Part A: Journal Entries to record accounting transactions
1. On December 31st the company sells on credit $5,000 of goods which had been bought a month previously at a cost of $3,500:
Debtors A/cDr5000
Cost of Goods Sold.Dr..3500
2. On December 31st the company sells an unwanted machine for $1,500. The machine was bought at the beginning of 2012 for $8,200 and was expected to be used for three years after which its value had been forecast to be $1,000.
Cash A/c.Dr 1500
Depreciation of Machinery A/c..Dr 7200
3. On January 2nd the company paid $500 by check for a three year buildings insurance policy.
Insurance Premium Charges A/c.Dr.500
4. On December 31st the manager reads the electricity meter and realizes that they will owe $100 more for electricity used than they had previously estimated.
Budgeted Electricity Expense A/c..Dr 100
5. Due to a shortage of cash the company was unable to pay December wages of one manager totaling $750, but promises to do so by January 15th 2014.
Wages A/cDr 850
6. On December 31st the company reads an announcement in the newspaper that one of their customers, who currently owes $2,000 for goods shipped in November, has filed for bankruptcy.
Bad Debt Expense A/cDr 2000
Allowance for Bad Debt Expense..Dr 2000
7. In March the company declared that dividends of $5,000 would be paid for 2012 and these were subsequently paid in June.
March:
Retained Earnings A/c.Dr 5000
June:
Dividend Payable A/c..Dr 5000
8. During 2013 the company spent $7,500 on a project with a research company for a new product which they initially expected to introduce in 2015, but which now seems to be much less certain.
Sunk Cost Losses A/cDr 7500
9. On December 1st the company placed an order for $15,000 of goods from a Chinese supplier, and paid a deposit of $6,000, with the remaining payment due when the goods have been delivered. The goods will be delivered in January 2014 and advertised for sale at $20000.
Inventory Purchase A/cDr 15000
10. The company’s managing director borrowed $1,000 in cash from the company on December 31st.
Advances to Managing Director A/cDr 1000
11. On November 1st the company received an order for $20,000 of goods, to be delivered monthly over the next four months. On December 1st the customer made a stage payment of $15,000, and by December 31st the company had delivered half of the order from inventory. The goods were bought in at a 20% discount to the selling price.
November 1st:
Accounts Receivables A/cDr 20000
December 1st:
Cash A/cDr 15000
December 31st:
Inventory A/cDr 10000
Cost of Goods Sold A/cDr 16000
12. The company owns a building which is on its Balance Sheet for a value of $250,000. On
December 31st the company’s finance manager received a call from a developer who explains that he is prepared to offer $500,000 for the building.
Building A/c..Dr 250000
Part 2: Financial Analysis:
a)Horizontal and Vertical Financial Statements
Horizontal Balance Sheet
Please refer to excel sheet
Horizontal Profit and Loss
Please refer to excel sheet
Vertical Balance Sheet
Please refer to excel sheet
Vertical Profit and Loss
Please refer to excel sheet
b)Cash Flow Statement
Refer to excel sheet
c) Analyzing the company:
i)Return on Sales: Net profit/ Revenue
2012: (2749317/83523330)= 3.2%
2013: (-42837/75266038)= -0.06%
Referring to the common-size income statement of the company, we find that during 2011, the net income of the company was 3.14% that declined significantly and resulted in a net loss of 0.06%. The decline in the net profit margins of the company was attributable to the low revenue figures that plumped by 9.88% during the year.
ii)Return on Equity: (Net Margins* Asset Turnover* Financial Leverage)
In order to have an in-depth analysis of the ROE multiple of the company, we will conduct the Du-pont Analysis of the company:
2012: (Net Income/ Revenue)* (Revenue/ Assets)* (Assets/ Shareholder Equity)
=(2749317/83523330)* (83523330/47762345)* (47762345/30644358)
=.032* 1.74* 1.55
=8.67%
2013 : (Net Income/ Revenue)* (Revenue/ Assets)* (Assets/ Shareholder Equity)
=(-42837/75266038)* (75266038/45414899)* (45414899/30198673)
=-0.0005* 1.65* 1.50
=-0.12%
The calculations above indicate that during 2012, high asset turnover and financial leverage produced high ROE multiple of 8.67%. However, during 2013, low return on sales plumped the ROE multiple to -0.12% despite high asset turnover and leverage multiples. This trend if continued could pose serious threat to the company in the form of lost confidence of the shareholders.
iii)Inventory Turnover Ratio: COGS/ Average Inventory
2012: 51970244/((16497185+18464019)/2)
=51970244/17480602
=2.97
2013: 49353746/((18234279+18464019)/2)
=49353746/18349149
=2.68
Referring to the calculations above, we can assert that during the year, the company has lost over its efficiency as indicated by decreased inventory turnover ratio. This means that it now takes more time for the company to sell their inventory and capital is tied up in the inventory for a longer period of time now.
d) Conclusion
In the Part-2 of the above report, we conducted the common-size analysis of the income statement and the balance sheet and all the results have been attached in the excel sheet. Post that, we used the income statement and the balance sheet to complete the cash flow statement of the company. At last, we conducted few ratios to unearth the financial position of the company and found through Du-Pont analysis that during 2013, it was the decline in the net margins of the company that resulted in negative ROE although asset turnover and financial leverage multiples were consistently higher. In addition, a decline in inventory turnover ratio also supported our view that the company has lost over its efficiency for inventory management.
