Accounting Business Reporting for Decision Making

360 Accounting: Business Reporting for Decision Making

Review Ltd

Balance sheet as at 30 June

2017 % to assets 2016 % to assets

CURRENT LIABILITIES

Account payable

Short-term borrowings

Current tax liabilities

34 738

44 000

29 250

12

16

11

27 156

56 000

25 086

10

21

10

Total current liabilities 107 988 39 108 242 41

NON-CURRENT LIABILITIES

Long-term borrowings

Deferred tax liabilities

92 500

43 316

33

16

78 000

49 748

30

19

Total non-current liabilities 135 816 49 127 748 48

Total liabilities 243 804 88 235 990 89

Net assets 34 474 12 27 930 11

EQUITY

Issued capital

Retained earnings

21 000

13 474

8

5

17 000

10 930

6

4

Total equity $ 34 474 12 $ 27 930 11

8.2 Selected information for two companies competing in the retail clothing industry is

presented below. LO4, 7

Forever30 Bardod

Sales revenue

Cost of sales

$2 000 000

(1 410 000 )

$1 000 000

(420 000 )

Gross profit

Less: Expenses

590 000

(315 000 )

580 000

(327 000 )

Profit $ 275 000 $ 253 000

Total assets $ 490 000 $ 475 000

Required

a. Analyse and compare the profitability of Forever30 and Bardod. Provide calculations to support

your analysis.

b. From your calculations in part (a), explain the different business approaches the two companies

have adopted.

c. Explain how increasing the proportion of debt to assets can affect profitability ratios.

SOLUTION TO 8.2

a. Forever30 Bardod

Return on assets $275 000/$490 000 = 56.1% $253 000/$475 000 = 53.3%

Profit margin $275 000/$2 000 000 = 13.75% $253 000/$1 000 000 = 25.3%

Asset turnover $2 000 000/$490 000 = 40.8 times $1 000 000/$475 000 = 2.1 times

b. Both companies are similar in the return on assets that they generated. However, Forever30 seems

to have a high turnover, low profit margin approach. Forever30 has a much lower profit margin

than Bardod, indicating that it is making less profit per dollar of sales. Forever30, however, has a

much more efficient use of assets to generate revenue as evidenced by the asset turnover.

c. Increasing the gearing ratio can have a positive effect on the ROE. If the ROA exceeds the cost

of borrowing, then borrowing to finance assets will have a positive impact. However, if the bor-

rowed funds are used to finance assets and the ROA is less than the cost of borrowings, then the

impact will not be favourable.

(continued)