QUESTION 1: Accounting adjusting entries and financial statements The following is the closing account balances as prepared for Sydney Company as at 30 June 2020 (for the 12 months beginning on 1 July 2019): DR CR $ $ Bank Overdraft 11,000 Accounts Receivable 200,000 Inventory 100,000 Prepaid Rent 10,000 Property, Plant and Equipment 450,000 Accumulated Depreciation 200,000 Accounts Payable 60,000 Bank loan 50,000 Share Capital 310,000 Retained Profit at 1 July 2019 34,000 Sales revenue 450,000 Cost of Goods Sold 265,000 Interest Expense 5,000 Wages Expenses 80,000 Rent Expense 5,000 1,115,000 1,115,000 The following information is given which may give rise to year-end adjustments. The effect of these transactions is not reflected in the account balances above. i. Depreciation on Property, Plant and Equipment is $45,000 per annum. ii. The balance in Prepaid Rent relates to the 12-month period from 1 January 2020 to 31 December 2020. iii. Insurance worth $18,000 was prepaid on 1 June 2020 for the period 1 June 2020 – 30 November 2020. No journal entry had been recorded for this purchase. iv. On 30 June 2020, the directors declared (payable) a dividend of $5,000, which the shareholders authorised. The dividend is to be paid on 15 September 2020. v. It is discovered that $10,000 cash received during the year and credited to sales are actually related to services to be delivered in July 2020. vi. $5,000 of wages relating to June 2020 have not been paid and need to be accrued. DPBS1140: Sample Final Examination Questions 1 Note: Use question 1 as practice for units 1-4 and your final exam will include 10 multiple choice questions on units 1-4 inclusive. You can practice further using the non assessable questions Part A Prepare journal entries for the necessary end of period adjustments Account name Debit Credit $ $ 2 Part B Prepare an Income Statement for the year ended 30 June 2020 Sydney Company Income Statement for the year ended 30 June 2020 Sales revenue Less: Cost of Goods Sold = Gross Profit Less other expenses: Interest expense Depreciation expense Rent expense Insurance expense Wages expense Total other expenses = Net Profit 3 Part C In the Balance Sheet as at 30 June 2020, what would be the closing balance of retained profits Show all workings Opening Balance Retained Profits ___________ Plus Net Profit for Period _________ Less Dividends declared _________ = Closing Balance _________ 4 FINANCIAL STATEMENT RATIOS Return on Equity Operating Profit after Tax Shareholders’ Equity Return on Assets Operating Profit after Tax Total Assets Gross Margin Gross Profit Sales Profit Margin Operating Profit after Tax Sales Revenue Earnings Per Share Operating profit after tax – preference share dividends Weighted Average Number of Ordinary Shares Outstanding Dividend Payout Ratio Total Dividends declared Operating profit after tax Alternatively, to calculate the ratio per share: Annual Dividends Declared per Share Earnings per Share Asset Turnover Sales Total Assets Inventory Turnover COGS Closing Inventory Debtors (Receivable) Turnover Credit Sales Accounts Receivable Current Ratio Current Assets Current Liabilities Quick Ratio Cash + Accounts Receivable + Short-term investments Current Liabilities Leverage Ratio Total Assets Total Shareholders’ Equity Debt to Equity Ratio Total Liabilities Total Shareholders’ Equity Debt to Asset Ratio Total Liabilities Total Assets Days in Inventory 365 Inventory Turnover Days in Debtors (Receivables) 365 Debtors (Receivables) Turnover Accounts payable turnover Total Inventory Purchased Accounts Payable Days in Payable 365 Payable Turnover Days in Inventory 365 Inventory Turnover Dividend Yield Ratio Annual Dividends Declared Per Share Share Price Price/Earnings Ratio Market Price Per Share Earnings Per Share P/E multiple Market Price per share Earnings per share = Market capitalization Net Income P/B multiple Market capitalization Book value of Equity 5 Term 2, 2021 P/S multiple Market capitalization Sales Revenue Enterprise Value (EV) MV of Debt + MV of Equity – Cash – Non-operating Assets EV/EBITDA multiple Enterprise Value EBITDA EV/EBIT multiple Enterprise Value EBIT EV/SALES multiple Enterprise Value Sales Revenue Free Cash Flow: (Indirect) EBIT(1 – T) + Depreciation – Capex – Chg NWC + Terminal Cash Flows Free Cash Flow: (Direct) (Revenue – Cost)(1 – T) + (Depr)(T) – Capex – Chg NWC + Terminal Cash Flows Change in Net Working Capital (CAt – CLt) – (CAt-1 – CLt-1) = (CAt – CAt-1) – (CLt – CLt-1) 6 QUESTION 2: Financial Statement Analysis Retail Limited Extracts from the Income Statements for the years ended 31 December 2020 and 2019 2020 $ 2019 $ Revenue 850,000 800,000 Less: COGS 595,000 480,000 Gross Profit 255,000 320,000 Less: Total expenses 170,000 200,000 Net profit 85,000 120,000 Retail Limited Extracts from the Balance Sheets as at 31 December 2020 and 2019 2020 $ 2019 $ Total non-Current Assets 325,000 350,000 Current Assets Accounts receivable 155,000 70,000 Inventory 100,000 30,000 Cash 200,000 250,000 Total Current Assets 455,000 350,000 Total Assets 780,000 700,000 Current Liabilities Accounts Payable Dividend Payable Total current liabilities 100,000 40,000 140,000 75,000 – 75,000 Non-Current Liabilities Long term loan Total Liabilities 210,000 350,000 150,000 225,000 Shareholders’ Equity Share Capital 300,000 200,000 Retained Earnings 130,000 275,000 Total Shareholders’ Equity 430,000 475,000 7 Based on the above extracts from the financial statements of Retail Limited for the years ended 31 December 2020 and 2019, you are required to answer the following: 1. Drawing on any two profitability ratios, comment on the financial performance of the company (3 marks) Explanation: 2. Drawing on any two relevant pieces of evidence from the balance sheet, explain whether the company’s liquidity improved or worsened during year 2020 (3 marks) Explanation: 3. Drawing on any two relevant ratios, explain whether the company’s solvency improved or worsened during the year (3 marks) Explanation: 4. Evaluate the Investment potential of the business in the short term ie 1 year (1 mark) ROE ROAA Gross margin Net Profit Margint profit margin Quick ratio Current ratiock ratio Cu rent ratio Debt to equity Debt to assets Leverage o equity Debt to assets Leverage ratio 8 QUESTION 3: Financial Statement Analysis You are required to indicate the effect of the transactions listed below on the ratio listed opposite it. For each transaction, state whether the ratio would increase, decrease, or have no effect. You are also required to provide a brief explanation for your answer. Transaction Ratio 1 Acquired a bank loan of $750,000 Debt-to-assets ratio 2 Inventory worth $30,000 was sold for $45,000 cash Return on equity 3 Declared a dividend of $500,000 Profit margin 4 Received a deposit from a customer of $10,000 for a project that will commence in the next Leverage Ratio financial period 5 Collected $30,000 from a customer Asset Turnover Note: Treat each transaction independently. The current ratio for the period was 2.4. The debt-to-asset ratio was 0.67. The return on equity ratio was 4%. All other ratios were positive. Effect Explanation 1 2 3 4 5 9 QUESTION 4: Audit Independence Threats Describe and explain what type of independence threat each of the following situation provides: 1. The client of an audit firm asked the audit partner to promote their shares for a stock exchange listing. (2 marks) 2. The husband of an auditor holds $23,000 worth of shares in the audit client. (2 marks) 3. The client manger engaging has a dominant personality and seeks to influence the decision making of junior staff. (2 marks) 4. Due to a recent audit controversy, the audit firm has lost several clients. This means AZ Bank represents 25% of the audit firm’s earnings. (2 marks) 10 QUESTION 5: Audit Opinions A. Describe the role of an external auditor (2 marks) B. What type of audit opinion would be offered in the following situation (4 marks) A problem with the client’s IT systems has meant that the audit team are unable to review important sales receipts to confirm the recording of revenue and expense receipts to confirm all expenditures. This means that the audit team were unable to determine whether proper books of account had been kept. C. Briefly describe any other type of audit opinion (2 marks) 11 QUESTION 6: Audit Opinions “John is a recent graduate from UNSW and has successfully applied for a job in a medium sized accountancy firm, Thompson & Smith, as a junior auditor. John is part of the team that audits the annual financial statements of XYZ Limited. The audit for XYZ Limited is nearing its completion and the audit team are considering what type of audit opinion can be issued. The audit partner has held some difficult meetings with the management team of XYZ Limited, disagreeing with how management have calculated depreciation of buildings. The audit partner believes that the manner in which depreciation has been calculated is incorrect and represents a material misstatement to the financial statement. The audit partner has also told John that all other areas of X
YZ Limited’s financial statements are correctly prepared. Unfortunately, XYZ Limited’s management are unwilling to follow the audit partner’s advice and won’t change how they have calculated deprecation for buildings. The audit partner has asked John to think about how this will affect the audit opinion.” Based on the above information, please answer the following questions: 1. Explain the purpose of an external audit (2 marks) 2. Justify the type of audit opinion that would likely be issued in the above situation (4 marks) 3. Outline any two other types of audit opinions that auditors provide (2 marks) 12 QUESTION 7: Internal Controls For each of the following situations, evaluate the segregation of duties implemented by the company and indicate the following: 1. Any deficiency in the segregation of duties described. Indicate “None” if no deficiency is present. 2. The potential financial statement misstatements that might occur because of the inadequate segregation of duties. 3. Additional controls that might mitigate potential misstatements. Situation A (4 marks): Nick’s is a small family-owned restaurant in a northern resort area whose employees are trusted. When the restaurant is very busy, any of the servers have the ability to operate the cash register and collect the amounts due from the customer. All orders are tabulated on “tickets.” Although each ticket has a place to indicate the server, most do not bother to do so, nor does management reconcile the ticket numbers and amounts with total cash receipts for the day. Situation B (4 marks): A sporting goods store takes customer orders via a toll-free phone number. The order taker sits at a terminal and has complete access to the customer’s previous credit history and a list of inventory available for sale. The order clerk has the ability to input all the customer’s requests and generate a sales invoice and shipment with no additional supervisory review or approval. 13 QUESTION 8: Cash Flow Statement and Analysis 1. Describe what information the cash flow statement adds above and beyond the accrual-based financial statements 2. Mention two items that are accounted for in the income statement, but not the cash flow statement; Also mention two items that are accounted for in the cash flow statement, but not in the income statement 3. Assume that a company has positive cash flow from operations and financing, but negative cash flow from investing. What does this cash flow pattern indicate 14 QUESTION 9 Cash Flow Statement and Analysis Retail Limited Extracts from the Income Statements for the years ended 31 December 2020 and 2019 2020 $ 2019 $ Revenue 850,000 800,000 Less: COGS 595,000 480,000 Gross Profit 255,000 320,000 Less: Total expenses 170,000 200,000 Net profit 85,000 120,000 Retail Limited Extracts from the Balance Sheets as at 31 December 2020 and 2019 2020 $ 2019 $ Total non-Current Assets 325,000 350,000 Current Assets Accounts receivable 155,000 70,000 Inventory 100,000 30,000 Cash 200,000 250,000 Total Current Assets 455,000 350,000 Total Assets 780,000 700,000 Current Liabilities Accounts Payable Dividend Payable Total current liabilities 100,000 40,000 140,000 75,000 – 75,000 Non-Current Liabilities Long term loan Total Liabilities 210,000 350,000 150,000 225,000 Shareholders’ Equity Share Capital 300,000 200,000 Retained Earnings 130,000 275,000 Total Shareholders’ Equity 430,000 475,000 15 Retail Limited Extracts from the Cash Flow Statement for the years ended 31 December 2020 and 2019 2020 $ 2019 $ Cash Flow from Operating Activities Receipts from Customers 510,000 565,000 Payments to Suppliers and Employees (490,000) (495,000) Interest Paid (22,000) (10,000) Income Tax Paid (18,000) (25,000) Net Cash from Operating Activities (20,000) 45,000 Cash Flow from Investing Activities Purchase of PPE 0 (30,000) Net Cash from Investing Activities 0 (30,000) Cash Flow from Financing Activities Issued Share Capital 100,000 0 Borrowed Debt 60,000 45,000 Dividend Paid (190,000) (20,000) Net Cash from Financing Activities (30,000) 25,000 Net Increase/Decrease in Cash (50,000) 40,000 Cash Balance Beginning 250,000 210,000 Cash Balance Ending 200,000 250,000 Based on the above extracts from the financial statements of Retail Limited for the years ended 31 December 2020 and 2019, you are required to answer the following: 1. Based on the financial statement information above, calculate a. the amount of credit sales of Retail Limited in 2020. b. the inventory purchases of Retail Limited in 2020. 2. Retail Limited’s management is concerned about its cash flow from operations in 2020. In 2019, the number of days to convert investments in inventory into cash flows from sales was 71. Calculate the number of days it took Retail Limited to convert its investments in inventory into cash flows from sales in 2020. Assume that accounts payable days were 55 in 2020. Comment on the change and provide two possible reasons for this change. Suggest two ways through which Retail Limited could improve cash generation. Hint: you can use information that you calculated in question 2 above. Credit Sales: Ending balance A/R = beginning balance A/R + Credit Sales – Cash Receipts Credit Sales = Ending balance A/R – Beginning balance A/R + Cash Receipts Inventory Purchases: Ending Inventory = Beginning Inventory + Purchases – COGS Purchases = Ending Inventory – Beginning Inventory + COGS 16 Ratios 2020: Change from 2019: Explanation: 3. Comment on how the company is financing its operating and investing activities in 2020 and 2019. 4. Assume that Retail Limited had the following additional transactions in 2020: 1) bought shares on the stock market for an amount of $15,000. 2) Received a dividend for the investment over $300 Answer the following questions: a. How would these transaction be categorized on the cash flow statement (1 marks) b. How would these transaction in combination change the 2020 net change in cash and the cash balance (2 marks) Transaction 1: Transaction 2: Days in Receivables = 365/AR turnover = Days in Inventory = 365/Inv. turnover = Cash Conversion Cycle = Days Inventory + A/R Days – 55 (A/P Days) = 17 QUESTION 10: Responsible Financial Management 1. Outline the difference between economic disclosures, social disclosures and environmental disclosures, as defined by the Global Reporting Initiative (GRI) (3 marks) 2. Name two social disclosures and two environmental disclosures that are likely to be included in UNSW’s sustainability report (4 marks) 3. Describe and explain three challenges auditors experience in providing assurance of Sustainability Reports. (3 marks) QUESTION 11 a) You notice that Cisco Computer Systems has a share price of $30.72 and earnings per share of $0.52. Its competitor Hewlett-Packard has earnings per share of $0.36. What is one estimate of the value of Hewlett- Packard shares Since Cisco Computer Systems and Hewlett-Packard are in the same industry, one estimate for the value of Hewlett-Packard is that it should have the same P/E ratio = Market Price Per Share/Earnings Per Share Cisco P/E = Using Cisco’s P/E to value HP’s earnings: HP Price = b) CSH has EBITDA of $5 million. You feel that an appropriate enterprise value/EBITDA ratio for CSH is 9. CSH has $10 million in debt, $2 million in cash and 0.8m shares outstanding. What is your estimate of CSH’s share price EV/EBITDA ratio Enterprise Value/EBITDA to estimate the enterprise value and calculate the price per share based on that estimate. 18 a) You purchased a machine for $1 million three years ago and have been applying straight-line depreciation to zero for a seven-year life. Your tax rate is 30%. If you sell the machine right now (after three years of depreciation) for $700,000, what is your incremental (after-tax salvage) cash flow from selling the machine Hint: You need to know the book value of the machine at the time of the sale. Only the part of the selling price above or below book value will have a tax effect. The book value is the purchase price minus accumulated depreciation. b) Castle View Games would like to invest in a division to develop software for a soon to- be-released video game console. To evaluate this decision, the firm first attempts to project the working capital needs for this operation. Its chief financial officer has developed the following estimates (in millions of dollars). If Castle View currently does not have any initial working capital invested in this division, calculate the cash flows associated with changes in working capital for the first five years of this investment. Year 1 Year 2 Year 3 Year 4 Year 5 Cash 6 12 15 15 15 Accounts receivable 21 22 24 24 24 Inventory 5 7 10 12 13 Accounts payable 18 22 24 25 30 Net Working Capital Change in NWC QUESTION 12 19 c) This year, The Boring Company, has an EBIT of $100m, interest expenses of $40m, depreciation expenses of $15m and capital expenditures of $30 million, and has increased its net working capital by $5m. Its tax rate is 35%. Compute earnings/Net Income (NI) and free cash flow (FCF). Earnings = NI = (EBIT – Interest)*(1 – Tax Rate) FCF = EBIT x (1 – Tax Rate) + Depreciation – Change in NWC – Capex + Terminal cash flows