Contemporary Issues in Accounting

Take Home Examination

(Assignment 2)

13-01-2024

2
 Part A: 1 COMPULSORY question worth 50 marks
1. The financial statements for Harridges Ltd are given below for the TWO years ended
30 June 2022 and 2023. Harridges Ltd operates a department store in the centre of a
small town.
Income Statement 2022 2023
Sales revenue £2,600.00 £3,500.00
Cost of sales -£1,560.00 -£2,350.00
Gross profit £1,040.00 £1,150.00
Wages and salaries -£320.00 -£350.00
Overheads -£260.00 -£200.00
Depreciation -£150.00 -£250.00
Operating profit £310.00 £350.00
Interest payable -£50.00 -£50.00
Profit before taxation £260.00 £300.00
Taxation -£105.00 -£125.00
Profit for the year £155.00 £175.00

Statement of Financial Position 2022 2023

ASSETS
Non-current assets
Property, plant and equipment £1,265.00 £1,525.00
Current Assets
Inventory £250.00 £400.00
Trade Receivables £105.00 £145.00
Cash and bank £380.00 £115.00
Total Current Assets £735.00 £660.00
TOTAL ASSETS £2,000.00 £2,185.00
EQUITY AND LIABILITIES
Equity
Share capital £1 shares fully paid £490.00 £490.00
Share premium £260.00 £260.00
Retained earnings £350.00 £450.00
Total equity £1,100.00 £1,200.00
Non-current liabilities
Borrowings - 10% loan notes £500.00 £500.00
Current liabilities
Trade payables £300.00 £375.00
Other payables £100.00 £110.00
Total liabilities £400.00 £485.00
TOTAL EQUITY AND LIABILITIES £2,000.00 £2,185.00

3
 Additional information:
Dividends were paid on ordinary shares of £65,000 and £75,000 in respect of 2022 and
2023 respectively.

Required:
(a) Choose and calculate TEN ratios that would be helpful in assessing the performance
of Harridges Limited. Use end of year values and calculate ratios for both 2022 and
2023. (20 marks)

2022 2023
LIQUIDY RATIOS
Current Assets Ratio (a.k.a. Current Current Assets Ratio (a.k.a. Current
Ratio) Ratio)
735/400=1.84 660/485=1.36
Quick Ratio (a.k.a. Acid Test) Quick Ratio (a.k.a. Acid Test)
(735-250)/400=1.21 (660-400)/485=0.54
PROFITABILITY RATIOS (a.k.a. PERFORMANCE RATIOS)
Return on Capital Employed (ROCE) Return on Capital Employed (ROCE)
Ratio Ratio
(310/(1100+500))*100=19.28% (350/(1200+500))*100=20.59%
Gross Profit Margin Ratio Gross Profit Margin Ratio
(1040/2600)*100=40% (1150/3500)*100=32.86%
Operating Profit Margin Ratio Operating Profit Margin Ratio
(310/2600)*100=11.92% (350/3500)*100=10.00%
EFFICIENCY RATIOS (a.k.a. TURNOVER RATIOS)
Inventory Days Ratio Inventory Days Ratio
(a.k.a. Inventory Turnover in Days Ratio) (a.k.a. Inventory Turnover in Days Ratio)
(250/1560)*365=59 (400/2350)*365=63
Receivables Collection Period Ratio Receivables Collection Period Ratio
(a.k.a. Trade Receivables Turnover Ratio) (a.k.a. Trade Receivables Turnover Ratio)
(105/2600)*365=15 (145/3500)*365=16
Payable Days Ratio Payable Days Ratio
(a.k.a. Trade Payables Turnover Ratio) (a.k.a. Trade Payables Turnover Ratio)
(300/1560)*365=71 (375/2350)*365=59
INVESTMENT RATIOS (a.k.a. VALUATION RATIOS)
Earnings Per Share Ratio Earnings Per Share Ratio
155/490=£0.32 175/490=£0.36
Price-earnings Ratio Price-earnings Ratio
1/0.32=£3.13 1/0.36=2.78

4
 Additional information: Dividends were paid on ordinary shares of £65,000 and £75,000
in respect of 2022 and 2023 respectively.

Required:
(b) Using the ratios calculated in (a) and any others you consider helpful, comment on the
business performance from the viewpoint of a prospective purchaser of a majority of
the shares. (30 marks)

In order to evaluate the performance of Harridges Ltd.'s business from the point of view of a
potential purchaser of the majority of the company's shares, let us have a look at the ratios that
I utilised and how they have varied over the course of two years. I chose Liquidity Ratios first
to assess Harridges Ltd’s ability to meet its short-term financial obligations using its available
liquid assets as that’s usually a good yard stick for measuring a company’s health.

Current Assets Ratio (Current Ratio): 2022: 1.84 / 2023: 1.36

The current ratio has decreased from 2022 to 2023, indicating a weakening via a slightly
diminished short-term liquidity position. A decrease should cause prospective purchasers to be
concerned about the company’s ability to cover its short-term obligations but this Current Ratio
indicates a decrease to £1.36 in current assets for every £1 in current liabilities. A Current Ratio
of above 1 is generally considered good, suggesting the company had enough short-term assets
to cover its short-term obligations despite the decrease. However, the Current Ratio is designed
to show a company’s ability to meet Short-Term Trade Payables as they fall due, using ALL
its Current Assets to see if there’s any liquidity issues. The Acid Test is less forgiving, but
before we move on to the next ratio, I thought I’d quote the following relevant extract:
“Be careful before you assume that a factor of (say) 1:2 suggests that the company will be going
into immediate liquidation. Some creditors, such as tax and dividends, may not have to be paid
for several weeks. In the meantime, the company may receive regular receipts of cash from its
debtors and it may be able to balance these against what it has to pay to its creditors …
supermarkets … may have a current assets ratio of less than 2:1. This is not likely to be a
problem for them because they are probably collecting sufficient amounts of cash daily through
the checkouts … if a company has more current assets than current liabilities, it is in a good
position as it has enough to turn into cash and pay its liabilities as they fall due over the next
12 months.” Dyson, J.R. and Franklin, E. (2020) 'Current Ratio', in Accounting for Non-
Accounting Students, Ed. 10. Harlow, UK: Pearson, p. 241.

5
Quick Ratio (Acid Test): 2022: 1.21 / 2023: 0.54
Now as you can see, the quick ratio has significantly decreased, once again suggesting a
potential liquidity issue which may once again raise concerns for a prospective buyer regarding
the company’s ability to meet its immediate obligations without relying on inventory because
the Acid Test is designed to show a company’s ability to meet Immediate Trade Payables,
using all Current Assets apart from Inventory [though I’m not entirely sure as to why it
doesn’t exclude Prepaid expenses also] to see if there’s any solvency issues. This test reveals
immediate liquidity strength, or weakness more realistically than the Current Rario. And now
we’re looking at a factor of close to 1:2 equivalent to 50% which is below the desired minimum
100%. Thusly, though the Liquidity ratios do at least on the surface raise some concerns, the
matter still remains inconclusive.

Return on Capital Employed (ROCE): 2022: 19.28% / 2023: 20.59%

The ROCE has increased, indicating improved efficiency in utilizing capital to generate profits.
This should be seen as a positive sign for a prospective purchaser. This ratio is to do with money
that has been introduced to the company e.g. Capital employed (e.g. Equity which stands for:
value for the capital introduced from share issues or retained profits and Long term borrowing
which is captured on the balance sheet under non-current liabilities) for the purpose of gauging
how effectively a company is at utilising its capital and to measure the profit generated from
the total capital employed (by revealing the percentage return on investment [a.k.a. operating
profit before interest and tax]). The increase suggests an improvement in the company's ability
to generate returns on the capital employed. This positive change indicates enhanced efficiency
in utilising equity and long-term borrowing to generate profits.

Gross Profit Margin Ratio: 2022: 40.00% / 2023: 32.86%

This ratio is to do with the core profitability of a company’s primary business operations,
assessing the relationship between revenue and the cost of goods sold (COGS). Its purpose is
to gauge how efficient a company is at producing and selling its goods and services and to
measure the profitability of its core business activities (by revealing the percentage of revenue
that exceeds the cost of goods). The decrease suggests a decline in efficiency of core business
operations. A lower gross profit margin may indicate increased costs or pricing pressures,
affecting profitability.

6
Operating Profit Margin Ratio: 2022: 11.92% / 2023: 10.00%
This ratio is to do with the overall operational efficiency of a company, measuring the
percentage of revenue that remains as operating profit after accounting for both COGS and
operating expenses. Its purpose is to gauge how efficient a company is at its core operations
and to measure the percentage of revenue that remains as operating profit (by revealing the
profitability of its day-to-day business activities). So, day-to-day operating profitability has
decreased as well to 10%, indicating potential challenges in controlling operating costs. A
prospective buyer may want to investigate the reasons behind this decline.

Inventory Days Ratio: 2022: 59 / 2023: 63

This ratio is to do with the Cash conversion cycle and the Inventory (a.k.a. Stock – the goods
which are for sale and need to be converted into cash/profit). Its purpose is to gauge how
efficient a company is at controlling its inventory and to measure how long it takes from buying
stock to selling it (inventory management and turnover speed). Well, the inventory days have
increased, suggesting that it takes longer to sell inventory. This could be a concern for a
potential buyer as it may tie up capital.

Receivables Collection Period Ratio: 2022: 15 / 2023: 16

This ratio is to do with the Operating cash cycle and Debtors (a.k.a. Trade, or other receivables
– outstanding amounts from business who owe the company money). Its purpose is to gauge
how efficient a company is at chasing outstanding credit and how long it takes from lending
money out to getting it back (debt recovery management). The receivables collection period
has increased slightly, indicating a marginal delay in collecting payments. A prospective buyer
may want to investigate the reasons behind this trend though hardly anything to worry about
from this ratio’s perspective.

Payable Days Ratio: 2022: 71 / 2023: 59

This ratio is to do with the Trading cycle and Creditors (a.k.a. Trade, or other payables –
outstanding amounts to businesses the company owes money to e.g. Banks). Its purpose is to
gauge how efficient a company is at paying its debts and how long it takes from borrowing
money to paying it back (payment obligations management and financial flexibility). The
payable days have decreased, indicating a potential shift in the company’s payment behaviour.
A prospective buyer may inquire about changes in supplier relationships. This result however
could positively impact cash flow and reflect efficient financial management.

7
Earnings Per Share (EPS): 2022: £0.32 / 2023: £0.36
EPS has increased, which is generally positive for shareholders. A potential buyer may see this
as a sign of improved profitability.

Price-Earnings Ratio: 2022: £3.13 / 2023: £2.78

The EPS Ratio measures how a company distributes profits per share, reflecting its earnings-
generating capability. Synonymous with post-tax profit, it provides key insights into per-share
profitability, positively impacting stock prices and contributing to overall shareholder value.
The P/E ratio has decreased, which might be attractive to a prospective buyer, indicating a
potential undervaluation. The increase also suggests improved profitability on a per-share basis,
which can be favourable for shareholders.
In summary, a prospective purchaser would likely have concerns about the decreasing liquidity
ratios and profit margins. However, the improvement in ROCE and EPS, along with a lower
P/E ratio, may present opportunities. Further due diligence is recommended to understand the
reasons behind these trends and their potential impact on the company’s future performance. In
2022 investors were willing to pay around 3.13 times the company's earnings per share for its
stock. This implies a certain level of optimism or expectation regarding the company's future
prospects and earnings growth. The 2023 decrease in the P/E Ratio to 2.78 may indicate a shift
in investor sentiment though willing to pay slightly less, around 2.8 times the earnings per share.
This could suggest a potential change in market expectations, possibly reflecting a more
cautious outlook.

In conclusion; three ratios made this fictitious company look back, another three did nothing,
whilst 4 ratios out of the 10 stood in the company’s favour. On paper it’s not exactly a failure
though neither is this entity the next big thing.

Part B: 2 COMPULSORY questions worth 25 marks each

2. A budget can be defined as a financial plan for the future period of time. Thus, it sets
out the intentions which management has for the period concerned.

Required:
Explain the five distinct purposes of budgets and their significance in financial
management. (25 marks)

8
Budgets serve various distinct purposes in financial management. Here are five key purposes
along with their significance:

1. Planning: To put it simply, a budget is an all-encompassing financial plan that details

anticipated expenditures and revenue for a particular time period in the future. Therefore, it
provides an outline of the goals that management has for the period of time that has been
established.

2. Control: Budgets serve as control mechanisms, enabling management to monitor and analyse
actual performance in comparison to the targets that were anticipated. This makes it easier
to identify any deviations from the plan at an early stage, which in turn makes it possible to
take effective corrective actions in a timely manner. Consequently, it serves as a foundation
for the assessment and accountability of performance.

3. Communication: Budgets are used as a medium of communication all throughout the

organisation. They communicate the expectations and priorities regarding finances, making
certain that all parties involved, including employees, have a clear understanding of the
financial goals and objectives. Having this clarity helps to build a shared knowledge of the
financial direction that the organisation is heading in.

4. Coordination: Budgets are helpful in coordinating the work of different departments and
teams at the organisation in order to achieve common organisational goals. In order to ensure
that all employees are contributing to the overall financial health and success of the company,
it is necessary to define precise financial targets. This allows the various departments within
the firm to work together in a coordinated manner.

5. Incentive: Budgets can be utilised as tools for encouragement and incentive. When
employees are given the opportunity to participate in the budgeting process and when their
financial success is linked to rewards, they are motivated to strive towards the achievement
of the goals previously established. It offers a structure that may be utilised for the purpose
of recognising and rewarding individuals or teams that contribute to the financial
performance of the organisation.

9
It is clear that budgets are a crucial component in the management of financial resources. This
is due to the fact that they simplify the process of planning, coordinating, controlling,
communicating, and motivating personnel within a company. The methodical approach that
they take makes it easier to complete both the management of resources and the management
of financial goals.

3. For accounting to be useful, there must be a clear understanding of for whom and for
what purpose the information will be used.

Required:
Identify the main users of accounting information for a university and indicate for what
purpose would these main users group need information. Your answer should be set as
below. (25 marks)

User Group Purpose

Management and Administration Purpose: Financial information is essential
for internal decision-making, strategy
planning, and resource allocation. The
university's management need precise and
prompt data in order to guarantee
operational efficiency and secure long-term
success. In the absence of efficient financial
management, it is possible that other
stakeholders may not receive sufficient
support.
Board of Trustees or Governing Body Ensuring Accountability, legal compliance,
and the overall governance of the institution
are the primary responsibilities of the
governing board, which plays a major
oversight role. It is crucial to have access to
comprehensive financial information
because their judgements have an impact on
the direction and policies of the institution.

10
Donors and Funding Agencies Donors and entities that provide financial
support are absolutely necessary for the
university to maintain its financial stability.
Establishing and sustaining trust with them
requires that you provide them with open
and honest facts regarding their financial
situation. In order to ensure that their
contributions are utilised in an efficient and
effective manner, these stakeholders want
confidence.
Regulatory Authorities and Accreditation Regarding the university's reputation and
Agencies legitimacy, it is of the utmost importance to
guarantee compliance with rules and to meet
accreditation standards. Financial
information is largely relied upon by
regulatory authorities and accreditation
organisations in order to evaluate the
stability of the institution and determine
whether or not it is capable of fulfilling its
educational objective.
Prospective Students and Parents Prospective students and their parents are
heavily influenced by financial factors when
it comes to making decisions about their
educational needs. They make decisions
based on factors such as affordability, the
availability of financial aid, and the general
financial health of the university.
Communication about finances that is clear
helps to attract and keep students.
Faculty and Staff For the purpose of developing academic
programmes, research efforts, and gaining a
knowledge of their own employment
conditions, all faculty and staff members

11
 require financial information. Having a
university that is financially stable creates a
safe atmosphere for its teachers and staff,
which in turn ensures that educational and
research activities will continue
uninterrupted.
Students Student stakeholders are extremely
important, despite the fact that they may not
have direct decision-making power.
Students' perceptions of the overall quality
of the institution are influenced by their
level of happiness with the university, which
is influenced by their understanding of the
university's financial stability and value for
money.
Internal Departments and Programs For the sake of day-to-day operations,
planning, and resource allocation, the
numerous departments and programmes that
make up the university require financial
information. For the purpose of preserving
the overall efficiency and effectiveness of
the organisation, it is of the utmost
importance to make certain that these
internal stakeholders have appropriate
access to reliable financial data.

12