Accounting Business Reporting for Decision Making

372 Accounting: Business Reporting for Decision Making

8.40 Limitations of ratio analysis   LO10

Read the following quote and discuss what you think the author means by ‘passively calculating

standard ratios’.

Corporations have substantial incentives to exploit the fact that accounting principles are neither fixed

for all time nor so precise as to be open to only a single interpretation. Analysts, who appreciate the

magnitude of the economic stakes, as well as the latitude available under the accounting rules, will see

clearly that a verdict derived by passively calculating standard ratios may prove dangerously naive.

Source: Fridson, M & Fernando, A 2002, Financial statement analysis: a practitioner’s guide, 3rd edn, John Wiley &

Sons, New York.

8.41 Analysing a company’s market performance   LO8

Visit the Yahoo!7 Finance website (http://au.finance.yahoo.com) and call up information on

JB Hi-Fi Ltd (symbol: JBH.AX).

a. Identify JB Hi-Fi Ltd’s current share price (day 1), the previous day’s share price (day 0) and

the share price return from day 0 to day 1.

b. You are considering purchasing shares in JB Hi-Fi Ltd. Identify the current bid and ask price

for the shares.

c. The summary information includes some market based ratios. Explain what each of the fol-

lowing represents and how the ratio is calculated: price–earnings ratio; earnings per share; and

market capitalisation.

d. Review the current month’s analysts’ recommendations for JB Hi-Fi Ltd and comment on the

market’s sentiment regarding JB Hi-Fi Ltd.

8.42 Preparing financial statements from ratios   LO4, 5, 6, 7

The following values relate to various ratios for an athletics store, for the most recent year. At the end

of the year, total assets as per the balance sheet were $900 000. The ratios relate to the accounts either

in respect of the 12-month period or at the date of the balance sheet for the end of the period.

Transaction Ratio

1. Profit to total assets 10%


2. Current ratio 2.5:1


3. Acid test ratio 1:1


4. Credit sales to trade accounts receivable 7.5:1


5. Gross profit to sales revenue 25%


6. Trade accounts payable to purchases 40%


7. Credit sales to total sales revenue 75%


8. Profit margin 10%


9. Return on equity (beginning of year) 30%


10. Non-current assets to current assets 10%

Required

Assuming there are no prepaid expenses and that trade accounts payable are the only liability,

using the above information:

a. prepare a detailed statement of profit or loss for the year, including cost of sales calculation

b. prepare the entity’s balance sheet as at the end of the year

c. discuss why ratios are regarded as more useful than absolute values.

8.43 Predicting statement of profit or losss and balance sheets   LO4, 5, 6, 7

The treasurer of Easyier Ltd has recently developed a computer model to help in the prediction of

profits, balance sheets and cash flows. By entering the expected sales figure and the value of var-

ious other parameters, the model will print profit-related data and produce a balance sheet. Given

the following parameters, compose the predicted statement of profit or loss and the balance sheet

produced by the model.