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Question 1

(a) Debt ratio of 54.55% illustrates that the entity might face difficulty in paying its debts inthe long term because the debt ratio is more than 50%. Debt ratio is calculated by dividingdebt by total asset. Hence, $240000 $440000!54.55%

"#uity ratio of 45.45% sho s that the company could face problems hen settling debts andreimbursing investors through interest. o in this case, the e#uity ratio is calculated by e#uitydivided by total asset.

&omparing these t o ratios, hen these t o percentages is added, the total ould summed to'00%. (his can be e)plained by the basic accounting e#uation on balance sheet hich is*+sset! iabilities - ner/s "#uity. Debt ratio and e#uity ratio are all based on the valuesfrom the balance sheet. Hence, no matter ho much the value is changed for debt ratio ande#uity ratio, the sum of both ratios ill remain '00% hich made a conclusive prove thatthese ratios are al ays consistent.

inally, debt e#uity ratio measures the financial leverage hich indicates that any change ofthe value of debt e#uity ratio ill change the t o ratio but ill remain consistent.

(c)

(i) (he short1term survival of an entity refers to assessing the li#uidity of an entity hichmeans if the company have the ability to pay1off its short1term liability. (his involve applyingall the li#uidity ratio to form the assessment. (he follo ing ratios are current ratio, #uicratio, receivables turnover, inventory turnover and creditors turnover.

&urrent ratio is a measure of li#uidity and this represents the ability for a company to pay

debt in short1term. 3uic ratio, ho ever, represents #uite similar to current ratio but onlyinclude cash, short1term investments and receivables hich means it sho s if the companycan pay the debt immediately. (he user should assess the company ith #uic ratio more

because #uic ratio is more conservative than current ratio. f both ratios are more than the benchmar hich is ', than the company is in a good shape. Ho ever, if both are lo er, theuser need to ma e decisions to improve the business health.

(ii) or user to assess an entity/s profit generating capacity, the user should assess by profitability ratios. (he ratios are return on o ner/s e#uity, payout ratio, return on assets, profit margin, asset turnover, gross profit margin, e)pense ratio and cash return on sales.

or most of these ratios, the higher the value, the more desirable hich means the company isdoing ell. (his ratios are only meaningful hen the user compare the value ith othercompanies. Hence, it ill be useful by analysing bet een companies or the trend over feyears.

(iii) (o help user evaluate an entity/s financing policy, they could use solvency ratio hichmeasures the ability of an entity to survive after a long period of time .(he ratios are debt tototal assets, interest coverage ratio and cash debt coverage.

(his is an appropriate ratio to evaluate entity/s financing policy because hat financing policy is a criteria describing corporation/s choice solvency ratio ith a goal to ma)imi ing

the value of a firm in a long1term. (herefore, hen the value of debt to total assets is lo andthe other ratios are higher, the company can present its high value.

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Question 2(a)

Income Statement

For The Year Ending December 31, 201

!e"enue#6evenue $250,500

7et ales $250,500$ost o% good so&d#

&ost of good sold $45,500'ross ro%it $205,500

ther re"enue#nterest ncome $'5,000

$220,000

E*+enses#

Depreciation e)pense 8 urniture $9,500

Depreciation e)pense 8 ffice "#uipment $2,000

"lectricity $2,500

nsurance $',000

:onus $ 500

6epair ")penses $;,500 6ental $'2,000

ffice upply ")pense $2500

(ransportation ")penses $5,000

<ages $24,000

(otal ")penses $5=,500

ro%it $'90,500

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(b) rom my friend/s perspective on suggesting reduce cost to improve profit, this couldor depending on a situation. 6educing cost ill only improve profitability hen number of

sales and sales price remain constant. Ho ever, hen the company reduce the cost hichaffects the #uality of the product, maintaining the same level of sales can only be done henthe company reduced its price. (his ill affects greatly on their net income hich might endup in a net loss.

(herefore, my friend should decide on cutting the cost only if the action does not affect the#uality of the product, sales price or sales figure. :y doing this ay, the company can lead tohigher profitability. n addition to cutting cost, my friend could also increase the profit byincreasing the revenue by commanding higher price through successful branding. :y doingthis, the company could established its identity that enable it to sell higher price than thecompetitor. Hence, increasing revenue by focusing on the #uality and branding ill allo thecompany to improve profits and solidifying customer can lead the company in better shape inlong1term.

(c) irst of all, both relevance and faithful representation is the fundamental #ualitativecharacteristics. 6elevance in accounting indicates that financial information must have the#uality that allo ing the users to ma e economic decisions by helping them to predict theoutcome in the past, present and future events and or confirming or correcting their pastevaluation. Hence, in order to have a relevant information, the information must include thefollo ing criteria hich are predictive value and feedbac value.

aithful representation is hen the information is free from error and bias. (his is to ma esure that they could accurately reflect the condition of the business. inancial statement can

be called faithful represented hen it includes the follo ing criteria hich are completeness,substance over form, neutrality and accuracy.

:ased on the father/s economic activity, the action considered relevant after he renovated theapartment. +fter he renovated the apartment, this creates the #uality of information to ma e adifference to >decision1ma er/ hich is the customers. Hence, hen customer bro se theapartment, they more li ely rent the apartment after renovated. He might have already

predicted the future of the event.

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Question 3 (a)

ormulas that determines all the li#uidity ratios*

&urrent ratio*

Current ratio = Current AssetsCurrent Liabilities

Acid-Test ratio:

Acid − test ratio =Bank Balance + Short − terminvestment + Receivables

Current Liabilities

Receivables Turnover:

Receivablesturnover = Net Credit Sales

Average Reveivables

Inventory turnover:

Inventoryturnover =Cost of sales

Averageinventory

Creditors turnover:

Creditorsturnover = Net Credit Purchases

Averagetrade creditors

2013 2014Current ratio 2.03 2.10Acid-test ratio 1.01 0.93Receivables turnover 11.6 ti!es 10.09 ti!esInventory turnover ".32 ti!es 4.0 ti!esCreditors turnover .0# ti!es ".96 ti!es

&urrent ratio determines ho easily for the company to pay off its current liability. or every

dollar in current liability, un Dry td have $2.0; and $2.'0 in 20'; and 20'4 respectively.(his represents that the company is financially stable here the ratio in both years aresufficiently higher than the benchmar hich is current ratio of '. urthermore, the companyincreased its current ratio by ;.45% hich put the company into a better financial position.:ased on the analysis, company ill have no problem for any customer that ish purchase oncredit because the company have high ability on paying debt.

n contrast, un Dry td have reduced its acid1test ratio hich means that the entity/simmediate short1term li#uidity have reduced to less than industrial benchmar . <hen thecompany have a #uic ratio lo er than ', the company have to rely on inventory or otherassets to pay the short1term liabilities. Due to this, it ill put the company at ris if thecompany invite the potential customer that intend to purchase on credit because it maydecrease the ability to pay debt instantly for the company.

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oo ing at the decreasing value for #uic ratio, it affects the rest of the li#uidity ratio hichare receivables turnover, inventory turnover and credit turnover. irstly, lo er receivableturnover occurs due to allo ing customers to ta e more on credit than purchasing cash.

econdly, lo er inventory turnover suggest that the company have reduced its ability to sellinventory easily hich might indicate either the inventory is obsolete or no longer favourableto customers. inally, lo er credit turnover indicates entity/s difficulty at paying debt #uic ly.:ased from the outloo of these three ratios, it is strongly recommended for company toincrease their sale more on customers ishing to pay by cash than on credit.

n conclusion, although current ratio illustrated that the company is in healthy business position, the company need to avoid potential customers ishing to purchase on credit because all the other li#uidity ratios decreased over the year due to allo ing many creditsales.

Question (a)

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n accounting, profit is not the same as cash generated. or e)ample, hen there isdepreciation e)pense, it ill be recorded under e)pense in income statement but it does notaffect the cash flo . (his ill reduce the net profit and the cash at ban ill remain the same.(his is because prepaid e)penses ill be recorded in income statement and these type ofe)penses is a non1cash items. (herefore, hile income statement sho negative income, thisactivity could lead high cash at ban . +nother situation that create this situation is accruede)penses here e)pense is incurred but not paid in cash. or instance, hen age e)pense isrecorded, this ill decrease net profit, possibly turn the value into negative, and remain cashflo positive.

(b) :ased on the information given, li#uidity ratio is applied to evaluate the situation. ?iventhe information available, current ratio and #uic ratio is used to analyse the financial

position. rom a calculation, +u @ong Aty td has a current ratio of '.9'*' hich means forevery dollar of the current liabilities, the company have $'.9' of current assets. Hence, thecompany have enough money to pay the debt off in short term.

+nother calculation, #uic ratio for the company is 0.BC*'. (he value of the #uic ratio issignificantly lo er than the benchmar hich tell us that the business might be at ris yfinancial position. (his could be due to the presence of the large level of inventory hich inturn creates a very lo level of li#uidity.

(c) (he accuracy of his assessment is not rong but there are many other things that he has toconsider before purchasing the business. Deducting the liabilities hich are $B5000 from itstotal assets hich are $200000 does not really sho an actual value of the business as this isonly the referring to tangible asset. f he desires to no ho much the business is actually

orth, he needs to determine hat intangible asset the business has, such as good ill, patents

and copyrights. urthermore, he needs to en#uire further details and as the e)isting o ner of the business to sho e)actly the value of the current and non1current assets and are recordedon the balance sheet and the degree of uncertainty about these values recorded. (his is toensure that my friend no s the type of assets he need to purchase once he ac#uire the

business and ho much could he save as replacement cost if the assets already e)ist in the business. n addition to that, he ill also no hether he can pay enough of his currentliabilities through his current asset through calculations from li#uidity ratio. <ith thecalculation he could ma e, he ill have high certainty of the financial health of the company.