AIOU 5418 Financial Accounting Solved Assignment 1 Spring 2025
AIOU 5418 Assignment 1
Q1 a). Who are the primary and secondary users of accounting information, and how does accounting address the specific needs of each user?
Accounting plays a crucial role in the financial ecosystem, providing vital information to various users who rely on accurate and timely data for decision-making. The users of accounting information can generally be categorized into primary users and secondary users, each with distinct needs that accounting practices strive to fulfill.
Primary Users of Accounting Information
Investors (Existing and Potential) Investors depend on financial information to evaluate profitability, risk, and growth potential before making investment decisions. They analyze financial statements, income reports, and balance sheets to determine the return on investment (ROI) and the sustainability of the business.
How Accounting Addresses Their Needs:
- Provides financial statements prepared under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
- Uses ratios like Earnings Per Share (EPS), Price-to-Earnings Ratio (P/E), and Return on Equity (ROE) to help investors assess financial performance.
- Ensures transparency and accountability through audited reports.
Creditors (Banks and Lenders) Creditors assess the financial stability and creditworthiness of businesses to determine whether to approve loans or extend credit.
How Accounting Addresses Their Needs:
- Provides the company’s liquidity position via the cash flow statement.
- Reports debt levels and repayment capabilities through leverage and solvency ratios.
- Ensures compliance with financial covenants agreed upon with lenders.
Management and Executives Company leadership relies on accounting data for strategic planning, budgeting, and operational efficiency.
How Accounting Addresses Their Needs:
- Offers management accounting tools, including cost-benefit analyses, variance analysis, and financial forecasting.
- Supports decision-making with reports on profitability, cost efficiency, and investment feasibility.
- Implements internal controls to mitigate financial risks and ensure accurate reporting.
Government and Regulatory Agencies Tax authorities, financial regulatory bodies, and government agencies use accounting information to enforce tax compliance and ensure adherence to financial regulations.
How Accounting Addresses Their Needs:
- Provides audited financial statements for tax calculations and reporting.
- Ensures compliance with statutory requirements such as corporate tax laws and financial regulations.
- Uses ethical accounting practices to prevent fraud and maintain corporate transparency.
Employees and Trade Unions Employees and labor unions seek financial clarity regarding the company’s stability, profitability, and ability to sustain employment and wages.
How Accounting Addresses Their Needs:
- Provides payroll accounting data and employee benefits analysis.
- Reports the company's profitability, ensuring fair wage negotiations.
- Uses financial reports to reassure employees of job security.
Secondary Users of Accounting Information
Analysts and Financial Advisors Market analysts and financial advisors examine accounting data to provide recommendations to investors, businesses, and clients.
How Accounting Addresses Their Needs:
- Offers detailed financial reports, including industry comparisons and performance trends.
- Provides historical financial data for predictive modeling and investment advice.
- Ensures standardization in reporting, enabling meaningful comparisons.
Customers Customers use accounting information to assess a company’s financial health, ensuring reliability in long-term transactions.
How Accounting Addresses Their Needs:
- Provides financial stability reports to ensure sustainable partnerships.
- Ensures ethical financial practices, fostering customer trust.
- Demonstrates the ability to continue supplying quality goods and services.
Competitors Competitors study financial reports of industry leaders to benchmark performance and strategize their own market positioning.
How Accounting Addresses Their Needs:
- Offers comparative financial analysis through publicly available financial statements.
- Helps competitors understand cost structures, profit margins, and growth strategies.
- Encourages innovation by revealing industry trends.
Academia and Researchers Educators and researchers use accounting information for academic studies, policy formation, and theoretical advancements.
How Accounting Addresses Their Needs:
- Provides access to financial data for economic research.
- Supports studies related to corporate finance, investment strategies, and regulatory frameworks.
- Helps students and researchers analyze financial trends over time.
The General Public and Media The public and journalists examine accounting information to understand corporate social responsibility, financial scandals, and economic contributions.
How Accounting Addresses Their Needs:
- Ensures transparency in corporate financial activities.
- Highlights corporate governance and ethical financial practices.
- Provides insights into economic trends and market conditions.
Conclusion
Accounting serves as the backbone of financial decision-making for a wide range of users, both primary and secondary. By ensuring accuracy, transparency, and compliance with financial regulations, accounting supports investors, management, regulators, and other stakeholders in making informed economic choices. Whether shaping business strategy, granting loans, influencing government policies, or guiding consumer trust, accounting remains indispensable in today's financial ecosystem.
Q1 b). The accountant for Ronaldo Company makes the assumptions or performs the activities listed below. Tell which of the following concepts of accrual accounting most directly relates to each assumption or action:
(a) periodicity, (b) continuity, (c) matching rule, (d) revenue recognition, (e) deferral, and (f) accrual.
1. In estimating the life of a building, assume that the business will last indefinitely.
2. Records a sale when the customer is billed.
3. Postpones the recognition of a one-year insurance policy as an expense by initially recording the expenditure as an asset.
4. Recognizes the usefulness of financial statements prepared monthly even though they are based on estimates.
5. Recognizes, by making an adjusting entry, wages expense that has been incurred but not yet recorded.
6. Prepare an income statement that shows the revenues earned and the expenses incurred during the accounting period.
1. In estimating the life of a building, assume that the business will last indefinitely
This assumption aligns with the continuity principle, which assumes that the business will continue operating indefinitely. This principle is crucial for asset valuation and depreciation calculations, ensuring that long-term investments are recorded appropriately. Without this assumption, assets might be valued based on liquidation rather than usage over time.
2. Records a sale when the customer is billed
This action follows the revenue recognition principle, which states that revenue should be recorded when it is earned, not when cash is received. If Ronaldo Company delivers goods or services and bills the customer, revenue is recognized at that moment, ensuring financial statements reflect actual earnings rather than just cash flow movements.
3. Postpones the recognition of a one-year insurance policy as an expense by initially recording the expenditure as an asset
This process aligns with the deferral principle. Deferrals involve postponing recognition of transactions that affect future periods. In this case, prepaid insurance is recorded as an asset and gradually expensed throughout the policy term to ensure expenses match the periods they benefit.
4. Recognizes the usefulness of financial statements prepared monthly even though they are based on estimates
The periodicity principle ensures financial reporting occurs at regular intervals, such as monthly, quarterly, or annually. Even if estimates are involved (e.g., depreciation or inventory valuation), financial statements provide timely insights into business performance, ensuring stakeholders can make informed decisions.
5. Recognizes, by making an adjusting entry, wages expense that has been incurred but not yet recorded
This follows the accrual principle, which ensures that expenses and revenues are recorded when they are incurred, regardless of cash payments. If wages are earned but not yet paid, an adjusting entry is required to record the expense in the correct period, maintaining accurate financial statements.
6. Prepare an income statement that shows the revenues earned and the expenses incurred during the accounting period
This action is based on the matching principle, which requires revenues and related expenses to be recorded in the same accounting period. By preparing an income statement that reflects earned revenues and incurred expenses, financial statements provide a clear picture of profitability and business performance.
Q2. Mr Asif has started a trading business. The transactions for the month of March 2024 are as under:
March 1. Invested Rs. 450,000 cash as capital.
March 3. Purchased furniture at the cost of Rs. 70,000 on credit.
March 4. Purchased merchandise at the cost of Rs. 250,000 for sale and paid cash.
March 6. Paid rent of shop for the month amounting to Rs. 25,000.
March 8. Sold merchandise at the price of Rs. 75,000 and collected cash.
March 10. Sold merchandise to Mr Arshad at the selling price of Rs. 60,000 and collected cash of Rs. 40,000, the balance due.
March 13. Paid telephone bill amounting to Rs. 3,000.
March 16. Purchased merchandise costing Rs. 80,000 on credit from Subhan Company.
March 18. Collected cash of Rs. 10,000 from Mr Arshad for goods sold to him on credit.
March 22. Paid electricity bill amounting to Rs. 6,500.
March 25. Paid Rs. 50,000 for the furniture purchased on credit.
March 31. Paid Salary of an employee amounting to Rs. 20,000.
Required:
Pass the journal entries of the above transactions, prepare T accounts and Trial Balance as of March 31, 2024.
Journal Entries
Here are the journal entries for the transactions in March 2024:
| Date | Account Title and Explanation | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Mar. 1 | Cash Capital (Being initial investment of cash as capital) |
450,000 | |
| 450,000 | |||
| Mar. 3 | Furniture Accounts Payable (Subhan Company) (Being purchase of furniture on credit) |
70,000 | |
| 70,000 | |||
| Mar. 4 | Purchases Cash (Being purchase of merchandise for cash) |
250,000 | |
| 250,000 | |||
| Mar. 6 | Rent Expense Cash (Being payment of shop rent) |
25,000 | |
| 25,000 | |||
| Mar. 8 | Cash Sales Revenue (Being sale of merchandise for cash) |
75,000 | |
| 75,000 | |||
| Mar. 10 | Cash Accounts Receivable (Mr. Arshad) Sales Revenue (Being sale of merchandise, part cash received, balance on credit) |
40,000 20,000 |
|
| 60,000 | |||
| Mar. 13 | Telephone Expense Cash (Being payment of telephone bill) |
3,000 | |
| 3,000 | |||
| Mar. 16 | Purchases Accounts Payable (Subhan Company) (Being purchase of merchandise on credit) |
80,000 | |
| 80,000 | |||
| Mar. 18 | Cash Accounts Receivable (Mr. Arshad) (Being cash received from Mr. Arshad) |
10,000 | |
| 10,000 | |||
| Mar. 22 | Electricity Expense Cash (Being payment of electricity bill) |
6,500 | |
| 6,500 | |||
| Mar. 25 | Accounts Payable (Subhan Company) Cash (Being payment for furniture purchased on credit) |
50,000 | |
| 50,000 | |||
| Mar. 31 | Salary Expense Cash (Being payment of employee salary) |
20,000 | |
| 20,000 |
T-Accounts
Here are the T-accounts for each account affected by the transactions:
Cash
| Debit | Credit |
|---|---|
| Mar. 1 450,000 | Mar. 4 250,000 |
| Mar. 8 75,000 | Mar. 6 25,000 |
| Mar. 10 40,000 | Mar. 13 3,000 |
| Mar. 18 10,000 | Mar. 22 6,500 |
| Mar. 25 50,000 | |
| Mar. 31 20,000 | |
| Bal. 220,500 |
Capital
| Debit | Credit |
|---|---|
| Mar. 1 450,000 | |
| Bal. 450,000 |
Furniture
| Debit | Credit |
|---|---|
| Mar. 3 70,000 | |
| Bal. 70,000 |
Accounts Payable (Subhan Company)
| Debit | Credit |
|---|---|
| Mar. 25 50,000 | Mar. 3 70,000 |
| Mar. 16 80,000 | |
| Bal. 100,000 |
Purchases
| Debit | Credit |
|---|---|
| Mar. 4 250,000 | |
| Mar. 16 80,000 | |
| Bal. 330,000 |
Rent Expense
| Debit | Credit |
|---|---|
| Mar. 6 25,000 | |
| Bal. 25,000 |
Sales Revenue
| Debit | Credit |
|---|---|
| Mar. 8 75,000 | |
| Mar. 10 60,000 | |
| Bal. 135,000 |
Accounts Receivable (Mr. Arshad)
| Debit | Credit |
|---|---|
| Mar. 10 20,000 | Mar. 18 10,000 |
| Bal. 10,000 |
Telephone Expense
| Debit | Credit |
|---|---|
| Mar. 13 3,000 | |
| Bal. 3,000 |
Electricity Expense
| Debit | Credit |
|---|---|
| Mar. 22 6,500 | |
| Bal. 6,500 |
Salary Expense
| Debit | Credit |
|---|---|
| Mar. 31 20,000 | |
| Bal. 20,000 |
Trial Balance as of March 31, 2024
| Account Title | Debit (Rs.) | Credit (Rs.) |
|---|---|---|
| Cash | 220,500 | |
| Capital | 450,000 | |
| Furniture | 70,000 | |
| Accounts Payable (Subhan Company) | 100,000 | |
| Purchases | 330,000 | |
| Rent Expense | 25,000 | |
| Sales Revenue | 135,000 | |
| Accounts Receivable (Mr. Arshad) | 10,000 | |
| Telephone Expense | 3,000 | |
| Electricity Expense | 6,500 | |
| Salary Expense | 20,000 | |
| Total | 685,000 | 685,000 |
The trial balance shows that the total debits equal the total credits, which indicates that the accounting equation is in balance.
Q3 a). Describe the accrual basis of accounting and how it is beneficial for reliable reporting of business results.
The accrual basis of accounting is a fundamental principle in financial reporting that records revenues and expenses when they are incurred, rather than when cash is received or paid. This approach ensures that financial statements reflect the economic realities of a business rather than just its cash transactions.
Understanding the Accrual Basis of Accounting
Accrual accounting recognizes transactions at the moment they occur, regardless of cash flow. This system includes two key components:
Revenue Recognition: Revenue is recorded when it is earned, even if payment is received later.
Expense Recognition: Expenses are recorded when they are incurred, not necessarily when paid.
This differs significantly from cash basis accounting, which only records transactions when money changes hands. The accrual method is widely used in businesses due to its ability to provide a more accurate representation of financial health.
Benefits for Reliable Business Reporting
1. Provides a True Picture of Financial Health
By matching revenues and expenses in the same period they occur, accrual accounting presents a realistic view of profitability. This is especially important for businesses with long-term projects, subscriptions, or deferred revenue agreements.
2. Improves Comparability and Consistency
Businesses often analyze financial statements over multiple periods. The accrual method allows for consistent comparisons by ensuring revenues and expenses align with relevant periods, making trend analysis more reliable.
3. Supports Decision-Making and Strategic Planning
Since financial statements under accrual accounting reflect actual business activities and obligations, stakeholders—including management, investors, and creditors—can make informed decisions about investments, expansions, and resource allocations.
4. Facilitates Compliance with Accounting Standards
International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) mandate the use of accrual accounting for corporate financial reporting. This compliance ensures credibility and reliability in business reporting.
5. Enhances Cash Flow Management
While accrual accounting does not track cash movements, it helps businesses forecast cash flow needs more effectively by accounting for unpaid invoices and upcoming obligations.
Challenges and Considerations
While accrual accounting provides significant advantages, it also comes with challenges, such as increased complexity and the need for careful bookkeeping to ensure accuracy in recognizing revenues and expenses.
Conclusion
The accrual basis of accounting is essential for reliable business reporting, offering a transparent and comprehensive financial picture that aids in sound decision-making, regulatory compliance, and performance evaluation. This method is particularly beneficial for businesses seeking long-term growth, financial stability, and investor confidence.
Q3 b). A trial balance of Shayan Trading Company for the year ended 30 June 2024 was prepared by the Accountant. A scrutiny of the various accounts revealed that the following adjustments are needed:
(i) Salaries amounting to Rs. 145,000 of certain employees for the month of June 2024 were neither paid nor was any provision made.
(ii) Depreciation at 10% on computer equipment costing Rs. 250,000 was yet to be recorded for the year.
(iii) Office supplies were purchased at the cost of Rs. 55,000 while the year-ended physical verification indicated that office supplies worth Rs. 22,000 were only available in the stores.
(iv) Accrued interest for 02 months at 10% per annum on an investment of Rs. 800,000 was neither recorded nor received.
(v) The utility bills for June 2024 amounting to Rs. 28,500 were received at the end of month which is due for payment on 05 July 2024.
(vi) The loan repayment instalment of Rs. 130,000 with interest of Rs. 12,000 till the end of June 2024 is due for payment on 01 July 2024.
Required:
Prepare to adjust accounting journal entries for the above adjustments.
(i) Salaries Payable
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Salaries Expense | 145,000 | |
| Salaries Payable | 145,000 | ||
| To record accrued salaries for June 2024 |
(ii) Depreciation Expense - Computer Equipment
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Depreciation Expense - Computer Equipment | 25,000 | |
| Accumulated Depreciation - Computer Equipment | 25,000 | ||
| To record depreciation for the year |
Calculation: Depreciation = 10% of Rs. 250,000 = Rs. 25,000
(iii) Office Supplies Expense
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Office Supplies Expense | 33,000 | |
| Office Supplies | 33,000 | ||
| To record office supplies consumed |
Calculation: Office Supplies Expense = Cost of Supplies Purchased - Cost of Supplies on Hand = Rs. 55,000 - Rs. 22,000 = Rs. 33,000
(iv) Interest Receivable and Interest Revenue
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Interest Receivable | 13,333 | |
| Interest Revenue | 13,333 | ||
| To record accrued interest revenue |
Calculation: Accrued Interest = Principal x Rate x Time = Rs. 800,000 x 10% x (2/12) = Rs. 13,333.33. (Rounded to the nearest whole number)
(v) Utilities Expense and Utilities Payable
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Utilities Expense | 28,500 | |
| Utilities Payable | 28,500 | ||
| To record accrued utility expenses |
(vi) Interest Expense and Interest Payable
| Date | Account Titles and Explanation | Debit | Credit |
| June 30, 2024 | Interest Expense | 12,000 | |
| Interest Payable | 12,000 | ||
| To record accrued interest expense |
Q4. Akbar Enterprises owned the following short-term equity investments in the shares of joint stock companies listed on the Islamabad Stock Exchange:
1) 4,000 shares of Rs. 1,000 each par value purchased at Rs. 130 each of Kohat Cement Company which have a market value of Rs. 150 each as of 30 June, 2020.
2) 2,500 shares of Rs. 50 each par value purchased at Rs. 60 each of Shahid Steel Company which have a market value of Rs. 65 each as on 30 June 2020.
During September 2020 Akbar Enterprises conducted the following transactions:
1) On 18 September 2020 all shares of Kohat Cement Company were sold at Rs. 160 each.
2) On 30 September 2020 all shares of Shahid Steel were sold at Rs. 55 each.
Required: In compliance with mark to market concept:
A) Pass necessary accounting entries to purchase and update the values of short-term investment by the end of 30 June 2020.
B) Present the short terms investments in the financial statements in the financial statements as of 30 June, 2020
C) Incorporate the sale of term short-term equity securities in the accounting record.
D) Present the income from the sale of equity securities and the remaining investment in the financial statements as of 30 September 2020.
A) Accounting Entries to Purchase and Update Values as of June 30, 2020
1. Purchase of Kohat Cement Company Shares:
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| [Purchase Date] | Short-Term Investments - Kohat Cement Co. | 520,000 | |
| Cash | 520,000 | ||
| Being purchase of 4,000 shares @ Rs. 130 each |
Calculation: 4,000 shares Rs. 130/share = Rs. 520,000
2. Purchase of Shahid Steel Company Shares:
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| [Purchase Date] | Short-Term Investments - Shahid Steel Co. | 150,000 | |
| Cash | 150,000 | ||
| Being purchase of 2,500 shares @ Rs. 60 each |
Calculation: 2,500 shares Rs. 60/share = Rs. 150,000
3. Adjustment to Market Value - Kohat Cement Company (June 30, 2020):
Market Value: 4,000 shares Rs. 150/share = Rs. 600,000
Cost: Rs. 520,000
Unrealized Gain: Rs. 600,000 - Rs. 520,000 = Rs. 80,000
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| June 30, 2020 | Short-Term Investments - Kohat Cement Co. | 80,000 | |
| Unrealized Gain on Short-Term Investments | 80,000 | ||
| Being adjustment of Kohat Cement shares to market value |
4. Adjustment to Market Value - Shahid Steel Company (June 30, 2020):
Market Value: 2,500 shares Rs. 65/share = Rs. 162,500
Cost: Rs. 150,000
Unrealized Gain: Rs. 162,500 - Rs. 150,000 = Rs. 12,500
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| June 30, 2020 | Short-Term Investments - Shahid Steel Co. | 12,500 | |
| Unrealized Gain on Short-Term Investments | 12,500 | ||
| Being adjustment of Shahid Steel shares to market value |
B) Presentation in Financial Statements as of June 30, 2020
In the Balance Sheet as of June 30, 2020, the Short-Term Investments would be presented at their fair market value:
Balance Sheet (Extract)
| Assets | Amount (Rs.) | |
|---|---|---|
| Current Assets: | ||
| Short-Term Investments: | ||
| Kohat Cement Company | 600,000 | |
| Shahid Steel Company | 162,500 | |
| Total Short-Term Investments | 762,500 |
In the Income Statement for the period ending June 30, 2020, the unrealized gain would be reported (usually as part of other income or a separate line item depending on the accounting standards followed):
Income Statement (Extract)
| Other Income (or similar heading) | Amount (Rs.) |
|---|---|
| Unrealized Gain on Short-Term Investments | 92,500 |
| (Rs. 80,000 + Rs. 12,500) |
C) Incorporate the Sale of Short-Term Equity Securities
Now, let's record the sale transactions in September 2020.
1. Sale of Kohat Cement Company Shares (September 18, 2020):
Selling Price: 4,000 shares Rs. 160/share = Rs. 640,000
Carrying Value (as of June 30, 2020): Rs. 600,000
Realized Gain: Rs. 640,000 - Rs. 600,000 = Rs. 40,000
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| September 18, 2020 | Cash | 640,000 | |
| Gain on Sale of Investments - Kohat Cement Co. | 40,000 | ||
| Short-Term Investments - Kohat Cement Co. | 600,000 | ||
| Being sale of 4,000 shares @ Rs. 160 each |
2. Sale of Shahid Steel Company Shares (September 30, 2020):
Selling Price: 2,500 shares Rs. 55/share = Rs. 137,500
Carrying Value (as of June 30, 2020): Rs. 162,500
Realized Loss: Rs. 137,500 - Rs. 162,500 = (Rs. 25,000)
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| September 30, 2020 | Cash | 137,500 | |
| Loss on Sale of Investments - Shahid Steel Co. | 25,000 | ||
| Short-Term Investments - Shahid Steel Co. | 162,500 | ||
| Being sale of 2,500 shares @ Rs. 55 each |
D) Presentation in Financial Statements as of September 30, 2020
As of September 30, 2020, Akbar Enterprises would have no short-term equity investments as all shares have been sold.
Balance Sheet (Extract) as of September 30, 2020
| Assets | Amount (Rs.) |
|---|---|
| Current Assets: | |
| Short-Term Investments: | Nil |
Income Statement (Extract) for the period ending September 30, 2020
The income statement for the period ending September 30, 2020 (or for the three months ended September 30, 2020, depending on the reporting period) would include the realized gains and losses from the sale of investments:
| Other Income (or similar heading) | Amount (Rs.) |
|---|---|
| Gain on Sale of Investments - Kohat Cement Co. | 40,000 |
| Loss on Sale of Investments - Shahid Steel Co. | (25,000) |
| Net Gain on Sale of Investments | 15,000 |
Keep in mind that the presentation in the actual financial statements might have slight variations depending on the specific accounting standards being followed (e.g., IFRS, local GAAP in Pakistan). However, the underlying principles of mark-to-market and the recognition of realized gains/losses upon sale remain consistent.
Q5. Discuss the conceptual framework of accounting information systems in an enterprise. Also, describe in detail the six basic fundamental principles of an accounting system.
Conceptual Framework of an Accounting Information System (AIS)
An Accounting Information System (AIS) is a vital component within an enterprise, integrating accounting methodologies with technology to ensure efficient management of financial data. It serves as the backbone for financial decision-making, reporting, and compliance, supporting business operations with real-time data analysis and systematic recordkeeping.
The conceptual framework of AIS in an enterprise involves a structured approach where financial data is collected, processed, and reported to support managerial decision-making. The AIS framework typically consists of the following components:
Inputs (Source Documents) – Includes invoices, receipts, purchase orders, and bank statements used to record financial transactions.
Processing Mechanisms – Comprises accounting software and procedures that classify, summarize, and analyze financial data.
Outputs (Reports and Statements) – Consists of financial statements, tax filings, and internal reports used for decision-making.
Storage – Includes databases and ledgers to retain historical financial records.
Internal Controls and Security – Ensures data integrity, reliability, and protection against fraud or unauthorized access.
AIS enhances accuracy, efficiency, and compliance, making it indispensable for enterprises aiming to improve financial management.
Six Fundamental Principles of an Accounting System
A well-structured accounting system operates on six basic principles that ensure transparency, reliability, and compliance. These principles include:
Relevance – Accounting information must be relevant to decision-making, helping managers, investors, and stakeholders evaluate the financial health and strategic direction of the enterprise.
Reliability – Information recorded in the AIS must be dependable and free from errors or biases. Reliability ensures financial statements accurately reflect the company's financial position, building trust among stakeholders.
Comparability – Financial data should be consistently prepared using standardized accounting principles (such as GAAP or IFRS), allowing for comparisons across different financial periods or between organizations.
Consistency – A company must apply accounting methods consistently over time, ensuring uniformity in financial reporting. Any changes in methodology should be well-documented and justified to maintain transparency.
Understandability – Financial statements should be clear and comprehensible, enabling users—whether investors, managers, or regulators—to interpret the financial information efficiently.
Integrity and Control – An AIS must incorporate strong internal controls to prevent fraud, ensure data accuracy, and comply with legal requirements. This includes authorization procedures, audit trails, and access restrictions.
Conclusion
An Accounting Information System is crucial for enterprises, facilitating financial management through automation, accuracy, and strategic analysis. By adhering to fundamental accounting principles, organizations ensure that their financial reporting remains transparent, reliable, and useful for decision-making.
AIOU 5418 Financial Accounting Solved Assignment 2 Spring 2025
AIOU 5418 Assignment 2
Q1. Modern Technology Company was established in August, 2018 with the following authorized capital:
i) Common Stock of Rs. 10 each 500,000 shares.
ii) 10% Preferred Stock of Rs. 50 each 200,000 shares.
The Company issued shares as under:
10-09-2018 60,000 Common Stock at Rs. 10 each.
20-12-2018 50,000 Common Stock at Rs. 12 each.
15-09-2019 30,000 Common Stock at Rs. 9 each.
10-10-2019 40,000 10% Preferred Stock at Rs. 60 each.
12-10-2019 100,000 10% Preferred Stock for Plant and Equipment valuing Rs. 6,000,000.
30-06-2020 Earned a profit of Rs. 900,000 during the year 2019-2020 The closing balance of Accounts Receivable amounted to Rs. 600,000 and Inventories amounted to Rs. 400,000.
30-06-2020 Declared 10% dividend on Preferred and 8% dividend on Common Stock. The Accounts Payable at year-end amounted to Rs. 100,000.
25-07-2020 Paid dividend to 10% Preferred and Common Stockholders.
Required:
A) Pass necessary journal entries until 30 June 2020.
B) Prepare a balance sheet as of 30 June 2020
C) Pass necessary accounting entries for payment of Dividends on 10% Preferred and Common Stocks on 25 July 2020.
A) Necessary Journal Entries until 30 June 2020
| Date | Account Title | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| 10-09-2018 | Cash | 600,000 | |
| Common Stock (60,000 shares x Rs. 10) | 600,000 | ||
| Being issuance of 60,000 common shares at par | |||
| 20-12-2018 | Cash | 600,000 | |
| Common Stock (50,000 shares x Rs. 10) | 500,000 | ||
| Share Premium - Common (50,000 shares x Rs. 2) | 100,000 | ||
| Being issuance of 50,000 common shares at a premium | |||
| 15-09-2019 | Cash | 270,000 | |
| Common Stock (30,000 shares x Rs. 10) | 300,000 | ||
| Share Discount - Common (30,000 shares x Rs. 1) | 30,000 | ||
| Being issuance of 30,000 common shares at a discount | |||
| 10-10-2019 | Cash | 2,400,000 | |
| Preferred Stock (40,000 shares x Rs. 50) | 2,000,000 | ||
| Share Premium - Preferred (40,000 shares x Rs. 10) | 400,000 | ||
| Being issuance of 40,000 preferred shares at a premium | |||
| 12-10-2019 | Plant and Equipment | 6,000,000 | |
| Preferred Stock (100,000 shares x Rs. 50) | 5,000,000 | ||
| Share Premium - Preferred (100,000 shares x Rs. 10) | 1,000,000 | ||
| Being issuance of preferred stock for plant and equipment | |||
| 30-06-2020 | Profit and Loss Summary | 900,000 | |
| Retained Earnings | 900,000 | ||
| Being recording of profit for the year 2019-2020 |
B) Balance Sheet as of 30 June 2020
Modern Technology Company
Balance Sheet
As of 30 June 2020
| Assets | Amount (Rs.) | Liabilities and Equity | Amount (Rs.) |
|---|---|---|---|
| Current Assets | Current Liabilities | ||
| Cash | 3,870,000 | Accounts Payable | 100,000 |
| Accounts Receivable | 600,000 | ||
| Inventories | 400,000 | ||
| Total Current Assets | 4,870,000 | Total Current Liabilities | 100,000 |
| Non-Current Assets | Equity | ||
| Plant and Equipment | 6,000,000 | Common Stock | 1,400,000 |
| Preferred Stock | 7,000,000 | ||
| Share Premium - Common | 70,000 | ||
| Share Premium - Preferred | 1,400,000 | ||
| Retained Earnings | 900,000 | ||
| Total Non-Current Assets | 6,000,000 | Total Equity | 10,770,000 |
| TOTAL ASSETS | 10,870,000 | TOTAL LIABILITIES and EQUITY | 10,870,000 |
C) Necessary Accounting Entries for Payment of Dividends on 25 July 2020
30 June 2020 (Declaration Date)
| Date | Account Title | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| 30-06-2020 | Retained Earnings | 812,000 | |
| Dividend Payable - Preferred | 700,000 | ||
| Dividend Payable - Common | 112,000 | ||
| Being declaration of cash dividends |
25 July 2020 (Payment Date)
| Date | Account Title | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| 25-07-2020 | Dividend Payable - Preferred | 700,000 | |
| Dividend Payable - Common | 112,000 | ||
| Cash | 812,000 | ||
| Being payment of declared cash dividends |
Q2. Subhan Industries, Jhelum was established about 10 years ago with an authorized capital of 500,000 Common Stock of Rs. 100 each. The Company had issued 300,000 Common Stocks at Rs. 130 each in the past. The balance of revenue reserves and retained earnings as appearing in the equity section of the balance sheet amounted to Rs. 800,000 and Rs. 650,000 respectively apart from the Premium on the Common Stock Account. The Company last year purchased its common stock of 50,000 at Rs. 125 each and retained it. During the current year, the Board of Directors decided to retire the common stock equivalent to the purchase quantum as the volume of business was facing a market slump.
Required:
a) Prepare necessary accounting entries for the purchase of own common stock by the company from the market as of last year.
b) During the current year prepare necessary accounting entries for retirement of the common stock purchased during the last year.
c) Prepare the equity section of the balance sheet of the company separately as of the last year after the purchase of common stock and the current year after the retirement of a certain portion of the common stock of the company.
(a) Accounting Entries for the Purchase of Own Common Stock (Last Year)
When the company purchased its own common stock (treasury stock), the following journal entry would be recorded:
| Account | Debit (Rs.) | Credit (Rs.) |
| Treasury Stock (50,000 shares x Rs. 125) | 6,250,000 | |
| Cash | 6,250,000 | |
| To record the purchase of own common stock |
(b) Accounting Entries for the Retirement of Common Stock (Current Year)
When the company retires the treasury stock, we need to reverse the original issuance and any related premium.
First, let's calculate the original issue price per share and the premium per share:
- Original Issue Price = Rs. 130 per share
- Par Value = Rs. 100 per share
- Premium per share = Rs. 130 - Rs. 100 = Rs. 30 per share
Now, let's prepare the journal entry for the retirement of 50,000 shares:
| Account | Debit (Rs.) | Credit (Rs.) |
| Common Stock (50,000 shares x Rs. 100) | 5,000,000 | |
| Premium on Common Stock (50,000 shares x Rs. 30) | 1,500,000 | |
| Retained Earnings (Balancing Figure) | 250,000 | |
| Treasury Stock | 6,250,000 | |
| To record the retirement of treasury stock |
Explanation of the Balancing Figure: The cost of the treasury stock (Rs. 6,250,000) is more than the original capital contributed (Common Stock + Premium on Common Stock = Rs. 5,000,000 + Rs. 1,500,000 = Rs. 6,500,000). The difference of Rs. 250,000 (Rs. 6,500,000 - Rs. 6,250,000) is debited to Retained Earnings, reducing it.
(c) Equity Section of the Balance Sheet
As of Last Year (After the Purchase of Common Stock):
| Equity | Amount (Rs.) |
| Common Stock (300,000 shares x Rs. 100) | 30,000,000 |
| Premium on Common Stock (300,000 shares x Rs. 30) | 9,000,000 |
| Revenue Reserves | 800,000 |
| Retained Earnings | 650,000 |
| Total Equity Before Treasury Stock | 40,450,000 |
| Less: Treasury Stock (50,000 shares x Rs. 125) | (6,250,000) |
| Total Equity | 34,200,000 |
As of Current Year (After the Retirement of Common Stock):
| Equity | Amount (Rs.) |
| Common Stock (250,000 shares x Rs. 100) | 25,000,000 |
| Premium on Common Stock (250,000 shares x Rs. 30) | 7,500,000 |
| Revenue Reserves | 800,000 |
| Retained Earnings (650,000 - 250,000) | 400,000 |
| Total Equity | 33,700,000 |
Q3. Zoobi Manufacturing Company is planning to introduce a new product for which it requires funds amounting to Rs. 3.000 million for the purchase of some plant and factory buildings. A friend of the owner of the company has suggested he meet the funds requirement through the issuance of Bonds. Accordingly, on 01 April 2020 the Company issued 3,000 bonds of Rs. 1,000 each at par value carrying 10% interest payable semi-annually over a period of 03 years.
Required:
a) Record the issuance of Bonds.
b) Record the interest accrued at the end of each financial year and payment of interest as per terms of the bond over its life.
c) Presentation of Bonds and their accrued interest at the financial year-end.
d) Retirement of bonds upon expiry of its tenure.
Zoobi Manufacturing Company - Bond Accounting
Let's walk through the accounting entries for Zoobi Manufacturing Company's bond issuance, interest payments, financial statement presentation, and retirement.
Understanding the Bond Details:
- Date of Issuance: April 1, 2020
- Number of Bonds: 3,000
- Face Value per Bond: Rs. 1,000
- Total Funds Raised: 3,000 bonds * Rs. 1,000/bond = Rs. 3,000,000 (Rs. 3 million)
- Interest Rate: 10% per annum
- Interest Payment Frequency: Semi-annually
- Bond Term: 3 years
a) Record the Issuance of Bonds:
When Zoobi Manufacturing Company issues the bonds, it receives cash and incurs a liability. The journal entry would be:
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| April 1, 2020 | Cash | 3,000,000 | |
| Bonds Payable | 3,000,000 | ||
| (To record the issuance of 3,000 bonds) |
b) Record the Interest Accrued at the End of Each Financial Year and Payment of Interest:
The financial year-end is assumed to be December 31st. Interest is paid semi-annually, meaning payments occur on September 30th and March 31st each year.
Year 1 (2020):
- Interest Calculation for the first period (April 1, 2020 to September 30, 2020 - 6 months):
Interest per bond per year = 10% of Rs. 1,000 = Rs. 100
Semi-annual interest per bond = Rs. 100 / 2 = Rs. 50
Total semi-annual interest = 3,000 bonds * Rs. 50/bond = Rs. 150,000
- Interest Payment (September 30, 2020):
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Sep 30, 2020 | Interest Expense | 150,000 | |
| Cash | 150,000 | ||
| (To record the first semi-annual interest payment) |
- Interest Accrual (December 31, 2020):
Since the last interest payment was on September 30th, interest has accrued for three months (October 1 to December 31).
Interest for 3 months per bond = (10% of Rs. 1,000) * (3/12) = Rs. 25
Total accrued interest = 3,000 bonds * Rs. 25/bond = Rs. 75,000
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Dec 31, 2020 | Interest Expense | 75,000 | |
| Interest Payable | 75,000 | ||
| (To record accrued interest at year-end) |
Year 2 (2021):
- Interest Payment (March 31, 2021): This payment covers the interest accrued from October 1 to March 31 (6 months).
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Mar 31, 2021 | Interest Payable | 75,000 | |
| Interest Expense | 75,000 | ||
| Cash | 150,000 | ||
| (To record the second semi-annual interest payment) |
- Interest Payment (September 30, 2021):
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Sep 30, 2021 | Interest Expense | 150,000 | |
| Cash | 150,000 | ||
| (To record the third semi-annual interest payment) |
- Interest Accrual (December 31, 2021): Similar to 2020, interest has accrued for three months (October 1 to December 31).
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Dec 31, 2021 | Interest Expense | 75,000 | |
| Interest Payable | 75,000 | ||
| (To record accrued interest at year-end) |
Year 3 (2022):
- Interest Payment (March 31, 2022):
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Mar 31, 2022 | Interest Payable | 75,000 | |
| Interest Expense | 75,000 | ||
| Cash | 150,000 | ||
| (To record the fourth semi-annual interest payment) |
- Interest Payment (September 30, 2022):
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Sep 30, 2022 | Interest Expense | 150,000 | |
| Cash | 150,000 | ||
| (To record the fifth semi-annual interest payment) |
- Interest Accrual (December 31, 2022): Interest has accrued for three months (October 1 to December 31).
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Dec 31, 2022 | Interest Expense | 75,000 | |
| Interest Payable | 75,000 | ||
| (To record accrued interest at year-end) |
Year 4 (2023):
- Interest Payment (March 31, 2023): This is the final interest payment before the bonds mature.
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Mar 31, 2023 | Interest Payable | 75,000 | |
| Interest Expense | 75,000 | ||
| Cash | 150,000 | ||
| (To record the sixth and final semi-annual interest payment) |
c) Presentation of Bonds and Their Accrued Interest at the Financial Year-End:
At each financial year-end (December 31st), the bonds and their accrued interest will be presented in the financial statements as follows:
Balance Sheet:
- December 31, 2020:
- Liabilities:
- Current Liabilities: Interest Payable - Rs. 75,000
- Non-Current Liabilities: Bonds Payable - Rs. 3,000,000 (Since the bonds mature in 2023, more than one year from this date)
- Liabilities:
- December 31, 2021:
- Liabilities:
- Current Liabilities: Interest Payable - Rs. 75,000
- Non-Current Liabilities: Bonds Payable - Rs. 3,000,000 (Since the bonds mature in 2023, more than one year from this date)
- Liabilities:
- December 31, 2022:
- Liabilities:
- Current Liabilities: Interest Payable - Rs. 75,000
- Current Liabilities: Bonds Payable - Rs. 3,000,000 (Since the bonds mature within one year from this date)
- Liabilities:
Income Statement:
- For the year ended December 31, 2020:
Interest Expense - Rs. 150,000 (paid) + Rs. 75,000 (accrued) = Rs. 225,000 - For the year ended December 31, 2021:
Interest Expense - Rs. 75,000 (reversal of prior accrual) + Rs. 150,000 (paid) + Rs. 75,000 (accrued) = Rs. 300,000 - For the year ended December 31, 2022:
Interest Expense - Rs. 75,000 (reversal of prior accrual) + Rs. 150,000 (paid) + Rs. 75,000 (accrued) = Rs. 300,000 - For the period ended March 31, 2023:
Interest Expense - Rs. 75,000 (reversal of prior accrual) = Rs. 75,000 (This will be part of the income statement for the year ending December 31, 2023)
d) Retirement of Bonds Upon Expiry of Its Tenure (March 31, 2023):
When the bonds mature on March 31, 2023, Zoobi Manufacturing Company will repay the face value of the bonds to the bondholders.
| Date | Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|---|
| Mar 31, 2023 | Bonds Payable | 3,000,000 | |
| Cash | 3,000,000 | ||
| (To record the retirement of bonds upon maturity) |
This completes the accounting entries and presentation related to the bond issuance, interest payments, and retirement for Zoobi Manufacturing Company.
Q4. Define the cash flow statement, and describe the items of cash inflows and cash outflows of the operating, investing and financing activities of the cash flow statement.
What is a cash flow statement?
A cash flow statement is a financial report that provides a detailed analysis of the cash inflows and outflows of a business over a specific period. It is one of the three fundamental financial statements, alongside the income statement and balance sheet, and serves as an essential tool for assessing a company's liquidity, financial health, and cash management efficiency.
Operating Activities - Cash Inflows
Receipts from customers: Cash received from sales of goods or services.
Interest and dividends received: Earnings from investments held by the company.
Other operating revenue: Any additional revenue generated from core business operations.
Operating Activities - Cash Outflows
Payments to suppliers: Cash spent on raw materials, inventory, and other inputs.
Employee salaries and benefits: Payments to employees for services rendered.
Operating expenses: Expenditures like rent, utilities, and insurance.
Taxes paid: Any income taxes or business taxes paid to government authorities.
Interest payments: Interest paid on loans or borrowings.
Investing Activities - Cash Inflows
Sale of fixed assets: Cash received from selling land, buildings, or equipment.
Sale of investments: Proceeds from the sale of stocks, bonds, or other financial investments.
Collection of loans: Cash received from loans given to third parties or subsidiaries.
Investing Activities - Cash Outflows
Purchase of fixed assets: Cash spent on acquiring property, equipment, or technology.
Investment in securities: Cash used to purchase stocks, bonds, or other financial instruments.
Loans granted: Cash disbursed to third parties as loans.
Financing Activities - Cash Inflows
Issuance of shares: Cash received from shareholders for newly issued equity.
Borrowing from financial institutions: Loans and credit lines obtained from banks.
Bond issuance: Cash generated through the issuance of corporate bonds.
Financing Activities - Cash Outflows
Repayment of borrowings: Cash used to settle loans and debts.
Dividend payments: Funds disbursed to shareholders as dividends.
Stock repurchase: Cash used to buy back company shares.
Conclusion
A well-structured cash flow statement provides transparency into a company's financial movements, helping investors, creditors, and management evaluate the organization’s ability to generate cash, meet financial obligations, and sustain growth. The ability to manage cash flow effectively ensures stability and supports strategic decision-making for future investments and business expansion.
Q5 a). What do you understand by the analysis of financial statements narrate the objectives and benefits of analyzing the financial statements.
Objectives of Financial Statement Analysis
Assess Financial Health: Helps stakeholders understand a company’s profitability, liquidity, solvency, and efficiency. Provides a clear view of its ability to meet short-term and long-term obligations.
Facilitate Investment Decisions: Investors use financial analysis to determine whether a company is a viable investment opportunity. Helps identify companies with strong earnings potential and growth prospects.
Evaluate Profitability: Assists in understanding revenue generation and cost management. Helps management devise strategies to improve profitability.
Support Credit Decisions: Lenders and creditors analyze financial statements to assess creditworthiness. Helps in determining the company’s ability to repay loans and debts.
Compare Performance: Enables benchmarking against industry standards or competitors. Helps in understanding trends in financial performance over time.
Aid Managerial Decision-Making: Provides essential financial metrics for planning and strategy formulation. Helps management make data-driven decisions on expansion, cost control, and resource allocation.
Benefits of Financial Statement Analysis
Improves Financial Transparency: Helps stakeholders understand the financial position of a company. Reduces the likelihood of financial mismanagement or fraud.
Enhances Decision-Making: Provides accurate financial data for informed business choices. Strengthens strategic planning and risk management.
Identifies Strengths and Weaknesses: Highlights areas where the company excels and aspects that need improvement. Allows businesses to capitalize on strengths and address financial weaknesses.
Optimizes Resource Allocation: Helps management allocate resources efficiently based on financial needs. Ensures cost-effectiveness and operational efficiency.
Supports Growth and Expansion: Assists in financial forecasting and planning for expansion. Helps businesses attract investors and secure funding for growth initiatives.
Encourages Compliance: Ensures financial statements adhere to legal and regulatory requirements. Promotes ethical business practices and corporate accountability.
Q5 b). The following financial data was extracted from the financial statements of three consecutive years of Arshad Trading Corporative:
2021
2022
2023
Sales
Rs.2,600,000
Rs.2,400,000
Rs.2,500,000
Cost of Sales
2,000,000
2,100,000
1,900,000
Current assets
1,200,000
1,300,000
1,200,000
Current liabilities
950,000
1,050,000
1,000,000
Inventories
650,000
700,000
600,000
Accounts Receivables
320,000
400,000
350,000
Prepaid expenses
Rs.20,000
Rs.25,000
Rs.30,000
Required:
Compute the following ratios for the years 2022 and 2023 and comment on each to ascertain liquidity analysis:
a) Working Capital
b) Current Ratio
c) Acid Test ratio
d) Days sales in Receivables
e) Accounts Receivable Turnover ratio
f) Days sales in inventories
g) Inventory turnover ratio
h) Operating cycle
a) Working Capital
Formula: Working Capital = Current Assets - Current Liabilities
2022: Rs. 1,300,000 - Rs. 1,050,000 = Rs. 250,000
2023: Rs. 1,200,000 - Rs. 1,000,000 = Rs. 200,000
Commentary: Working capital decreased from Rs. 250,000 in 2022 to Rs. 200,000 in 2023. This indicates a reduced buffer of liquid assets available to cover short-term liabilities. While still positive, the decline suggests a slightly weaker short-term financial position in 2023 compared to 2022.
b) Current Ratio
Formula: Current Ratio = Current Assets / Current Liabilities
2022: Rs. 1,300,000 / Rs. 1,050,000 = 1.24
2023: Rs. 1,200,000 / Rs. 1,000,000 = 1.20
Commentary: The current ratio, which measures the company's ability to pay off current liabilities with its current assets, decreased slightly from 1.24 in 2022 to 1.20 in 2023. A ratio above 1 generally suggests sufficient liquidity. The slight decrease indicates a marginally reduced ability to cover short-term obligations in 2023 compared to the previous year.
c) Acid Test Ratio (Quick Ratio)
Formula: Acid Test Ratio = (Current Assets - Inventories - Prepaid Expenses) / Current Liabilities
2022: (Rs. 1,300,000 - Rs. 700,000 - Rs. 25,000) / Rs. 1,050,000 = Rs. 575,000 / Rs. 1,050,000 = 0.55
2023: (Rs. 1,200,000 - Rs. 600,000 - Rs. 30,000) / Rs. 1,000,000 = Rs. 570,000 / Rs. 1,000,000 = 0.57
Commentary: The acid test ratio, a more stringent measure of liquidity that excludes less liquid assets like inventory and prepaid expenses, increased slightly from 0.55 in 2022 to 0.57 in 2023. This suggests a marginal improvement in the company's ability to meet its short-term obligations with its most liquid assets. However, a ratio below 1 indicates that the company does not have enough highly liquid assets to cover its current liabilities.
d) Days Sales in Receivables
Formula: Days Sales in Receivables = (Accounts Receivable / Sales) * 365
2022: (Rs. 400,000 / Rs. 2,400,000) * 365 = 0.1667 * 365 = 60.81 days (approximately)
2023: (Rs. 350,000 / Rs. 2,500,000) * 365 = 0.14 * 365 = 51.10 days (approximately)
Commentary: The number of days it takes the company to collect its receivables decreased from approximately 61 days in 2022 to about 51 days in 2023. This is a positive trend, indicating that the company is becoming more efficient in collecting its dues from customers. A shorter collection period generally improves cash flow.
e) Accounts Receivable Turnover Ratio
Formula: Accounts Receivable Turnover Ratio = Sales / Accounts Receivable
2022: Rs. 2,400,000 / Rs. 400,000 = 6 times
2023: Rs. 2,500,000 / Rs. 350,000 = 7.14 times (approximately)
Commentary: The accounts receivable turnover ratio increased from 6 times in 2022 to approximately 7.14 times in 2023. This also indicates improved efficiency in collecting receivables. A higher turnover ratio suggests that the company is collecting its receivables more quickly.
f) Days Sales in Inventories
Formula: Days Sales in Inventories = (Inventories / Cost of Sales) * 365
2022: (Rs. 700,000 / Rs. 2,100,000) * 365 = 0.3333 * 365 = 121.67 days (approximately)
2023: (Rs. 600,000 / Rs. 1,900,000) * 365 = 0.3158 * 365 = 115.27 days (approximately)
Commentary: The number of days it takes the company to sell its inventory decreased from approximately 122 days in 2022 to about 115 days in 2023. This suggests an improvement in inventory management and a quicker conversion of inventory into sales. A shorter inventory holding period generally reduces storage costs and the risk of obsolescence.
g) Inventory Turnover Ratio
Formula: Inventory Turnover Ratio = Cost of Sales / Inventories
2022: Rs. 2,100,000 / Rs. 700,000 = 3 times
2023: Rs. 1,900,000 / Rs. 600,000 = 3.17 times (approximately)
Commentary: The inventory turnover ratio increased slightly from 3 times in 2022 to approximately 3.17 times in 2023. This aligns with the decrease in days sales in inventories and indicates that the company is selling its inventory slightly faster in 2023. A higher turnover ratio is generally preferred as it suggests efficient inventory management.
h) Operating Cycle
Formula: Operating Cycle = Days Sales in Inventories + Days Sales in Receivables
2022: 121.67 days + 60.81 days = 182.48 days (approximately)
2023: 115.27 days + 51.10 days = 166.37 days (approximately)
Commentary: The operating cycle, which represents the time it takes for the company to purchase inventory, sell it, and collect the cash from the sale, decreased from approximately 182 days in 2022 to about 166 days in 2023. This indicates an improvement in the overall efficiency of the company's cash flow cycle. A shorter operating cycle means the company is converting its inventory and receivables into cash more quickly.
Overall Liquidity Analysis:
While the working capital and current ratio experienced slight decreases, the acid test ratio showed a marginal increase. Notably, there were positive developments in the efficiency of managing receivables and inventory, as indicated by the decrease in days sales in receivables and inventories, and the corresponding increases in the turnover ratios. Consequently, the operating cycle also shortened.
In conclusion, while the basic liquidity measures (working capital and current ratio) showed a slight weakening, the improvements in the management of receivables and inventory suggest that the company became more efficient in converting its current assets into cash during 2023. It would be beneficial to compare these ratios to industry averages and previous periods to gain a more comprehensive understanding of Arshad Trading Corporative's liquidity position and trends.
No comments:
Post a Comment