period method
Project 1:
Year Cash inflows Cumulative cash inflows
1 175000 175000
2 175000 350000
3 175000 525000

Computation of pay back method for project 1
Initial investment 350000
Pay back period = 2 years
Project 2:
Year Cash inflows Cumulative cash inflows
1 205000 205000
2 100000 305000
3 90000 395000
Computation of pay back period for project 2
Initial investment 335000
Calculation: 0.3333333333
Pay back period = 2 years 3 months
c) Net present value method
Project 1:
Year Cash inflows PV factor
Discounted cash
inflows
1 175000 0.870 152173.913
2 175000 0.756 132325.142

3 175000 0.658 115065.341
Total of discounted cash inflows 399564.395
Computation of net present value from project 1
Particulars Amount
Total of discounted cash inflows 399564.395
Less: initial investment 350000
Total of NPV 49564.395
Project 2
Year Cash inflows PV factor
Discounted cash
inflows
1 205000 0.870 178260.870
2 100000 0.756 75614.367
3 90000 0.658 59176.461
Total of discounted cash inflows 313051.697
Computation of NPV from project 2
Particulars Amount
Total of discounted cash inflows 313051.697
Less: initial investment 335000
Total of NPV -21948.303
b) Advise to the director
From the above computation we articulate that pay back and NPV of project 1 is far
better as compared to project 2 because pay out period of project 1 takes only 2 year but another

project takes 3 months more for receiving back the initial investment amount. Moreover, by
looking at the Net present value, project 1 generates positive result so director should accept this
proposal and reject the another project as it generates negative NPV with initial investment.
c) Advantages and limitations of two methods
1) Pay back period method:
Advantages:
 It's the simple process based on forecasted cash flows as compared to net present value
method which is a lengthy method and requires more time along with discounted cash
flows for calculation (Veilleux and et.al, 2020).
 Small firms having very limited funds, and they are extremely careful about their
spending so it becomes easy for the entity to decide which project is going to pay them
back at the earliest.
Limitations:
 This method only focuses on pay back period with fewer data i.e., it only considers cash
flow and not looks into the time value of investments as net present value is using.
 Pay back period also ignores discounted cash flows, they assume that amount receiving
earlier is going to value more and dismiss the time value of money whether it is negative
or positive.
2) Net present value method:
Advantages:
 This method takes into consideration all cash flows from a project and compute the
amount by considering the time value money as it is ignored in case of pay back period
method.
 The formula used in calculation of NPV is simple and easy to produce meaningful result
by taking care about time value of money with its investment. Moreover, in this firm just
need to know current cash flow and initial investment for ascertaining the ratio.
Limitations:
 This method is highly sensitive to discount rate to figure out present value and its impact
i.e., whether it derives positive or negative output. Therefore, a small change in their
figure will put unfavourable impact on outcomes derived.

 Selecting specific rate for computing future cash flow is almost impossible because the
firm or anyone doesn't know that from which rate it will derive good result on investment
made or will face with low risk of loss.

REFERENCES
Books and journals
Kumaat, L. C., Paendong, Y. S. and Lintong, J. S., 2021. Financial Statement Model Based on
SAK EMKM In The “Polife” Student Entrepreneur Group. Indonesian Journal of Social Science
Research. 2(1). pp.26-32.
Veilleux, G and et.al., 2020. Techno-economic analysis of microgrid projects for rural
electrification: A systematic approach to the redesign of Koh Jik off-grid case study. Energy for
Sustainable Development. 54. pp.1-13.
Online
Sum of Years Digits Method of Depreciation. 2021 [ONLINE]. Available through: <
https://www.wallstreetmojo.com/sum-of-year-digits-method-depreciation/ >