Accounting for Management Decisions: Financial Analysis & Solutions

This assignment analyzes the financial performance of Modern Furniture Ltd, focusing on working capital management and depreciation methods. The solution examines cash flow discrepancies, highlighting issues with accounts receivable, inventory turnover, and accounts payable days. It provides recommendations for improving liquidity and financial stability, including strategies to reduce accounts receivable days, decrease inventory turnover, and manage accounts payable. The assignment also covers depreciation methods, comparing straight-line, units of production, and declining balance methods, and discusses the matching principle and the relationship between carrying value and market value. The solution includes detailed calculations and interpretations based on provided financial data and industry trends. The analysis underscores the importance of sound financial decision-making for business success.

ACCOUNTING FOR MANAGEMENT DECISIONS
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Three reasons are highlighted below.
 One of the key reasons is the cash paid to suppliers which is $ 1,610,000 in
comparison with the actual cost of sales of $ 850,000. This is primarily on account of
payments for last year supplies being made this year.
 Also, while the sales in accordance with the income statement (on accrual basis) are $
1,800,000 but the cash receipts from customers are much lower at $ 1,330,000.
 The other expenses represented in the income statement on accrual basis stand at $
22,000 in contrast with the cash payment of $ 112,000 on other expenses owing to
settling previous payables.
Question 4
(a) For Modern Furniture Ltd, there is an increase in the accounts receivable days during the
period which is significantly higher than the average industry trends. This poses an issue as it
is indicative of higher time required to collect receivables on account of credit sales. This
would increase the length of cash cycle and require higher working capital (Damodaran,
2015).
A similar trend is observed for the inventory days also which is increasing while the same for
the industry has registered marginal increase. This huge increase in the inventory turn
highlights the difficulty that the company is facing with regards to sales generation from
inventory (Parrino & Kidwell, 2014). This may also be indicative of the drop in demand for
the company products. The accounts payable days during the given year tends to increase
which leads to shorter cash cycle which is positive for the company. However, taking into
consideration the decreasing cash balance of the company, it is apparent that the payable days
are increasing owing to the cash crunch faced by the company due to which it is not able to
pay suppliers (Petty et. al., 2015).
The above analysis clearly indicates that the company is facing significant liquidity short
term issues which are potentially having adverse impact on the operations pushing the
company to the verge of bankruptcy as captured by the balance of only $ 5,000 as cash at the
end of FY2017 (Arnold, 2015).

(b) The above analysis clearly implies that the company needs to use some drastic measures
in order to resolve the current crisis. These are listed below.
 The company needs to lower the accounts receivable days. For this the optimum
strategy is to provide lucrative discounts to the customers for making cash payments
or early payments. A potential cost associated with this is that the margins of the
company would be lower but the advantage is that the liquidity situation would
improve which is the immediate requirement (Damodaran, 2015).
 The inventory turnover days need to be reduced. The inventory with the company has
constantly increased and hence this pending inventory needs to be converted into sales
before purchasing any new inventory. Lucrative discounts on bulk purchases can be
given so as to lower the inventory and obtain cash. A potential cost associated with
this is that the margins of the company would be lower but the advantage is that the
liquidity situation would improve which is the immediate requirement (Petty et. al.,
2015).
 The accounts payables days need to be brought lower so as to restore confidence
amongst the suppliers that there dues would be settled by the company. Hence, before
ordering new purchases, the company should aim to clear a sizable portion of existing
dues to suppliers. Also, lucrative payment terms can be negotiated with them in order
to allow a higher credit period (Parrino and Kidwell, 2014).
Question 5(a)
(a) Method A is straight line depreciation since depreciation expense in both the years
remains the same as $12,000.
Depreciation Expense = (132000 – 12000)/10 = $ 12,000
Method B is units of production depreciation as the depreciation tends to increase in 2018
owing to higher units produced in that year.
Total units of production during useful life = 150,000
Total depreciation amount during useful life = (132000-12000) = $ 120,000
Depreciation per unit production = 120000/150000 = $0.8
Depreciation Expense (2017) = 0.8*8000 = $ 6,400

Depreciation Expense (2018) = 0.8*13000 = $ 10,400
Method C is declining balance depreciation as the depreciation expense is lowering in
subsequent year and is the highest for the first year.
Depreciation Expense (2017) = (132000)*0.213 = $ 28,116
Depreciation Expense (2018) = (132000-28116)*0.213 = $ 22, 128
(b) Method A – Straight line Method
Depreciation Expense = (132000 – 12000)/10 = $ 12,000
Accumulated Depreciation = 24000 +12000 = $ 36,000
Carrying value of asset = 132,000 – 36,000 = $ 96,000
Method B – Units of Production Method
Depreciation Expense = 0.8*10000= $ 8,000
Accumulated Depreciation = 16800 + 8000 = $ 24,800
Carrying value of asset = 132,000 –24,800 = $ 107,200
Method C – Declining Balance Method
Depreciation expense = (132000-28116-22128)*0.213 = $ 17,414
Accumulated Depreciation = 50244+17414 = $ 67,658
Carrying value of asset = 132,000 – 67,658= $ 64,342
(c) The matching principle requires that the expenses need to be reported in the same period
as revenue. Since depreciation is one of the expenses, hence based on the usage of asset for
revenue generation, suitable depreciation method needs to be selected which accurately
reflects the extent of depreciation charged in the given year (Arnold, 2015).

(d) I disagree with the statement as the market value of the asset may be significantly
different from the carrying value of the asset. The carrying value is dependent on the
depreciation charged based on account norms which is not essential in actual market value
determination. Hence the two tend to be usually different (Damodaran, 2015).
(e) The selling of equipment would tend to lower the fixed asset by the carrying value while
enhancing the cash by the selling value. The gain or loss in the process is recorded in the
shareholders’ equity (Petty et. al., 2015).
Carrying value of asset = 132000 – 24000 = $ 108,000
Change in asset = 98,000 -108,000 = - $ 10,000
Change in liability = No change
Change in owner’s equity = -$10,000 (Loss on sale of asset)
References
Arnold, G. (2015) Corporate Financial Management. 3rd ed. Sydney: Financial Times Management.
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John
& Sons.
Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley
Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., & Nguyen, H. (2015).
Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French Forest
Australia