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Acct10001 Tutorial Notes

Accounting Reports And Analysis (University of Melbourne)

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Acct10001 Accounting Reports and Analysis

Undergraduate; BSC Year 1

Semester 1 2019

Tutorial Notes

Julia Hooke

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05/03/2019 – Intro to Accounting

ASSESSMENT
- Tutorial-based (10%)
o Prep quizzes
o Assessable tests
- Assignments (20%)
o 1: Transaction analysis and financial statement preparation
o 2; Financial statement analysis
- Exam (70%)
o Hurdle requirement
o 3 hour closed book

Tutor: [email protected]

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14/03/2019 – Tutorial Notes 1

NUMBER OF DECISION SHARE OF EXTENT OF

OWNERS MAKING PROFITS LIABILITY
SOLE TRADER 1 Owner Owner
PARTNERSHIP Shared between Unlimited
220 Partners
partners
PRIVATE
150
COMPANY Board of
Dividends Limited
PUBLIC Directors
1 infinite
COMPANY

Example 1: Is a customer who owes us money an asset?

Yes. We have control of the money that is owed as it is a legal right. It has future economic
benefit for the business. It arrives from selling goods on credit.
- Probable inflow of FEB
- Cost/value can be measured
 Can be recognised in balance sheet

Example 2: Is the entity’s good reputation an asset?

Yes. It is an intangible asset. It has future economic benefit in selling the company. It arises
from past events of performance. The company can have control over their reputation.
- Probable inflow of FEB can reasonable assumed
- Cost/value cannot be measured reasonably
 Cannot be recognised in the balance sheet
 Good will: difference between value and cost of assets

LIABILITIES
Example 3: Is money borrowed from the bank a liability?
Yes. It will result in future outflow from the business and cannot be controlled. It arises from
past events of a loan.
- Future outflow of cash
- Present obligation to pay money
 Can be recognised in the balance sheet

Example 4: Have ordered goods from a supplier but the goods have not been delivered nor
have we paid for them?
It is just preparation for a transaction, not an actual business transaction therefore it cannot
be classified as an asset or liability.
- No obligation as there is no transactions
- Money isn’t expected to outflow as the goods aren’t delivered yet
 Can’t be recognised as a liability

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INCOME
Income  increase in asset or decrease in liability
Borrowing money from a bank cannot be income as the liabilities increase with assets

Example 5: Provided services on credit.

Increases in accounts receivable (asset)  increase in equity and income
- Increase in assets not because of contributing equity
- Therefore, it is income

Example 6: The customer from above pays us the amount owed 60 days after service.
Decrease in (accounts receivable) asset but increase in cash inflow asset  not
change/income
- Increase in asset of cash
- Decrease in accounts receivable
- Cancels out and no change in equity/ not an income

EXPENSES
Example 7: Paid wages
An expense as a decrease in cash is an increase in liabilities.
- Increase in other current liabilities
- Decrease in assets (cash)
Example 8: Payment of a dividend
Decrease in cash but it is paid to the shareholders therefore it is not an expense.
- Decrease in assets
- Caused by shareholders so it isn’t an expense
- Money is paid to shareholders

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27/03/2019 – Tutorial Notes 3

ASSETS
Doubtful  based off past transactions/information
- Check credit terms  guidelines of when you want to be paid back
- Check previous records with customers

INVENTORIES
Inventories at cost
- Worked-in-process; accounting for labor. eg, a half-done chair
- Finished good; wages, delivery, materials of putting together the final good
- Raw materials
Inventories at net realisable value
- Net realisable value  lowest cost of selling (including delivery, etc.)
o Lowest out of cost to make and value of finished goods

QUESTION 1: Under what circumstances would inventory’s net realisable value fall below
cost?
- Broken or damaged
- Old chairs not needed
- Market is overflooded with chairs
- General economic decline

QUESTION 2: Critically analyse entity’s inventories.

- Making a lot  work in progress
- But not many finished goods
- Can’t sell 100,000 inventories if it’s all work in process
- Most of finished goods (50,000/55,000) are at NRV  sold for less than what it cost
to make them

QUESTION 3: Discuss whether cost or fair value would be the most appropriate basis
under which to report:
- Land and buildings  fair value; more relevant, land is intangible (and can’t be
depreciated), worth more, heritage buildings, change in value of money (inflation)
- Works of art/other collections  If artist is more popular would use fair value
- Plant and equipment  old – fair value or recent – cost, despite depreciation, value
shouldn’t change too much because it’s not a long-term asset

QUESTION 4: Rank from highest to lowest of depreciation rate; buildings, motor vehicles,
furniture, computing equipment:
1. Computing equipment (1-2 years)  33.33%
2. Motor vehicles (5 years)  20%
3. Furniture (20 years)  10%
4. Buildings (50 years)  2.5%

QUESTION 5: Comment of the accumulated depreciation relative to the buildings.

The depreciation is only 7% of the buildings suggesting the buildings are only 3 years old.
Since the buildings are old, the depreciation must be from the time of the last revaluation.

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04/03/2019 – Tutorial Notes 4 (absence)

QUESTION 1A: A business misclassified large borrowings as non-current rather than

current liabilities. What is the importance of such classification? Are there potential
agency issues?
- Lenders would want to know before lending any more money to see whether the
business will be able to meet repayments
- Shareholders would want to know whether the business will be able to make
repayments
- Business may be calculating ratios etc. wrong due to error in current/non-current
liabilities

QUESTION 1B: Directors claimed that there had been a recent change to accounting
standards and some ‘greyness’ in its interpretation. They also claimed the documentation
was too complex. Is this reasonable?
- Directors need to be able to give correct information, or else need to bring someone
in who can provide the correct information
- Directors are expected to have a certain level of financial literacy and understanding
of basic accounting conventions
- Directors take ultimate responsibility for the financial statements, as they sign-off on
them as being true and fair and complying with CA 2001 and AASBs

QUESTION 2 – Emerged that VW deliberately installed software that manipulated nitrogen

oxide output that would result in cars emitting more than what is allowed. This resulted in
a lawsuit in which VW faced payments of $7.3 billion to fix the cars as well as other legal
charges. VW then announced that it would postpone the release of financial results as
there was too much uncertainty.
Consider the likely impacts this scandal would have had.
- Payments which are probable would be recognised as a provision
- Fines from lawsuit etc. are possible but more unknown and difficult to estimate, so
this would be likely disclosed in notes as a contingency

QUESTION 3A – Balance sheet of ARA Investments Ltd reveals total liabilities of $56 million
and net assets of $84 million. The average rate charged by lenders is 6.25%.
What is the rate of return required by investors?
- Rate of return required would be higher than 6.25% as investors would want to earn
a greater return given the larger risk of investing in a business rather than just putting
money in the bank
- The analysis determines that the rate of return required by investors is 12.5%.

QUESTION 3B – Determine the weighted average cost of capital (WACC).

- = ((56/(84+56)) x 6.25) + ((84/(84+56)) x 12.5) = 0.1
- WACC = 10%

QUESTION 3C – Assume that ARA Investments Ltd is exempt from income tax and that its
earnings before interest for the year ending 2018 was 11% of total assets.
Discuss whether or not shareholders would be satisfied with this result.

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- ROA (Earnings Before Interest and Tax/TA) vs ROE (Net Profit After Tax/Equity)
- ROA=11%, therefore EBIT = 11% x 140 = 15.4
- Interest = 56 x 6.25 = 3.5
o NPAT = 15.4 – 3.5 = 11.9
- ROE = 11.9/84 = 14%
- Shareholders would therefore be satisfied

QUESTION 4: Assume earnings before interest for the year was 8% of total assets.
Discuss whether or not lenders would be satisfied. Does the fact ROA < WACC suggest ARA
Investments made a loss for the year?
- ROA = 8% < WACC = 10%
- Lenders not too concerned about returns on assets, just want to know that they are
being paid back
o Already get their required rate no matter what the business earns
o Are virtually guaranteed to get their money back as they are the first ones to
be repaid if there was any issue
- Doesn’t necessarily mean there is a loss, just means that the shareholders will be
getting a lower return

QUESTION 5: ARA Investments Ltd is considering expanding by acquiring a further $60

million in assets. They are considering using debt to finance this investment.
- (116/(116+84)) x 6.25 + (84/(116+84)) x 12.5
- WACC = 8.9%
- WACC is now lower which decreases ROA necessary to satisfy shareholders
- BUT debt ratio is now 58% - may be considered too high? (Too much risk etc)

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11/04/2019 – Tutorial Notes 5

SELLING GIFT CARDS
- Sale: cash increases but so does unearned revenue
- Redemption: unearned revenue decreases and revenue increases, inventory goes
down and cost of sales increases
- Expiry: unearned revenue becomes revenues
“Unofficial policy” of honoring expired gift cards
- Recognised as revenue
- Inventory goes down and so does expenses (cost of sales)
- If it becomes routine, provisions would have to be made  expenses would be
recorded
- Constructive liability  from the practices happening in the business, people are
expecting it is likely to happen
Management wishes to recognise 1/3 of gift cards as revenue before they’ve expired based
on past trends
- Would desire to recognise early as it makes their income look higher
- Could be appropriate depending on how long the trends have been observed but
might not be as the trends could change

DEPRECIATION
- Look out how often the equipment is used
- Look at the warranty and the producer’s notes
- Look at the past use of similar equipment
- Original cost price of $80,000; annual depreciation of $8,000  6 years later,
carrying amount of $32,000
- Asset is used for extra year no impact on financial statements
- Asset is obsolete early  asset is written off as impairment
- Asset is obsolete early but life estimate was only 8 years  depreciation becomes
10,000; therefore over 6 years the carrying amount becomes $20,000 which
becomes written off as impairment
- Impact of reported profit is impacted by the estimation of useful life

DISCONTINUED OPERATIONS
- Investors can see the current position of the business
- Make judgements about whether to invest
- Make predictions about future performance based on the past and present

OTHER COMPREHENISVE INCOME

- Revalue method of land a buildings
- Becomes unrealised gain (other comprehensive income) and doesn’t affect profit in
current period
- Could affect profit in future years if it is sold; changing value of asset could also make
the depreciation higher

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11/04/2019 – Tutorial Notes 6

FINANCING
- Loan and repayments
- Share issue and buy back
- Dividends paid

INVESTING
- Shares in other companies
- Potentially – dividends paid back
- PPE (sale of equipment)
- Loans to other institution
- Acquired land by paying a deposit

OPERATING ACTIVITIES
- Everything else:
o Receipts from customers
o Payments to suppliers/employers
o Interest paid/received
o Dividends received
o Tax expenses

CHANGE IN CASH
- End of cash – start of cash

NOT APPLICABLE
- Gains from sale of equipment (cash less cost)
- Purchase of inventory on account
- Writing off a bad debt

NOTES
- Notes need to disclose the reconciliation between net profit and net operating cash
flow
- Depreciation is not a cash flow

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02/05/2019 – Tutorial Notes 7

PROFITABILITY
- Return on equity
o Return on assets
 Profit margin
 Gross profit margins  cost of sales
 Expense ratios
 Asset turnover
o Debt ratio

EXAMPLE – Qantas Airlines

- Current ratio is too low
o More liabilities than assets
o Not able to meet short term commitments
o Unearned revenue  because tickets are bought in advance
 High liabilities is just the wait to get people on a plane
- Earnings before interest and tax is low
o Not managing their sales
o Poor cost control
o Competitive industry and costs are high
- Return on equity is low
o High expenses
o Explained by the EBIT being low
o Could be caused by borrowings explaining why liabilities outweigh assets
- Debt to equity is low
o Suggests borrowings
- ROE > ROA
o High levels of debt/gearing
o Relying on debt
o Low margins and significant investment in assets (planes)
- Net tangible assets backing
o Assets are generally leased
- Price earnings  good level
o High confidence in entity’s ability to generate future cash flow
Virgin Airlines
- Higher debt  ROE > ROA and debt to equity is high
o ROE > ROA because they are relying on debt not equity
o Effectiveness of gearing  virgins uses higher gearing effectively
- NTAB is lower  leasing more planes
- Current ratio is low  planes aren’t their assets
- Could be borrowing money to lease planes
- Net profit margin is higher  could be more popular
- Price earnings is lower but still good level  confident but not as confident as
QANTAS because they don’t own as many planes
ATO = ROA/EBIT PM QANTAS = 1.145 Virgin = 0.94
Debt Ratio  Total assets = debt + equity  debt : equity/debt

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QANTAS = 1.11/2.11 = 0.53 Virgin = 1.8/2.8 = 0.64

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STATEMENT OF CASH FLOW

Cash flows from operating activities
Receipts from customers 185
Payments to suppliers and employees (140)
Dividends received N/A
Interest received 2
Interest paid (4)
Tax paid (6)
Net cash from operating activities 37

Cash flow from investing activities

Payments for PPE (7.5)
Proceeds from sale of PPE N/A
Net cash from investing 7.5

Cash flow from financing activities

Proceeds from issue shares 5
Proceeds from borrowings N/A
Repayments of borrowing (10)
Dividends paid (20)
Net cash flow from financing activities 25

Net change in cash 4.5

Cash at start 9
Cash at end 13.6

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16/05/2019 – Tutorial Notes 8: Budgeting

TASK 1:
Ron has cut expenses by 10% by cutting staff training.
Implications:
- Reduced quality of production/service
- Affect reputation of company
- Workers will be slower
- Cost more in the long run

TASK 2:
Airlines have cut back services to various locations
Businesses affected:
- Small businesses and hotels
- Travel agents
- Tourism industries
- Fuel companies
- Companies looking send workers to see customers
- Alternative transport companies or car rental services
- Attractions in places that weren’t cut

TASK 3
Chief Accountant has high expectations of sales managers
- Authoritarian
- Targets too high leaves workers feeling unmotivated
- They weren’t able to contribute in the first place
- They don’t get to contribute
- Look at a participative budgeting structure
- Review progress regularly and adjust goals accordingly
- Some factors may be beyond control (purchasing/resources)

TASK 4
Credit/Received October November December January
October 30 24 6
November 40 32 8
December 50 40
January 25
Credit Totals 30 64 88 73
Cash sales 33 31 42 30
Total 63 95 130 103

Expenses December January

Selling/admin (58) (58)
Vehicle Service (45)
Car hoist (20)

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Lonnie Car Repairers

Cash Budget for the 2 months ending 31 January 20
December January
Receipts
Customers 130,000 103,000
Interest on term deposit
Total receipts 130,000 103,000
Payments
Selling/ Admin (58,000) (58,000)
Vehicle Service (45,000)
Car hoist (20,000)
Total payments (123,000) (58,000)
Surplus / (Deficit) 7,000 45,000
Cash balance at start 30,000 37,000
Cash balance at end 37,000 82,000

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23/5/19 Tutorial Notes 9: CVP Analysis

EXERCISE 1: SALES MIX
Total FC = 450,000
A B C D
Sales mix 50000 30000 100000 20000
Selling price 10 15 8 25
VC/unit 6 10 6 15
CM 4 5 2 10
Sales mix ratio 0.25 0.15 0.5 0.1
WACM/unit = 3.75
Breakeven volume = 450000/3.75 = 120000
A = 30000
B = 18000
C = 60000
D = 12000

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Given that 200,000 units were sold;

200000 x 3.75 – 450000 = 300000

FC = 500,000
A B C D
CMU 4 5 2 10
Sales mix % 0.25 0.15 0.4 0.2
WACM 1 0.75 80 2
Total WACM = $4.55
Breakeven volume = 500000/4.55 = 109891
Lower than previous (120000)  recommend going ahead with it

EXERCISE 2: INCOME STATEMENT

Selling Price = 2000000/200000 = 10
VC = 1.2M + 230000 + 176000 = 1,606,000
VC/Unit = $8.03
CMU = $1.97
FC = 230000 + 264000 = 494000
Breakeven = 494000/1.97 = 250762 units
Profit = 250762 x 10 – 494000 = $2,013,614

Selling Price = 10 + 0.50 = 10.50

VC/Unit = $8.93
CMU = $1.57
FC = 494000 – 60000 = 434000
Breakeven = 434000/1.57 = 276,434
Profit = 1.57 x 476,434 – 434000 = 314001.38

Point of Indifference: 60000/0.4 = 150,000 (loss is 198,500)

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EXERCISE 3: DIFFERENT ALTERNATIVES

CMU = 20/6 = 14
1. FC = 5600
Breakeven = 5600/14 = 400 units
2. FC = 3800 + VC = 0.1 x sales
CMU = 12
Breakeven = 3800/12 = 317 units
3. VC = 0.15 x revenue
Breakeven at zero units

EXERCISE 4: SPA COMPANY

Cost for external purchase = 92.50 x 12800 = 1184000

Manufacture Cost per unit = 83.75

FCU = 17.25
Avoidable = 66.5 X 12800 = 851200
0.4 x 112800 x 17.25 = 778320
Total = 1629520

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23/5/19 Tutorial Notes 10: Revision

DEPRECIATION
- Decreases assets, equity and profit
- Not a cash flow
- Decreases future benefit but not value
- Is an allowable tax rate

AGENCY THEORY EXERCISE

4 years 5 years 6 years
Profit before 20 20 20
depreciation
Depreciation 7.5 6 5
expense
Profit before tax 12.5 14 15
Income tax expense 3.75 4.2 4.5
@ 30%
Profit after tax 8.75 9.8 10.5
Previous profit 7.5 7.5 7.5
Annual growth 16.7% 30.7% 40%
Bonus achieved Yes Yes Yes
- If you choose 4 years, then your minimizing taxes and depreciation
- If you choose 6 years, then your maximizing profit
- Cookie jar: allows company to get small extra bits of money by changing estimates
o Not largely ethical but fits within accounting standards
o All accounting policies and changes in estimates must be disclosed in notes

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