Financial Analysis and Creditworthiness Assessment of XYZ Imports

This report provides a comprehensive financial analysis of XYZ Imports, a company that manufactures electronic components. The analysis includes a review of the company's financial statements, which were not prepared according to GAAP and were unaudited. The report addresses several accounting issues, including revenue recognition, allowance for bad debts, interest expense recognition, and the treatment of research and development expenses. The financial statements are reinstated to reflect the correct accounting principles. The analysis assesses the company's creditworthiness, evaluating key ratios like the debt-to-equity ratio and interest service coverage ratio before and after the adjustments. The report also examines the ethical implications of the company's financial reporting choices, highlighting instances where the company may have inflated its profits. Based on the analysis, the report concludes with a recommendation regarding whether a bank should extend credit to XYZ Imports, considering both the company's weaknesses and potential strengths. The report also includes journal entries for the adjustments.

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FINANCIAL STATEMENT – XYZ IMPORTS, Australia
ADVANCED FINANCIAL
ACCOUNTING
ASSIGNMENT

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Contents
Background and Introduction..................................................................................... 2
Discussion and analysis.............................................................................................. 2
Conclusion.................................................................................................................. 5
References................................................................................................................. 6
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Background and Introduction
XYZ Imports is a small local company which deals in manufacturing electronic components for the
computer. The company also has a small research and development staff and is privately owned. The
financial statements have not been prepared as per GAAP and the same has not been audited as well.
There are several accounting issues due to which the reinstatement of the financial statements of required.
The financials have also been reviewed to suggest if the bank should offer credit facilities to XYZ.
Discussion and analysis
a. Reinstated financial statements of the entity as per relevant GAAP
Assets Amt. Liabilities Amt.
Current assets: Current liabilities:
Cash $444,000 Accounts payable $800,000
Accounts receivable 505,714 Interest on Notes Payable 42,400
Less: Provision for bad debt -25,286 Accrued expenses payable 100,000
Inventories 1,920,000 Total current liabilities $942,400
Advance income tax 166,394
Prepaid expenses 30,000 Noncurrent liabilities:
Total current assets $3,040,823 Notes payable $2,120,000
Noncurrent assets: Total Liabilities $3,062,400
Property, plant & equipment, gross $3,940,000
Less: Accumulated depreciation -1,360,000
Property, plant & equipment, net 2,580,000 Owners’ equity
Common stock, $1 par 2,000,000
Land 1,060,000 Retained earnings 1,618,423
Deferred research & development costs 0 Total owners’ equity 3,618,423
Total assets $6,680,823 Total liabilities & owners’
equity $6,680,823
As of December 31, 2019
XYZ Imports
Balance Sheet
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Particulars Amt. ($) Amt. ($)
Sales revenue 4,635,714
Less: Cost of sales
Beginning inventory 1,205,000
Cost of production 3,665,000
Goods available for sale 4,870,000
Less: Ending inventory 1,920,000
(2,950,000)
Gross margin 1,685,714
Less: Research & development expense 1,000,000
Depreciation expense 100,000
Selling and administrative expenses 400,000
Interest on Notes Payable 42,400
Provision for Bad debt 25,286
(1,567,686)
Net income before taxes 118,028
Less: income taxes (23,606)
Net income after taxes 94,423
For the Year Ended December 31, 2019
XYZ Imports
Income Statement
Particulars Amt. ($) Amt. ($)
Owners’ equity 2,000,000
Common stock, $1 par
Retained earnings:
Opening Balance 1,524,000
Profit for the year 94,423
Closing Balance 1,618,423
Total Equity 3,618,423
For the Year Ended December 31, 2019
XYZ Imports
Statement of Retained Earnings
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b. The journal entries for the above adjustments has been shown below:
In the books of XYZ Imports
Journal
For the Year Ended December 31, 2019
Date Particulars Dr./Cr. Amt. ($) Amt. ($)
Sales Dr. 314,286
To Accounts Receivables Cr. 314,286
(Being revenue reversed on account of non-shipping of
inventory)
Inventory Dr. 200,000
To Cost of Sales Cr. 200,000
(Being inventory inwarded)
Provision for Bad Debt Dr. 25,286
To Accounts Receivables Cr. 25,286
(Being amount provided for bad debts)
Interest on Notes payable Dr. 42,400
To Interest Payable Cr. 42,400
(Being interest liability booked)
R&D expense Dr. 650,000
To Accumulated depreciation on R&D expense Cr. 650,000
(Being R&D expense written off)
Advance Income Tax Dr. 166,394
To Income Tax Cr. 166,394
(Being income tax credit recorded)
 For the 1st transaction of non-shipping of inventory, revenue realised in books has been reversed
and the inventory has been added to closing inventory. The sales price was determined by taking
the gross margin % as 36.36% (1800000 as percentage of 4950000) and the corresponding cost of
sales (200000) was also reversed (Fay & Negangard, 2017).
 The provision for bad debts has been created at 5% based on past historical experience of the
company.
 IN the third case, since the books of accounts are prepared on accrual basis, so the liability for
interest on notes payable has been created.
 In case of research and development expenditure, the GAAP as well as IFRS states that the all the
research expenditure should be expensed off and the development expenditure should be
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capitalised if it results in the commercially viable asset and therefore the entire research expenses
of $1000000 has been expensed off.
c. Creditworthiness is a valuation measure which is being performed by lenders to check if there is a
possibility of default from the borrower. Two measures which are considered to be most
appropriate is the debt equity ratio and interest service coverage ratio (Belton, 2017). The results
as per original vs restated financial statements have been shown below and it clearly shows that
the creditworthiness has deteriorated miserably as the interest service coverage ratio is just 4
times as compared to 22 times and even the debt equity ratio has increased implying that the
proportion of debt capital is more and hence the risk as well.
Particulars Before After
Debt equity ratio 0.49 0.59
Interest service coverage ratio 22.41 3.78
d. The managers of XYZ Imports have not made ethical financial reporting choices and that is
evident from the below mentioned facts:
 They recognised revenue based on order rather than shipping and transfer of risk and
reward.
 They have not provided for many expenses in their income statement like that of interest
on notes payable, provision for bad debt, etc.
 The company has disregarded the accounting standards with respect to treatment of R&D
expenses (Knechel & Salterio, 2016).
In line of the above facts, it can be said that the company tried to inflate its profits and thereby
showing good financial position and performance to get the loan.
Conclusion
e. In line with the above discussion and analysis, the bank should not render credit to XYZ Imports
as the financial position of the company is weak, the debt ratios are on moderate side, the
company is not using appropriate accounting policies and standards of reporting. However,
considering the profitability of the company and the higher proportion of equity in overall capital
employed, the bank may consider for granting the loan (Boccia & Leonardi, 2016).
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References
Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior
Performance (Vol. 2). London: Macat International ltd.
Boccia, F., & Leonardi, R. (2016). The Challenge of the Digital Economy. Markets,
Taxation and Appropriate Economic Models, 1-16.
Fay, R., & Negangard, E. (2017). Manual journal entry testing : Data analytics and
the risk of fraud. Journal of Accounting Education, 38, 37-49.
Knechel, W., & Salterio, S. (2016). Auditing:Assurance and Risk (fourth ed.). New
York: Routledge.
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