Question 1:
Gary Green has started a lawn mowing business (GG Grass of HomeMowing) as a temporary job/business which he intends to run until he starts his business degree at the University of South Australia in four months. Gary has never owned or run a business before. To start the business on 1 April 2014, he deposited $1,000 into a new bank account opened in the name of the business. The $1,000 consisted of a $600 loan from his father and $400 of his own money. Gary rented some equipment, purchased supplies, and hired friends to mow and trim his customer's lawns.
At the end of each month Gary sent invoices to his customers. On 31 July, he was ready to dissolve the business and start his university studies. As he was so busy, he kept few records other than his cheque book and a list of amounts owed to him by customers.
At 31 July, Gary's business account cheque book shows a balance of $690, and his customers still owe him $500. During the period, he collected $4,250 from customers. His cheque book lists payments for supplies totalling $400, and he still has fuel and supplies that cost a total of $50 on hand. He paid his employees $1,900, and he still owes them $200 for their final week of work.
Gary rented some equipment from Scholes Machine Shop. On 1 April, he signed a six-month rental agreement on lawnmowers and paid $600 for the full period. Scholes will refund the unused portion of the prepayment if the equipment is in good order when he returns it. In order to get the refund, Gary has kept the equipment in excellent condition. In fact during May,Gary paid $300 to repair one of the mowers.
To transport employees and equipment to jobs, Gary used a trailer that he bought for $300. He believes that the period's work used up one-third of the trailer's service potential. The business cheque book lists a payment of $460 for private cash withdrawals by Gary during the period. In July Gary paid back the money his father had lent to him.
Gary estimates that he spent approximately 70 hours working on the business during the period. He plans to recommence operations on a similar basis during major breaks in his university study and believes he will do better in later periods as he now has an existing customer base to work from.
Required
a) Prepare the business Income Statement for the period.
b) Prepare the classified Balance Sheet at the end of the period.
c) Was Gary's venture successful? Give the reasons for your answer. 150 - 250 words only.
Question 2:
The owner of a business reviews the Income Statement prepared by you and asks, "Why do you report a profit of only $60,000 when cash collections of $185,000 were received and cash payments for expenses during the period totaled only $80,000?"
1. How would you respond to the owner's question?
2. Give two examples which support your answer to part 1 of this question.
Question 3:
Drew Sandler owns a party planning company called Party Right. She has some idea about accrual accounting but is not very clear on what to do, so she has come to you for help. Drew aims to achieve a profit margin on her business of 10%, that is, she expects profit divided by total revenue to be at least 10% or more. Drew has provided the Income Statement below, which shows a profit margin of 7% ($29,000/$414,285). If Drew cannot achieve a profit margin of at least 10%, sheintends to sell the business. Drew knows that some accrual accounting adjustments need to be made and that is why she is seeking your help.
PARTY RIGHT
Income Statement
For the year ended 30 June 2014
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$
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$
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INCOME
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Revenues:
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Corporate Function revenue
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123 550
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Wedding Plan revenue
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290 735
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414 285
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EXPENSES
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Salaries
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57 815
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Subcontracting expenses
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283 170
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Liquor licence
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2 600
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Insurance expense
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12 500
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Advertising expense
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7 000
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Rent expense
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19 800
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Sundry expenses
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2 400
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385 285
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PROFIT
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29 000
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To determine the adjustments that need to be made, you have a long discussion with Drew that reveals the following:
A. The Corporate Function revenue includes $900 for cash received but the services have not yet been provided to the customer.
B. A staff member went on holidays at the end of June and his July wages of $2,300 are included in ‘salaries'.
C. A prepayment of rent of $1,400 for June is still shown in the Balance Sheet as an asset.
D. Depreciation expense of $6,000 for the year has not yet been charged to the accounts.
Required
a) Prepare the required adjusting journal entries. Make sure that your journal entries are complete and properly formatted.
b) Reproduce the revised Income Statement as it would appear after the adjustments have been processed.
c) Should Drew retain the business or sell it, given her requirement that the profit margin must be 10%? Explain the reason for your conclusion, showing calculations.
Question 4:
Metacorp Ltd and Universal Ltd both began operations on 1 January 2014.
Income Statement
For the year ended 31 December 2011
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Metacorp Ltd
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Universal Ltd
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$
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$
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Revenues
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500 000
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500 000
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Less: Cost of Sales
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276 000
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300 000
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GROSS PROFIT
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224 000
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200 000
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Other expenses*
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86 000
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106 000
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PROFIT
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138 000
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94 000
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*Includes finance costs of $16 000 for both companies. Depreciation expense was $20 000 for Metacorp and $40 000 for Universal Ltd. Assume no income tax.
Balance Sheet
As at 31st December 2014
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Metacorp Ltd
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Universal Ltd
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Cash
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$ 40 000
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$ 40 000
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Receivables
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100 000
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100 000
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Inventories
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104 000
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80 000
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Property, plant and equipment (net
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110 000
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90 000
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$354 000
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$310 000
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Current Liabilities
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$ 60 000
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$ 60 000
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Non-current liabilities
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90 000
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90 000
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Equity
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204 000
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160 000
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$ 354 000
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$ 310 000
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Required:
A. Calculate the following ratios for each company:
1. rate of return on total assets
2. rate of return on ordinary equity
3. profit margin
4. gross profit margin
5. current ratio
6. receivables turnover
7. inventory turnover
8. debt ratio.
Where an average is required for the computation of a ratio the closing balance may be used instead.
Industry Average
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rate of return on total assets
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35.5%
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rate of return on ordinary equity
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58.8%
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profit margin
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18.8%
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gross profit margin
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40.0%
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current ratio
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3.7:1
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receivables turnover
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6.0 times
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inventory turnover
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3.75 times
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debt ratio
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32.4%
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times interest earned
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6 times
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B. Discuss the profitability, liquidity and financial stability of Metacorp Ltd using industry average where appropriate. (200 - 250 words maximum)