Accounting for Business: Financial Statement Analysis and AASB 118

This accounting assignment provides a detailed analysis of financial ratios, including current ratio, quick ratio, accounts receivable turnover, and inventory turnover, to assess a company's liquidity and efficiency. It evaluates the implications of changes in these ratios from 2018 to 2019 and their impact on short-term financial health. Furthermore, the assignment delves into the definition of income and revenue as per AASB 118, applying these principles to various scenarios for Green Apple, a software company, to determine whether transactions constitute revenue or income. Finally, it explores the perspectives of lenders and buyers in business valuation, considering factors such as short-term liquidity, liabilities, and asset comparisons to determine optimal lending and purchasing decisions. Desklib is your go-to resource for more solved assignments and study materials.

ACCOUNTING FOR BUSINESS
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PART A
a) 1) Current Ratio – This ratio pertains to short term liquidity. It hints at the company’s
capacity to entertain the current liabilities using the current assets available on the books
of the company.
2) Quick Ratio: This ratio pertains to short term liquidity. It hints at the company’s capacity
to entertain the current liabilities using the current liquid assets available on the books of the
company.
3) Accounts Receivable Turnover – This ratio pertains to operational efficiency. It hints at the
company’s ability to collect cash from the outstanding debtors i.e. those who were sold goods
on credit.
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4) Inventory Turnover – This ratio pertains to operational efficiency. It hints at the
company’s ability to produce sales based on the inventory available with the company.
b) Liquidity Ratios –Taking the above computations into consideration, it is apparent that on
one hand there is some improvement witnessed in quick ratio while on the other hand, a
sizable decline is witnessed in current ratio. Hence, the overall short term liquidity
position for the company in 2019 would be considered as inferior in comparison to the
position in 2018. A positive aspect of the company’s corresponding ratios in this regards is
that despite the fall, the existing ratios do not indicate any major issue with the short term
liquidity position. However, any further drop in the subsequent years may make the
company vulnerable to cash crunch (Arnold, 2015).
Efficiency ratios – In relation to these ratios, the key positive is the improvement that the
company has shown in these ratios over the one year period from 2018 to 2019 when the
turnover ratios have undergone sizable improvement. The drop in average collection
period and average inventory turnover period augers well for reduction in the overall cash
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conversion cycle. However, there is significant improvement still required as the inventory
turnover days for the company (in 2019) are significantly greater in comparison to the
industry average. Further, the average collection period from debtors continue to be high
as the company policy provides a maximum credit period of only 30 days against the
collection period in 2019 of about 37 days (Berk et. al., 2015).
PART B
It is essential to consider the definition of income and revenue which has been outlined as per
AASB 118. Income primarily refers to any instance of cash inflow or reduction in cash
outflow which leaves the reporting entity in an economically better position. Revenue refers
to the income which is obtained by conducting primary or main business activities
considering the nature of business (AASB, 2014).
1) Green apple is a software company and hence selling anti-virus software is one of the
primary activities. Thereby, the proceeds of sale from the same would constitute as
revenue. Also, as the proceeds provide economic benefit for the company, these would
contribute towards income.
2) As discussed, the company sells software and hence would provide updates of the
software also which is essentially a primary activity as well. Thereby, the proceeds of sale
from downloads of the same would constitute as revenue. Also, as the proceeds provide
economic benefit for the company, these would contribute towards income.
3) The company is not an investment company and neither earning money through such
activities the main objective of setting up Green Apple. Thus, interest income would not
be treated as income. Nevertheless, the company derives economic benefit from interest
based cash inflow and hence it would be income for the company.
4) With regards to settling a particular liability which involves cash outflow, the company
has been able to get a rebate which lowers the extent of cash outflow which otherwise
would have been caused. Thereby, economic benefit is obtained by Green Apple owing to
which the transaction leads to income. However, it would not lead to any revenue since it
is essentially related to lowering of expenses.
5) In regards to share proceeds, it is essential to understand that no economic benefit is
derived by Green Apple as the money has been provided in return for shares and hence it
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is an exchange. Thereby no income or revenue would be realised by Green Apple as a
result of the given transaction.
.
PART C
a) From the lender perspective, the pivotal aspect is to ascertain the liquidity of the
borrower with regards to the time horizon of repayment. In the given case, this time
horizon of repayment is six months and thereby short term liquidity ought to be accessed
for the two borrowers in fray namely ABC & XYZ. A suitable ratio in this regards is
current ratio whose computation is done below (Gitman, Juchaou and Flanagan, 2015).
Considering the above liquidity performance of the two potential borrowers, it is evident that
as a lender, lower risk of default would be associated with ABC company and hence it is
preferred borrower for any lender given the duration.
b) In scenario presented, the buyer would have to settle the liabilities and thereby valuation
would be significantly impacted by the outstanding liabilities present on the balance
sheet of the potential targets. If the current liabilities for the two companies are
compared, clearly, the net debt (adjusted for cash on books) is significantly higher for
ABC company when compared with the other company i.e. XYZ. Also, the short term
liquidity position of ABC is in shambles which indicate acute cash crunch and immediate
infusion of capital required to keep the business earning. The higher risk and higher
liabilities associated with ABC would imply that buyer would provide higher valuations
to XYZ company (Mayer, McGuigan and Kretkow, 2015).
c) He decision would change in the new scenario as the existing liabilities are the
responsibilities of the existing promoters of the company. As a result, the comparison can
shift to the comparison of the assets shown in the book particularly the non-current
assets. The non-current asset is higher in case of ABC company and also the overall
balance sheet size is higher. The liabilities of ABC do not pose a concern anymore.
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Hence, higher valuation would be paid for ABC when compared with XYZ (Arnold,
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 29 2019]
Arnold, G. (2015) Corporate Financial Management. 3rd ed. Sydney: Financial Times
Management.
Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N. (2013) Fundamentals
of corporate finance. London: Pearson Higher Education AU.
Gitman, L.J., Juchaou, R., and Flanagan, J. (2015) Principles of Managerial Finance.6th ed.
NSW: Pearson Australia.
Mayer, R. C., McGuigan, J. R., and Kretkow, W. J. (2015) Contemporary Financial
Management.10th ed. London: South- Western College Publisher.
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