Question No: 49 ( Marks: 3 )
If a company uses Rs.20, 000 to buy merchandise for inventory. What do you think would be the effect on working capital? Give reason.
If company purchase inventory on cash current assets of company increase and on the other hand cash is decrease. So there is no effect in working capital.
Question No: 50 ( Marks: 3 )
Ahmad Incorporation has Owner’s Equity of amount Rs.75, 000 as an opening balance. During the period, three major transactions occurred:
Issuance of stock: Rs.22, 000
Dividend distribution: Rs.10, 000
Net Loss: Rs.6, 000.
Based on these transactions, what would be the Ahmad’s ending balance of Owner’s Equity?
Answer
Owner’s Equity (beg) 75000
Add; Stocks Issued 22000
Less; Dividend distribution 10000
Less; Net Loss 6000
Owner’s Equity (end) 81000
Question No: 51 ( Marks: 5 )
ABC Company is famous for its automobiles. The business has undergone the following changes in the month of March. Prepare the journal entries for the transactions.
1. Mar. 1 Owner deposited Rs. 50,000 cash in a bank account in the name of the business.
2. Mar. 5 purchased land for Rs. 160,000, of which Rs. 40,000 was paid in cash. A short-term note payable was issued for the balance of Rs. 120,000
3. Mar. 6 An arrangement was made with the XYZ Company to provide parking privileges for its customers. XYZ Company agreed to pay Rs. 1,200 monthly, payable in advance. Cash was collected for the month of March.
4. Mar. 7 Arranges with Times Printing Company for a regular advertisement in the Times at a monthly cost of Rs. 390. Paid for advertisement during March by check, Rs. 390
5. Mar. 15 Parking receipts for the first half of the month were Rs. 1,836, exclusive of the monthly fee from XYZ Company
1. bank 50,000
cash 50,000
2. land 160,000
cash 40,000
notes payable 120,000
3. Cash 1200
Unearned parking revenue 1200
4. Advertisement cost 390
bank 390
5. cash 636
Unearned parking revenue 1200
Parking revenue 1836
Question No: 52 ( Marks: 5 )
Following data is taken from the ABC Corporation.
|
1999 (Rs.) |
2000 (Rs.) |
|
| Total assets |
400,000 |
300,000 |
| Total liabilities |
300,000 |
180,000 |
| Share capital (Rs. 10 par |
100,000 |
90,000 |
| Total debt |
120,000 |
140,000 |
Requirement:
Calculate the following.
a) Debt ratio (2.5)
b) Debt to total asset ratio (2.5)
Debt ratio = total Liabilities / total assets
= 300,000/ 400000
= 0.75
Debt ratio = total Liabilities / total assets
= 1,80,000/300,000
= 0.6
Debt to total assets ratio = total debt / total assets
= 120000/400000
= .3
Debt to total assets ratio = total debt / total assets
= 140000/300000
= .46
Question No: 53 ( Marks: 5 )
Assume that you wish to invest in the stocks of a high-tech corporation and that one of your investments goals is to receive dividend income from the stocks that you purchase. You begin your research by examining Microsoft, one of the world’s most successful software corporations. You quickly discover that, as of 1997, Microsoft had never paid a dividend. Furthermore, the company’s 1997 balance sheet reported holdings of nearly Rs. 9 billion in cash and highly liquid securities. With all of these liquid resources available, why do you suppose that Microsoft has never paid a cash dividend to its stockholders?
As the cash balance as well as liquid securities of the company are on high side which dep icts that the company has never paid cash dividend but paid stock dividend instead of cash dividend. if the company had paid cash dividend , its cash balance and liquid securities would have been reduced.
Paper#2
Question No: 43 ( Marks: 3 )
If the retained earnings account has a debit balance, how is it presented in the balance sheet and what is it called?
If a corporation has experienced significant net losses since it was formed, it could have negative retained earnings (reported as a debit balance instead of the normal credit balance in its Retained Earnings account). When this is the case, the account is described as “Deficit” or “Accumulated Deficit” on the corporation’s balance sheet.
Question No: 44 ( Marks: 3 )
Using the following information, compute the dividend yield to the nearest tenth.
Income Rs. 130,000
Beginning shares outstanding 250,000
Ending shares outstanding 270,000
Current price per share Rs. 7.50
Dividend per share Rs. 1.20
Dividend yield = divi per share / market price
= 1.20/7.50
= 0.16*100
=16%
Question No: 45 ( Marks: 3 )
What information is provided by the balance sheet to the short term and log term creditors?
short-term creditors: Interest of short-term creditors is to watch the ability of business to meet its debts as these become due; i.e. Short-term solvency. They want to see whether business has the ability to meet its current liabilities out of its current assets. If the entity can not maintain a short-term debt paying ability, it will not be able to maintain a long-term debt-paying ability, nor will it be able to satisfy its stockholders.
long-term creditors: Interest of long-term creditors is to see the long-term solvency of the business and rate of return on their loans. Solvency is the ability to meet outside liabilities from total assets. Indicators of solvency are the Long-term Solvency, which are as follows:-
i) Debt –To-Total-Assets: The debt-to-total assets ratio is derived by dividing a firm’s
total debt by its total assets: It indicates percentage of total assets financed by debt
= Total outside liabilities /Debt = 75 = 37.5%
Total assets (total liabilities +shareholders funds) 200
Question No: 46 ( Marks: 5 )
Assume that you are a commercial loan officer at a large bank. One of your clients recently submitted an application for Rs. 300,000 five year loan. You have worked with this business before on numerous occasions and have periodically been forced to deal with late and missed payments attributed to cash flow problems. Thus you are surprised to see in the business plan accompanying the application that the management expects to reduce the company s operating cycle from 190 days to 90 days. A footnote to the business plan indicates that the reduction in the operating cycle will result from a tighter credit policy and the implementation of a just-in-time inventory system.
Requirement:
Would the company be able to reduce the operating cycle by applying the new strategy and would you give the loan to the company on this basis?
As the company has reduced its operating cycle from 190 days to 90 days which has tightened the credit policy, as a result of which sales of the company will be reduced which will decrease the revenue of the company and profit of the company will also be decreased. Implementations of just in time inventory system will also tight the liquid position of the company. Keeping in view this situation, application for loan of Rs. 300,000 will not be exceed to by the bank.
Question No: 47 ( Marks: 5 )
In each of the following situations, indicate the form of organization that you would expect the business to take.
a) A neighborhood lawn-moving business operated by a teenager
b) A company organized to manufacture an electric car
c) A small retail clothing store, owned and operated by a brother and sister
d) A medical group consisting of six doctors, organized in a state that does not allow professional practices to incorporate.
e) A flight school owned by an airline pilot. The business is profitable, but the owner uses the profits to buy planes and expand the business.
a) Sole Proprietorship
b) Limited company
c) Sole proprietorship
d) partnership firm
e) Sole proprietorship
paper#3
Question No: 49 ( Marks: 3 )
What do you understand by the efficiency of the operating cycle?
Efficiency of operating cycle/process: It is determined by activity ratios, keeping in view the
conversion process, which is as follows:-
Cash/assets —- → Inventory —-→ Receivables —- → Cash
Processing Sales, collection
Operating Cycle=Inventory sale days (average) +Receivable Collection days (average).
The shorter the operating cycle, the higher the quality of current assets and the greater the efficiency of management.
Question No: 50 ( Marks: 3 )
What will be the effect on the book value per share of the common stock of a company, if the corporation obtains a loan?
When a corporation obtains a bank loan there is no effect upon book value per share of common stock. Assets and liabilities both increase by its amount. Therefore, net assets will remain unchanged.
Question No: 51 ( Marks: 5 )
Current assets and current liabilities data for companies D and E are summarized as follows:
|
Company D |
Company E |
|
| Current assets |
Rs. 400,000 |
Rs. 900,000 |
| Current liabilities |
200,000 |
700,000 |
| Working capital |
Rs. 200,000 |
Rs. 200,000 |
Requirement:
Evaluate the relative liquidity of the companies. Which company is more favorable?
For Company D:
Current Ratio = Current Assets / Current Liabilities
= 400,000 / 200,000
= 2
For Company E:
Current Ratio = Current Assets / Current Liabilities
= 900,000 / 700,000
= 1.285
Company D is more liquid then E.
Question No: 52 ( Marks: 5 )
Following is the balance sheet of the ABC Company.
ABC Corporation
Balance Sheet
Mar. 31, 1991
| Assets | |
| Cash |
Rs. 12,500 |
| Notes receivables |
104,000 |
| Accounts receivables (net) |
68,500 |
| Inventories at cost |
50,000 |
| Plan & equipment (net of depreciation) |
646,000 |
| Total assets |
Rs. 881,000 |
| Liabilities & Stockholder’s equity | |
| Accounts payable |
Rs. 72,000 |
| Notes payable |
54,500 |
| Accrued liabilities |
6,000 |
| Common stock (60,000 shares, Rs. 10par) |
600,000 |
| Retained earnings |
148,500 |
| Total liabilities and owner’s equity |
Rs. 881,000 |
Requirement:
Calculate the current ratio and quick ratio for both years. (2.5+ 2.5)
Current Ratio=Current Assets / Current Liabilities
= 235,000 / 132,500
= 1.77
Quick Ratio = Current Assets – Inventories / Current Liabilities
= (235,000 – 50,000) / 132,500
= 185,000 / 132,500
= 1.39
Question No: 53 ( Marks: 5 )
You have been given the two years data of XYZ company as follows:
2005 2004
Net sales 1,493,622 1,403,243
Assets:
Beginning of the year 1,039,731 889,584
End of year 1,1143701 1,039,731
Calculate the Total Assets Turnover ratio for both years.
For Year 2005:
Total Assets Turnover Ratio = net sales / total assets
= 1,493,622 / 1, 114, 3701
= 0.134
For Year 2004:
Total Assets Turnover Ratio = 1,403,243/ 1,039,731
= 1.349
Paper#4
Question No: 45 ( Marks: 3 )
How does working capital help management in making rationale decisions?
Management of working capital
Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.
- Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
- Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials – and minimizes reordering costs – and hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic production quantity (EPQ).
- Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
- Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to “convert debtors to cash” through “factoring“.
Question No: 46 (Marks: 5 )
Consider the following information.
Cash Rs. 15,000
Beginning net receivables Rs. 55,000
Ending net receivables Rs. 57,000
Net sales Rs. 640,000
Net credit sales Rs. 480,000
Cost of goods sold Rs. 390,000
Average inventory Rs. 62,000
Requirement:
Compute the receivable turnover to the nearest tenth.
Receivables turn over ratio = Net credit sales /Average Debtors
= 480,000 / [(55,000+57,000)/2]
= 480,000 / 56,000
= 8.57
Question No: 48 (Marks: 5 )
Assume that you are a graduate student and going to form a web page consultancy firm. You are very young and compassionate to form this company. You need a bank loan of Rs.50,000 for computer equipment , as a collateral you have a bike your father gave you after securing 80% marks in FSc. Not wanting to lose your bike and to protect yourself you decided to organize a corporation. Explain will it be beneficial idea for you or not.
At the time of giving loan, the bank needs collateral as a security by hypothecation of bike in favour of bank in order to secure its loan in case of default but the physically the bike will remain in use with the graduate student. I will be a beneficial idea to form a wed page consultancy firm.
Question No: 49 (Marks: 10 )
The data shown below were taken from the financial records of J Ltd at the end of the year. The financial year of the company ends on 31, December each year.
| Accounts Payable | Rs 50,000 | Accrued Liabilities | Rs. 33,000 |
| Cash | 32,000 | Inventories Jan | 42,000 |
| Inventories Dec | 38,000 | Marketable Securities | 10,000 |
| Operating Expenses | 120,000 | Prepaid Expenses | 25,000 |
| Purchases (Net) | 360,000 | Accounts Receivable Jan | 61,000 |
| Accounts Receivable Dec | 61,000 | Long Term Loan | 150,000 |
| Plant Assets | 400,000 | Sales | 604,000 |
| Sales Returns | 20,000 | Retained Earning | 133,000 |
| Share Capital (Rs.10 Par) | 92,000 | Market Price | 18 |
| Interest expense | 30,000 |
On the basis of above information, calculate the following.
Debt to equity ratio (2)
Ratio of borrowed capital to Shareholders’ funds is called
Debt – Equity Ratio. The debt-to-equity ratio is computed by simply dividing the total debt of the firm (including current liabilities) by its shareholders’ equity:
= 2,90,000 = 0.6 i.e. Debt is 0.6 of Equity =Debt Ratio = 48.4: 62.5
1,65,6000 Equity Ratio
(Debt equity Ratio)
Debt to total asset ratio (4)
Debt –To-Total-Assets: The debt-to-total assets ratio is derived by dividing a firm’s
Total debt by its total assets: It indicates percentage of total assets financed by Debt
= Total outside liabilities /Debt = 2,90,000 = 48.4%
Total assets (total liabilities +shareholders funds) 5,99,000
Equity ratio: Total stockholders equity (including preferred stock) = 16,56,000 = 276.46%
Total assets (total liabilities + shareholders funds) 5,99,000
Question No: 50 ( Marks: 10 )
How many types of audit opinions are there? Assume that you have been appointed as an Auditor of the company, after the audit of the company, what can be your possible audit opinions. Briefly explain each of the audit opinion.
Paper#5
1) differentiate between profit and profitability(3 marks)
Profit is one of financials performances of a company and an evidence of its success, which is achieved if the income exceeds the expenses. Profit growth determines the potential growth of the company, increases its business activity.
The term “profitability” has its origin from the rent, which literally means income. Thus, the term “profitability” in broad sense refers to yield, revenue performance and efficiency.
Profitability indicators are used for comparative assessment of individual businesses performance and industries that produce different amounts and types of products.
The ability of a company to earn a profit. It is a relative measure of success for a business.
Ability of a firm to generate net income on a consistent basis. It is often measured by price to earnings ratio.
2) why retained earnings are more preferable for stockholders than net income?(3 marks)
Retained earnings are more preferable for stockholders because retained earning are part and parcel of equity capital. While calculating the net worth of the business, equity capital + retained earnings + additional paid in capital are add up. Book value per share increases as the retained earnings increases.
Question No: 49 ( Marks: 3 )
What do you understand by the efficiency of the operating cycle?
It is determined by activity ratios, keeping in view the conversion process, which is as follows:-
ANSWER
Efficiency of operating cycle/process: It is determined by activity ratios, keeping in view
the conversion process, which is as follows:-Cash/assets —- → Inventory —-→ Receivables —- → Cash
Processing Sales, collection
Operating Cycle=Inventory sale days (average) +Receivable Collection days (average).
The shorter the operating cycle, the higher the quality of current assets and the greater the efficiency of management
Question No: 50 ( Marks: 3 )
What will be the effect on the book value per share of the common stock of a company,if the corporation obtains a loan?
ANSWER
When a corporation obtains a bank loan there is no effect upon book value per share of common stock. Assets and liabilities both increase by its amount. Therefore, net assets
will remain unchanged.
Question No: 51 ( Marks: 5 )
Current assets and current liabilities data for companies D and E are summarized as follows:
Company D Company E
Current assets Rs. 400,000 Rs. 900,000
Current liabilities 200,000 700,000
Working capital Rs. 200,000 Rs. 200,000
Requirement:
Evaluate the relative liquidity of the companies. Which company is more favorable?
ANSWER
1. For Company D:
Current Ratio = Current Assets / Current Liabilities
= 400,000 / 200,000
= 2
2. For Company E:
Current Ratio = Current Assets / Current Liabilities
= 900,000 / 700,000
= 1.285
SO Company D is more favorable then E
Question No: 52 ( Marks: 5 )
Following is the balance sheet of the ABC Company.
ABC Corporation
Balance Sheet
Mar. 31, 1991
Assets
Cash Rs. 12,500
Notes receivables 104,000
Accounts receivables (net) 68,500
Inventories at cost 50,000
Plan & equipment (net of depreciation) 646,000
Total assets Rs. 881,000
Liabilities & Stockholder’s equity
Accounts payable Rs. 72,000
Notes payable 54,500
Accrued liabilities 6,000
Common stock (60,000 shares, Rs. 10par) 600,000
Retained earnings 148,500
Total liabilities and owner’s equity Rs. 881,000
Requirement:
Calculate the current ratio and quick ratio for both years. (2.5+ 2.5)
ANSWER
1. Current Ratio=Current Assets / Current Liabilities
= 235,000 / 132,500
= 1.77
2. Quick Ratio = Current Assets – Inventories / Current Liabilities
= (235,000 – 50,000) / 132,500
= 185,000 / 132,500
= 1.39
Question No: 53 ( Marks: 5 )
You have been given the two years data of XYZ company as follows:
2005 2004
Net sales 1,493,622 1,403,243
Assets:
Beginning of the year 1,039,731 889,584
End of year 1.143701 1,039,731
Calculate the Total Assets Turnover ratio for both years.
ANSWER
1. For Year 2005:
Total Assets Turnover Ratio = 1,493,622 / 1, 114, 3701
= 0.134
2. For Year 2004:
Total Assets Turnover Ratio = 1,403,243/ 1,039,731
= 1.349
Question No: 46 (Marks: 5 )
Consider the following information.
Cash Rs. 15,000
Beginning net receivables Rs. 55,000
Ending net receivables Rs. 57,000
Net sales Rs. 640,000
Net credit sales Rs. 480,000
Cost of goods sold Rs. 390,000
Average inventory Rs. 62,000
Requirement:
Compute the receivable turnover to the nearest tenth.
Receivables turn over ratio = Net credit sales /Average Debtors
= 640,000 / [(55,000+57,000)/2]
= 640,000 / 56,000
= 11.43
Question No: 44 (Marks: 3)
Using the following information, compute the dividend yield to the nearest tenth.
Income Rs. 130,000
Beginning shares outstanding 250,000
Ending shares outstanding 270,000
Current price per share Rs. 7.50
Dividend per share Rs. 1.20
Dividend Yield
Some stockholders invest primarily to receive regular cash income in the form of dividends. Others do so to secure capital gains through rising market price of common stock.
Dividend yield = Dividend per share x 100
Market price per share
= 1.20 x 100 = 16%
Question No: 53 ( Marks: 5 )
Assume that you wish to invest in the stocks of a high-tech corporation and that one of your investments goals is to receive dividend income from the stocks that you purchase. You begin your research by examining Microsoft, one of the world’s most successful software corporations. You quickly discover that, as of 1997, Microsoft had never paid a dividend. Furthermore, the company’s 1997 balance sheet reported holdings of nearly Rs. 9 billion in cash and highly liquid securities. With all of these liquid resources available, why do you suppose that Microsoft has never paid a cash dividend to its stockholders?
As the cash balance as well as liquid securities of the company are on high side which depicts that the company has never paid cash dividend but paid stock dividend instead of cash dividend. if the company had paid cash dividend , its cash balance and liquid securities would have been reduced.
Question No: 45 ( Marks: 3 )
What information is provided by the balance sheet to the short term and log term creditors?
Short-term creditors: Interest of short-term creditors is to watch the ability of business to meet its debts as these become due; i.e. Short-term solvency. They want to see whether business has the ability to meet its current liabilities out of its current assets. If the entity can not maintain a short-term debt paying ability, it will not be able to maintain a long-term debt-paying ability, nor will it be able to satisfy its stockholders.
Long-term creditors: Interest of long-term creditors is to see the long-term solvency of the business and rate of return on their loans. Solvency is the ability to meet outside liabilities from total assets. Indicators of solvency are the Long-term Solvency, which are as follows
Debt –To-Total-Assets: The debt-to-total assets ratio is derived by dividing a firm’s total debt by its total assets: It indicates percentage of total assets financed by debt = Total outside liabilities /Debt = 75 = 37.5% Total assets (total liabilities +shareholders funds) 200
Some analyst argues that deferred tax should be included in the debt of the company. Why? 3
some analysts may consider preferred stock as debt rather than equity in this calculation, and some analysts also argue that deferred taxes should be considered in the debt portion of the calculation because some forms of deferred taxes may never be paid and are thus part of a company’s capital base.
Why It Matters:
- In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations. However, low debt-to-equity ratios may also indicate that a company is not taking advantage of the increased profits that financial leverage may bring.
- Capital-intensive industries tend to have higher debt-to-equity ratios than low-capital industries because capital-intensive industries must purchase more property, plants, and equipment to operate. This is why comparison of debt-to-equity ratios is generally most meaningful among companies within the same industry, and the definition of a “high” or “low” ratio should be made within this context.
List down the component of stockholders equity 3
Stockholders’ equity represents the claim that the corporation’s shareholders have to the company’s net assets. As an auditor you have to account for net assets.
Stockholders’ equity has three common components:
- Paid-in capital,
- Treasury stock,
- Retained earnings
State and explain any five generally acceptable accounting principles. 5
Following are some of the Generally Accepted Accounting Principles:
- Entity principle/ separate entity principle: According to this principle, a business is treated as a separate entity from the owner. The owner’s private expenditure/spending are not recorded in the books of the business entity. For example money received as prize by a person have no effect on the books of accounts because no business transaction is involved.
- Cost principle: according to this principle an asset on the balance sheet is recorded based on its nominal or original cost when acquired by the company.
- Going-concern assumption: The ‘going concern’ concept in accounting is an assumption that the business will continue to exist for the foreseeable future. This assumption is also closely related to cost principle as without the ‘going concern’ concept, accountants would have to record all assets at current price instead of historical cost.
- Objectivity principle: definite, factual basis for assets valuation; measuring transactions objectively. An accounting principle according to which information that is supplied in a company’s financial statement must be supported by actual and real evidence and should not be based on personal feeling or opinion.
- Stable currency principle. The currency remains more or less stable and rate of inflation is almost zero.
- Adequate disclosure concept: facts necessary for proper interpretation of statements; “subsequent events”, lawsuits against the business, assets pledged as securities/collaterals, contingent liabilities etc; reflected in Notes.
Debt is not always a bad thing. Explain 3
Debt is not always a bad thing. In fact, there are instances where the leveraging power of a loan actually helps put you in a better overall financial position.
The chance that you can pay for a new home in cash is slim. Carefully consider how much you can afford to put down and how much loan you can carry. The more you put down, the less you’ll owe and the less you’ll pay in interest over time.
Although it may seem logical to plunk down every available dime to cut your interest payments, it’s not always the best move. You need to consider other issues, such as your need for cash reserves and what your investments are earning.
What info is contained in Balance sheet which is of interest to short term n long term creditors? 3marks.
The three key sections of a balance sheet are:
- Assets
- Liabilities
- Owner’s equity
Assets and liabilities are sub-divided into current (short-term) and non-current (long-term) and may have several components within each sub-division such as cash at bank, inventory, property, accounts payable, or business bank loans. The individual items will differ depending on the nature of the business and industry.
It is called a balance sheet because assets minus liabilities (net assets) must equal the owner’s equity (they must balance).
A balance sheet is based on the formula:
Owner’s equity = Assets – Liabilities
What is vertical & common size analysis? What is its usefulness? 3marks
Component percentages/ Vertical Analysis/ Common- Size Analysis: This type of analysis indicates the relative size of each item in the Financial Statements as a percentage of the total of that Statement i.e. Total Assets or total Liabilities & Shareholders equity in Balance Sheet and Sales in Income Statement. Such a statement is then called common-size Financial Statement. This type of analysis technique is also called Vertical Analysis.
Assume that company had total assets turnover of 1.5, net profit margin of 6% and assets of Rs. 5000,000 and liabilities of Rs. 3000,000.
Requirement: Calculate net sales and net income. 5
answer
Total asset turn over = sales/assets
1.5 = net sales/5000, 000
Net sales =.1.5*5000, 000 =7500, 000
Net income= net sales *given %of profit/sales %
Net income = 7500, 000*6/100
Net income =450,000
Why stock holder preferred earning per shares rather then net income? 3 marks
An earnings measure calculated by subtracting the dividends paid to holders of preferred stock from the net income for a period and dividing that result by the average number of common shares outstanding during that period. EPS is the amount of reported income, on a per-share basis, that a firm has available to pay dividends to common stockholders or to reinvest in it. As with other financial measures, EPS can vary with differing accounting techniques; therefore, reported EPS may give a very misleading signal as to how the firm is really doing. Also called income per share. See also basic earnings per share, diluted earnings per share.
Can a stock have negative price to earning ratio. Support your answer with valid reason. 3
Yes, a stock can have a negative price-to-earnings ratio (P/E), but it is very unlikely that you will ever see it reported. Although negative P/E ratios are mathematically possible, they generally aren’t accepted in the financial community and are considered to be invalid or just not applicable.
We’ll explain why this is.
The price-earnings ratio is arguably the most popular fundamental factor used by investors who try to determine the attractiveness of an asset’s current value and, more importantly, whether the current price level makes for a good buying opportunity. The ratio is calculated by dividing a financial asset’s current share price by its per-share earnings. Generally speaking, a low P/E value suggests that an investor needs to pay a low amount for each dollar of earnings made by the company. This could be used by investors as a sign that the given asset is undervalued and a potentially good investment at current levels. Conversely, a relatively high P/E value is used to suggest that investors will need to pay a high amount for the company’s earnings, which can then be used to suggest that the asset is relatively expensive and that it may be a good idea to wait for a better entry.
Mathematically, there are only two ways for a ratio of this form to have a negative value:
- The numerator falls below zero
- The denominator falls below zero.
In the case of the P/E ratio, it is impossible for the numerator to fall below zero because this represents the price of the asset. However, the denominator, which is equal to the earnings of the company, can become negative. EPS values below zero mean that the company is losing money and is the reason why it is possible to have a negative P/E ratio.
Negative EPS numbers are usually reported as “not applicable” for quarters in which a company reported a loss. Investors buying a company with a negative P/E should be aware that they are buying a share of a company that has been losing money per share of its stock.
Question No: 50 ( Marks: 3 )
What will be the effect on the book value per share of the common stock of a company, if the corporation obtains a loan?
When a corporation obtains a bank loan there is no effect upon book value per share of common stock. Assets and liabilities both increase by its amount. Therefore, net assets will remain unchanged.
Explain the dividend or share?
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be distributed to shareholders. There are two ways to distribute cash to shareholders: share repurchases or dividends. Many corporations retain a portion of their earnings and pay the remainder as a dividend.
A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of after tax profits among shareholders. Retained earnings (profits that have not been distributed as dividends) are shown in the shareholder equity section in the company’s balance sheet – the same as its issued share capital. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from the fixed schedule dividends.
What is the accurate picture of profitability of business?
Profitability is the primary goal of all business ventures. Without profitability the business will not survive in the long run. So measuring current and past profitability and projecting future profitability is very important.
Profitability is measured with income and expenses. Income is money generated from the activities of the business. For example, if crops and livestock are produced and sold, income is generated. However, money coming into the business from activities like borrowing money do not create income. This is simply a cash transaction between the business and the lender to generate cash for operating the business or buying assets
Difference in cost & expense
Cost is the price of an asset. Sometimes it is called “cost basis.” The cost basis of an asset includes every cost to purchase, acquire, and set up the asset, and to train employees in its use. For example, if a manufacturing business buys a machine, the cost includes shipping, set-up, and training. Cost basis is used to establish the basis for depreciation and other tax factors.
An expense, on the other hand, doesn’t usually have an asset attached to it. An expense is an ongoing payment, like utilities, rent, payroll, and marketing. You could say that an expense is a cost of doing business, but I am going to avoid that word. Expenses are used to produce revenue and they are deductible, reducing the business’s income tax bill.
For example, the expense of rent is needed to have a location to sell from, to produce revenue. The cost of a business phone is required to take calls from customers who want to buy the business’s products and services. There is usually no asset associated with an expense. Although we use the term “cost” with expenses, they are really just payments.
Cost of goods sold
Cost of goods sold is the cost of goods consumed plus any other charge paid in bringing the goods in salable condition. For example, if business purchased certain items for resale purpose and any expense is paid in respect of carriage or bringing the goods in store (transportation charges). These will also be grouped under the heading of ‘cost of goods sold’ and will become part of its price. In manufacturing concern, cost of goods sold comprises of purchase of raw material plus wages paid to staff employed for converting this raw material into finished goods plus any other expense in this connection.
Income statement
Income Statement summarizes operating results of a business by matching revenues with expenses over the same accounting period.
Net income is the increase in owner’s equity resulting from profitable operations of a business. This is accompanied by increase in total assets, (but not necessarily cash) or decrease in total liabilities. It may happen that a profitable business may also run short of cash, because the profit that it earns is tied up in other assets i.e. Accounts Receivables, fixed assets etc or else, it was used in paying out its obligations like Accounts Payable etc. Net loss is the corresponding decrease in owner’s equity.
Elements of Income Statement
- Revenues
- Expenses
Why ERP is important
An organization that has no ERP will be running on many kinds of software that do not allow interaction. Customization also may be difficult it in some cases. This will negatively affect the optimized functioning of organization’s business activities.
The organization will be facing hardship in many areas of its functions. The engineering design of the software will be needed in order to improve the product, and to follow the client’s behavior and choices since the first contact is quite important. Administration of the different receipts interdependence will be very complex, such as invoices regarding materials purchases, general expenditures or salaries.
Receivable turn over
An accounting measure used to quantify a firm’s effectiveness in extending credit as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets.
Formula:
Some companies’ reports will only show sales – this can affect the ratio depending on the size of cash sales.
Operating cycle and cash cycle
The operating cycle starts with acquiring of inventory or raw material ands ends with receipt of payments of your good.
Operating Cycle=Inventory sale days (average) +Receivable Collection days (average).
Cash Cycle
The cash cycle starts when you pay your supplier and ends when your buyer pays you.
Or
The length of time from the actual outlay of cash for purchases until the collection of receivables resulting from the sale of goods or serv
a) how much cash Haris will pay? Marks 2
Cost of new machine 75000
Trade in allowance 15000
Cash payment 60000
b) What would be the gain or loss if the first crane is disposed off? Marks.3
Cost of old crane 60000
Less accumulated deprecation (48000)
Book value of crane 12000
Trade in allowance 15000
Profit on exchange 3000
Ahmad Incorporation has Owner’s Equity of amount Rs.75, 000 as an opening balance. During the period, three major transactions occurred:
Issuance of stock: Rs.22, 000
Dividend distribution: Rs.10, 000
Net Loss: Rs.6, 000.
Based on these transactions, what would be the Ahmad’s ending balance of Owner’s Equity?
Owner’s Equity (beg) 75000
Add; Stocks Issued 22000
Less; Dividend distribution 10000
Less; Net Loss 6000
Owner’s Equity (end) 81000
Assume that you are a commercial loan officer at a large bank. One of your clients recently submitted an application for Rs. 300,000 five year loans. You have worked with is business before on numerous occasions and have periodically been forced to deal with late and missed payments attributed to cash flow problems. Thus you are surprised to see in the business plan accompanying the application that the management expects to reduce the company s operating cycle from 190 days to 90 days. A footnote to the business plan indicates that the
Reduction in the operating cycle will result from a tighter credit policy and the implementation of a just-in-time inventory system. Requirement: Would the company be able to reduce the operating cycle by applying the new strategy and would you give the loan to the company on this basis?
As the company has reduced its operating cycle from 190 days to 90 days which has tightened the credit policy, as a result of which sales of the company will be reduced which will decrease the revenue of the company and profit of the company will also be decreased. Implementations of just in time inventory system will also tight the liquid position of the company. Keeping in view this situation, application for loan of Rs. 300,000 will not be exceed to by the bank.
Differentiate between profit n profitability (3 marks)
Indicators of profitability: Difference between Profit and Profitability. Profit is an absolute figure whereas profitability is ratio of profit to some other item like sales.
Why retained earnings are more preferable for stockholders than net income? (3)
Retained earnings is an element of stockholders equity, does not indicate the form in which these resources are currently held. These may have been invested in land, building, equipment or any other assets, or might have been used in liquidating debts.
OR
Retained earnings are more preferable for stockholders because retained earning are part and parcel of equity capital. While calculating the net worth of the business, equity capital + retained earnings + additional paid in capital are add up. Book value per share increases as the retained earnings increases.
How does working capital help management in making rationale decisions?
Arithmetically it is the difference of Current Assets and Current Liabilities. Two companies with same working capital can have different current ratios. Similarly two companies may have same current ratio but different working capital. the more efficient the inventory management of the firm and the “fresher” more liquid,
Working capital turnover ratio = Cost of sales or Net sales
Net working capital
OR
Management of working capital Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.
- · Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
- · Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials – and minimizes reordering costs – and hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic production quantity (EPQ).
- · Debtor’s management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
- · Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to “convert debtors to cash” through “factoring”.
Working capital management involves the relationship between a firm’s short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash.
Working Capital = Current Assets – Current Liabilities
What information is provided by the balance sheet to the short term and log term creditors? (3)
Balance sheet showing financial position at the end of the accounting period i.e. a Picture of what the business owns and what it owes.
Balance sheet is the summarized analysis in a ‘T’ form of all assets and liabilities of the entity, with liabilities listed on left hand side and assets on right hand side. Asset is any owned physical object (tangible asset) or a right (intangible asset) having economic value to the owner. Liability is an obligation of the business to deliver goods or to provide a benefit in future.
If the retained earnings account has a debit balance, how is it presented in the balance sheet and what is it called? (3)
The amount it keeps is the balance in a stockholders’ equity account called Retained Earnings. This general ledger account is a real or permanent account with a normal credit balance.
a corporation has experienced significant net losses since it was formed, it could have negative retained earnings (reported as a debit balance instead of the normal credit balance in its Retained Earnings account). When this is the case, the account is described as “Deficit” or “Accumulated Deficit” on the corporation’s balance sheet.
3) Assume that you are a commercial loan officer at a large bank. One of your clients recently submitted an application for Rs. 300,000 five year loans. You have worked with this business before on numerous occasions and have periodically been forced to deal with late and missed payments attributed to cash flow problems. Thus you are surprised to see in the business plan accompanying the application that the management expects to reduce the company’s operating cycle from 190 days to 90 days. A footnote to the business plan indicates that the reduction in the operating cycle will result from a tighter credit policy and the implementation of a just-in-time inventory system.
Requirement: Would the company be able to reduce the operating cycle by applying the new strategy and would you give the loan to the company on this basis? (5)
Operating cycle is the time required to purchase or manufacture inventory, sell the product and collect cash.
Just in time (JIT) Inventory System. In this case, the purchase of merchandise or raw
materials and component parts is done just in time for sale or for use in manufacture; It reduces money “tied-up” in inventory of raw material and finished goods. There is no need to maintain large inventory storage facilities. But the disadvantage is that delay in arrival of raw material may halt operations.
OR
As the company has reduced its operating cycle from 190 days to 90 days which has tightened the credit policy, as a result of which sales of the company will be reduced which will decrease the revenue of the company and profit of the company will also be decreased. Implementations of just in time inventory system will also tight the liquid position of the company. Keeping in view this situation, application for loan of Rs. 300,000 will not be exceeding to by the bank.
Financial leverage
Leverage: It means operating a business with borrowed money. It should be used to earn a return (on assets or equity) greater than cost of borrowing i.e. interest. Alternate term for this is “Gearing”.