Accounting Question Thread

[eeps]

Question:

Using the ratios provided give reasons why the change in the Working Capital Ratio may be misleading to management.

*WCR went from 3:1 in 2010 to 6:1 in 2011.*

- STO went from 40 to 60 days.
- DTO went from 50 to 70 days.
- Cash Flow Ratio went from 3 times to 2 times.

Could someone help?

Thanks.

[Yitzi_K]

Well the change in WCR is very favourable, as it has in fact doubled, whereas the change in the other three ratios is unfavourable. Therefore taking the WCR ratio on it's own to be an indicator that the liquidity situation is positive would be misleading as there are clearly other very negative issues with liquidity, as shown by the increase in DTO, STO and decrease in the CFI.

Depending on the marks allocated, you may wish to give reasons why the WCR would be improving while the others are getting worse, for example there is lots of unsold stock.

[eeps]

Well the change in WCR is very favourable, as it has in fact doubled, whereas the change in the other three ratios is unfavourable. Therefore taking the WCR ratio on it's own to be an indicator that the liquidity situation is positive would be misleading as there are clearly other very negative issues with liquidity, as shown by the increase in DTO, STO and decrease in the CFI.

Depending on the marks allocated, you may wish to give reasons why the WCR would be improving while the others are getting worse, for example there is lots of unsold stock.

Thanks for the detailed answer!

[Rockim]

hey guys, I'm struggling to find a answer for this question 

Explain how it is possible for a business to budget for an improvement in Net Profit Rate, yet also budget for a decline in the Gross Profit Rate?

cheers

[eeps]

hey guys, I'm struggling to find a answer for this question  

Explain how it is possible for a business to budget for an improvement in Net Profit Rate, yet also budget for a decline in the Gross Profit Rate?

cheers

You could say that the business is budgeting for an improvement in NPR because it predicts that the expense control of the business will be better OR that 'Other Revenues' may increase - leading to a possible improvement. At the same time, the business may budget for a decline in Gross Profit Ratio because the cost of stock increased (maybe due to the supplier increasing its price) OR there may be a decrease in the mark-up of stock, thus a decline in GPR may be on the cards.

I'm not sure exactly... that was my guess at the question!

This question is a different question - I'm yet to come across a question like this one. Though it is a good question.

[Rockim]

oh cheers mate!

Its a profitability theory question in the Neville Box Textbook, which may or maybe not be the reason why your unfamiliar with it.

[eeps]

Question:

With reference to two Accounting Principles explain why ratio comparsions with industry averages can be misleading.

I can't think of another principle besides Reporting Period - that one business may have different reporting periods from another. Does anyone have another principle which would fit the question?..

Cheers.

[Yitzi_K]

Consistency. If different businesses apply different accounting methods, then comparing ratios with the average would be useless as the differences could be a result of the different accounting methods rather than actual performance differences.

[eeps]

Cheers.

[eeps]

I'm a bit confused with the CSE 2010 Exam.

In Q. 2.1.1, you have to reconstruct the Stock Control account and Creditors Control account to work out the estimated Payments to Creditors. I'm having trouble working out the Stock Control account... I don't really get how the solutions got a Stock Loss of $2,000.

Could someone explain how they got it... or was it just my inability to read the question carefully from the information?

Cheers.

(Question and Solution are below.)

EDIT*: I don't think there is a "Stock Loss".

[sam.utute]

Question:

Using the ratios provided give reasons why the change in the Working Capital Ratio may be misleading to management.

*WCR went from 3:1 in 2010 to 6:1 in 2011.*

- STO went from 40 to 60 days.
- DTO went from 50 to 70 days.
- Cash Flow Ratio went from 3 times to 2 times.

Could someone help?

Thanks.

Just a little note about this question. I saw something along these lines in the VCTA Compak 2009 exam (I think it was that one).
Keep in mind that the unfavourable changes in STO and DTO will not really affect WCR, as it could result in merely a lower bank balance and higher debtors and stock. While the changes wil deteriorate liquidity, as all three are current assets, changes in composition of current assets would not affect WCR.

[eeps]

Just a little note about this question. I saw something along these lines in the VCTA Compak 2009 exam (I think it was that one).
Keep in mind that the unfavourable changes in STO and DTO will not really affect WCR, as it could result in merely a lower bank balance and higher debtors and stock. While the changes wil deteriorate liquidity, as all three are current assets, changes in composition of current assets would not affect WCR.

LOL what?! :S

The change in DTO and STO would suggest that the business is either: unable to sell its stock - thus, not converting stock into sales quickly OR that the business isn't chasing up outstanding debtors - increasing the chance of bad debts. Isn't that why the WCR is misleading to management?.. for those reasons. I thought the worsening indicators (CFI, STO and DTO) affected WCR, as shown in the increase from 3:1 in 2010 to 6:1 in 2011. - pretty much what Yitzi_K said.

I'm sort of confused on your point.

[Yitzi_K]

I'm a bit confused with the CSE 2010 Exam.

In Q. 2.1.1, you have to reconstruct the Stock Control account and Creditors Control account to work out the estimated Payments to Creditors. I'm having trouble working out the Stock Control account... I don't really get how the solutions got a Stock Loss of $2,000.

Could someone explain how they got it... or was it just my inability to read the question carefully from the information?

Cheers.

(Question and Solution are below.)

EDIT*: I don't think there is a "Stock Loss".

It must be a mistake. The Cost of Sales has to be $100,000, as the mark up is 100%, but for some reason they've split it into $97,000 Cost of Sales and $3,000 Stock Loss. There is absolutely no indication why, or even how, that could be the case, so yes, I'd say it's a mistake.

[sam.utute]

VCTA 2009 Exam

1.5.3 Explain the impact of the trend in the Debtors Turnover of Rayden Retail on (1) the Working Capital and (2) liquidity.

My little point was about this question. The fact that changing the composition of current assets will not effect WCR.
Their Suggested Answer:
The increase in the Debtors Turnover may result in the amount of debtors increasing in the balance sheet. A slowing in Debtors Turnover does not change the Working Capital Ratio, as whether or not the Current Asset is shown as a debtor or cash will not effect the total Current Assets.

Sorry for posting a bit of topic.

[eeps]

VCTA 2009 Exam

1.5.3 Explain the impact of the trend in the Debtors Turnover of Rayden Retail on (1) the Working Capital and (2) liquidity.

My little point was about this question. The fact that changing the composition of current assets will not effect WCR.
Their Suggested Answer:
The increase in the Debtors Turnover may result in the amount of debtors increasing in the balance sheet. A slowing in Debtors Turnover does not change the Working Capital Ratio, as whether or not the Current Asset is shown as a debtor or cash will not effect the total Current Assets.

Sorry for posting a bit of topic.

Ah k. Yeah, that makes sense now.