SOLUTIONS

Question 5 (From Tute 7)

Ratios that focus on profitability include:
Return on equity
Return on assets
Net profit margin
Gross profit margin
Comment: Carrefores profitability is improving based on the two year trend.
ROE has increased and is now above Industry average. They have significantly
increased their efficiency of using assets to generate sales(ROA) and the profit
margin per sale has increased from 15.3c in every $ of sales to 17.6 cents. Gross
margin has only increased slightly so the operating expense rate has been
reduced also maybe cutting some unproductive expenses.
(b)Asset turnover ratio = Sales revenue/average total assets
This ratio helps assess the efficiency of assets by showing the amount of sales
being generated per dollar of investment.

(c) The Return on total assets for Careforre Limited for 2013 and 2014.
2013
2014
Industry Average
2014
Return on assets 8.5%
11.6%
10.5%
Profit Margin
15.3%
17.6%
17.8%
Asset Turnover
0.56 times
0.66 times
0.59 times
ROA = Asset turnover * Profit margin
(d) The liquidity measures are the current ratio, quick ratio and the cash flow
ratio. From 2013 to 2014, the ratios appear to be improving. However, compared
to the industry the company is not in as good a liquidity position as its
competitors.
(e) The debt to equity ratio indicates how many dollars of debt exist per dollar
of equity. For Careforre Limited, the debt to equity ratio is greater than 100%

and therefore it is more reliant on debt then equity. A comparison of this ratio
with the industry average shows that Careforre Limited uses greater debt
compared to equity than the industry.
The interest coverage ratio is inversely related to an entitys financial risk. A
ratio less than one indicates that an entitys net interest expense exceeds its
EBIT. The interest coverage ratio of Careforre Limited is greater than one and it
improved slightly from 2013 to 2014. It is not good compared to the industry
average.

Revision
Classwork
Question 1

Tutorial 8 Multiple - Choice Questions

1. The principle of double entry states that all transactions involve:

(a)
(b)
(c)
(d)

two debit entries

at least one debit and one credit entry
two credit entries
none of the above

2. The basic properties of a liability include:

(a) Past obligation
(b) Acquired as a result of a present transaction
(c) A future inflow of an economic benefit
(d) None of the above

2. A debtor paid the amount owing ($600) and received a 5%

discount. Part of the entry to record the receipt of money would
include:
(a) debit bank $600
(b) credit discount expense $30
(c) credit Accounts Receivable $570
(d) debit discount expense $30

3. If Office Equipment was sold for $30,000 cash then assets would
(a) increase by $30,000

(b) increase by $60,000

(c) decrease by $30,000
(d) remain unchanged
.
3. Insurance of $200 was paid by cash but this amount was posted to
Rent in error. What is
the entry required to correct this error?
(a) Dr Rent, Cr Insurance
(b) Dr Rent, Cr Bank
(c) Dr Insurance, Cr Rent
(d) Dr Insurance, Cr Bank
4. If assets decreased by $6,000 and liabilities decreased by $5,000
owners equity would
(a) increase by $9,000
(b) increase by $1,000
(c) decrease by $9,000
(d) decrease by $1,000

5. At year end the Acme Co had current assets of $18,000, current

liabilities of $6,000, non- current liabilities of $22,000 and owners
equity totaling $40,000. Therefore non-current assets must equal
(a) $38,000
(b) $6,000
(c) $50,000
(d) $30,000
6. Expenses are partly defined as:
a) amounts withdrawn by owner for personal use
(b) a decrease in equity in the recording period
(c) the personal liabilities of the owners
(d) all of the above
6. If a business has cash sales of 20,000, credit sales of $4,000 and
has paid the following amounts-rent $1,500, insurance $4,000,
creditors $8,000, wages $4,000, the net profit of the business is:
(a) $14,500
(b) $10,500

(c) $19,500
(d) $6,500

7. Soong Chen contributed $4,000 capital into a new business. The

business generated revenue of $8,500 with expenses of $5,500.
She also contributed an extra $1,000 during the year as capital. At
year end assets of the business totaled $15,000 with liabilities of
$8,600. How much money has Soong taken out in drawings during
the year?
(a)
(b)
(c)
(d)

$2,600
$1,300
$8,000
$1,600

8. Horizontal analysis is a technique for evaluating financial

statement data
(a) within a period of time.
(b) over a period of time.
(c) on a certain date.
(d) as it may appear in the future.
9. In horizontal analysis, each item is expressed as a percentage of
the
(a) net income amount.
(b) shareholders equity amount.
(c) total assets amount.
(d) base year amount.
10.

Which one of the following would be considered a long-term

solvency ratio?
(a) Receivables turnover.
(b) Return on assets.
(c) Acid-test ratio.
(d) Debt to total assets ratio.

Question 2

Cash Flow statement and commentary

Mexicana Restaurants Pty Ltd

Cash flow statement for the year ended 30th June 2009
Cash Flows from Operating Activities
Cash from Customers
Payments to Suppliers
Payments of Expenses
Payment of Tax
Net Cash Flow from Operating Activities
Cash Flows from Investing Activities
Cash from sale of van
Payment for new kitchen equipment
Cash paid for purchase of new delivery
vans
Net Cash Flow from Investing Activities
Cash Flows from Financing Activities
Cash received from Loan
Cash inflow from additional capital
Cash payment of dividends
Net Cash Flow from Financing Activities

$
785,000
(409,000)
(203,000)
(54,200)

118,800
15,800
(151,500)
(90,000)
(225,700)
50,000
140,000
(30,000)

Net Cash Flow

Opening Cash Balance (1 July 2008)
Closing Cash Balance (30 June 2009)

160,000
53,100
15,000
$ 68,100

Comments on cash flow statement

The companys operating cash flows are good. It indicates that the profits
of $225,800 have been by and large realised ($173,000 out of the profits
realised in cash)

The company is reinvesting the operating cash inflow into growing the
business by buying more kitchen machinery and other non-current assets,
with minimal bank loans.

Additional capital has been brought in by the shareholders showing

commitment to long term business growth. The company paid out some
dividends as well, rewarding owners.

Overall, the cash inflow from Operations and Financing was used to fund
investment for business growth and expansion. The cash flow statement
shows healthy business growth and liquidity.

Question 3
Solution:
$
Net Sales
Opening stock
Add: Net Purchases

Calculation of Profit

90,000
660,000
750,000
Less: Closing stock (105,000)
Cost of sales
Gross profit
Adm. & Selling expenses
Audit fees
Operating Profit

750,000

(645,000)
105,000
45,000
15,000

60,000
45,000

Question 4
Australian Computers Ltd, which assembles and sells computer hardware
and accessories, has three divisions at Carlton, Hawthorn and Geelong. These
divisions have the following revenues, variable costs and overheads for the
year 2014:
Carlton

Hawthorn
Geelong

$
Sales

$
400,000
300,000

$
525,000

Variable costs

160,000
150,000

236,250

Divisions fixed costs

135,000
120,000

155,750

Allocated corporate overheads

55,000
45,000

Divisions Profit/Loss

50,000
(15,000)

100,000
33,000

The Companys Management, unhappy with the performance of Geelong

division, would like to close down the operations there. If this occurs, the fixed
costs of the division could be eliminated, but allocated corporate costs such as
CEOs salary etc. will still remain and to be reallocated to the other two
divisions.
REQUIRED
You, as a professional cost accountant, are required to advise the company on
the impact of the closure of the Geelong division on the overall profits of the
company.

Solution

$
Sales
Variable costs
Direct fixed costs

Current profits
Carlton
Hawthorn Geelong
Total
($)
$
$
$
400,000
525,000
300,000
1,225,000
160,000
236,250
150,000
546,250
135,000
155,750
120,000
410,750

Divisional profits
30,000
268,000
Allocated o/h
Operating profit

105,000

133,000

55,000
100,000
200,000
50,000
33,000
68,000

45,000
(15,000)

Closure of Geelong Division would result in a loss of contribution of $300,000

150,000 120,000 = $30,000, resulting in a net operating profit of only $
38,000 for the company ($68,000 - $30000) instead of $68,000. As long as the
divisional profits are positive you would not close the division as this amount
offsets some of the allocated o/h (or Corporate costs)- aka an uncontrollable
cost
Hence, it is advisable to keep the division going and try to make more profits
in Geelong by increasing sales or reducing costs.
Question 6

MD Financial Services has an additional $10,000 to expand the business and has two
departments - Taxation and Business Risk. It has been decided to expand in either of the two
departments but the expansion can only occur in one department. The details about these
departments for 2014 are provided below:
Initial investment
Profit

Taxation
$100,000
$14,200

Business Risk
$72,000
$29,000

The additional Investment and profits expected are as follows:

Additional investment
Expected profit increase

Taxation
$10,000
$2,100

Business Risk
$10,000
$3,000

(a) Calculate the ROI for both products before the new investment
(b) Calculate the expected ROI based on the additional investment and
expected profit for both products
(c) Calculate ROI for both products assuming the expansion takes place and
discuss the Managers reaction to the expansion for their own department.
Solution:

(a) ROI Initial Investment

Taxation = 14,200/100,000 = 14.2%
Business Risk = 29,000/72,000 = 40.3%

(b) ROI Additional Investment

Taxation = 2,100/10,000 = 21.0%
Business Risk = 3,000/10,000 = 30.0%
(c) ROI including total investment
Taxation =16,300/110,000 = 14.8%
Business Risk = 82,000/32,000 = 39.0%
The manager of Taxation would be in favor of the expansion as the ROI
has increased from 14.2% to 14.8% whilst Business Risk would not favor
the expansion as the ROI would decrease from 40.3% to 39.0%. From the
companys point of view the expansion would have a better result for the
company by using the investment of $10,000 in Business Risk as the
additional investment shows a much higher ROI in Business risk (30% vs
21%)