Revenue IAS 18

IAS18 is mainly concerned with the recognition of revenues arising from fairly common
transactions that is

 The sale of goods

 Rendering of services
 The use of other assets of the entity yielding interest, royalties and dividends.

For this module we are going tom look at the sale of goods

Generally revenue is recognized when an entity has transferred to the buyer the significant risks
and rewards of ownership and when revenue can be measured reliably.

IAS 18 defines revenue as

 The gross inflow of economic benefits

 During the period
 In the course of ordinary activities
 Which result in the increase of equity
 Other than increase relating to contributions from equity participants.

It can be noted from the above definition that revenue refers to income that arises from ordinary
activities and it includes sales, fees, interest, dividends and royalties. Gains arise when assets and
liabilities undergoes a change in value.

2. Measurement of revenue

 Revenue is measured at fair value (that is the amount for which an assets can be
exchanged or a liability settled between knowledgeable and willing partners at arm’s
length transaction.
 The following are taken into account in determination of value :
 Trade and settlement discounts and volume rebates.
 Goods and services exchanged for that of similar nature-no revenue recognition
 Goods or services exchanged for dissimilar goods or services-revenue recognized at fair
value.
 When selling price of product includes an amount for subsequent servicing that amount is
defined and recognized over period that service is performed.
 Where transaction in effect constitute a financing element.

NB FOR THE PURPOSE OF THIS MODULE WE WILL LOOK AT THE TRADE

AND SETTLEMENT AND VOLUME REBATEES OTHERS WILL BE DONE AT A
HIGHER LEVEL.
 3. Recognition of revenue in the sales of goods.

According to the standard revenue is recognized if

 Risks and reward of ownership have to be transferred to the buyer

 Seller retains no continuing managerial involvement associated with ownership
 Amount of revenue can be measured reliably
 Probable that economic benefits associated with the transaction will flow to the enterprise
 Costs incurred in the transaction can be measured reliably

Revenue and expenses that relate to the same transaction are recognized simultaneously-
matching principle. For example, the costs of producing an item of finished goods should be
carried as assets in the statement of financial position until such a time as it is sold; they should
be written off as a charge to the trading account.

The following are examples of where significant risks and rewards of ownership have not been
deemed to have passed are given in IAS18:16

 When the seller retains obligation for unsatisfactory performance not covered by normal
warranty provisions.
 When the receipt of revenue from a particular sale is contingent upon the derivation of
revenue by the buyer from its sale of goods.
 When goods are shipped subject to installation.
 When the buyer has the right to return the purchase for a reason stated in the sales
contract.

Examples of revenue recognition

 A printing machine is sold to a company on the condition that the company secures
the right to a printing contract. The risks and reward pass to the buyer upon being
awarded the contract. Revenue will therefore be recognized at a later date.
 Academic books are bought by a bookshop on condition that unsold books can be
returned to the publisher for credit. When does the publisher recognize revenue? The
publisher recognizes revenue when the bookshop sells the books to the customer.
 Certain retail products

IAS 18 Appendix has some transactions that can be recognized as revenue, please can you check
the following items :

 Subscriptions of publications
 Lay bye sales
 Where delivery is delayed at the buyer’s request
 Goods shipped subject to condition.
Exercise 1

Given that prudence is the main consideration, discuss under what circumstances, if any revenue
might be recognized at the following stage of a sale.

 Goods are acquired by the business which it confidently expects to resell quickly.
 A customer places a firm order for goods.
 Goods are delivered to the customer.
 The customer is invoiced for goods.
 The customer pays for the goods.
 The customer’s cheque in payment for the goods has been cleared by the bank.

Class discussion

Illustration volume rebates

A Ltd sells goods to B Ltd. One invoice is for $100 less a 20% trade discount. At the end of the
period, B Ltd can claim a volume rebate of 10% of the sales less trade discounts if purchases
exceed $100,000. B Ltd has already purchased $200,000 worth of goods.

Calculate the revenue that will be disclosed in the statement of comprehensive income

Class discussion

Practice questions

1. NUST Ltd is in the business of developing and selling computerized accounting solutions
NUST Ltd concluded a lay bye sale agreement with a customer on 01 February 2011. The
customer has agreed to make the following payments after which the goods will be
collected by the customer
 01/02/2010 $1,000
 01/03/2010 $1,000
 01/04/2010 $6,000
 01/05/2010 $2,000

Required

Prepare journal entries for the above transactions for the year ended 28/02/2010 and
28/02/2011
 Events after the reporting period IAS10
The events after the reporting period are those events, favourable and unfavourable, that occur
between the end of the reporting and the date when financial are authorized for issue. The
management of an entity completes draft financial statements for the year to 31/12/20x1 on
28/02/20x2.on 18/03/20x2 the board of directors reviews the financial statements and authorizes
them for issue. The entity announces its profit and selected other financial information on
19/03/20x2. The financial statements are made available to shareholders and others on
1/04/20x2. The shareholders approve the financial statements at their AGM on 15/05/20x2 and
the approved financial statements are then filed with the regulatory body on 17/05/20x2

The financial statements are authorized for issue on 18/03/20x2(date board authorization for
issue)

Two types of events can be recognized:

(a) Those that provide evidence of conditions that existed at the end of the reporting
period(adjusting events after the reporting period) and
(b) those that are indicative of conditions that arose after the reporting period( non-adjusting
events after the reporting period)

Between reporting date and the date the financial statements are authorized (i.e. for issue outside
the organization), events may occur which show that assets and liabilities at the reporting date
should be adjusted, or that disclosure of such events should be given.

1.1 Events requiring adjustment

The standard requires adjustment of assets and liabilities in certain circumstances
An entity shall adjust the amounts recognized in its financial statements to reflect
adjusting events. Where in certain circumstances events indicate that the going concern is
no longer appropriate, then the accounts may have to be restated on a break-up value.
An example of additional evidence which becomes available after the reporting date is
where a customer goes bankrupt, thus confirming that the trade receivable account
balance at the end of the year is uncollectable.
For other examples of adjusting events please refer to the handout given.
1.2 Events not requiring adjustment
These are events which do not affect the situation at the reporting date and should not be
adjusted for, but should be disclosed in the financial statements.
For examples refer to the handout given.
1.3 Dividends
Dividends proposed or declared (but not paid) are no longer recognized as a liability and
do not appear in the accounts.
1.4 Disclosures
The following disclosures are given for events which occur after the reporting date which
do not require adjustment. If disclosure of events occurring after the reporting date is
required by the standard, the following information should be provided:
(i) The nature of the extent
(ii) An estimate of financial effect or a statement that such an estimate cannot be
made.

Exercise1

State whether the following events occurring after the reporting date require an adjustment to the
assets and liabilities of the financial statements.

(a) Purchase of an investment

(b) A change in the rate of tax, applicable to the previous year
(c) An increase in the pension benefit
(d) Losses due to fire
(e) An irrecoverable debt suddenly being paid
(f) The receipts of proceeds of sales or other evidence concerning the net realizable value
of inventory
(g) A sudden decline in the value of property held as a long term investment.

Exercise2

The directors of a company are considering the company’s draft financial statements for the year
ended 30/09/2002

The following material points are unresolved:

(i) One of the company’s buildings was destroyed in a flood in October 2002. The
estimated value of the building was $4 million, but was insured for only $3 million.
The company’s going concern status is not jeopardized. The directors are unsure what
adjustments on disclosure if any should be made.

(ii) Some goods which had cost $120,000 and which were included in closing inventory
at 30/09/2002 at that figure were found to have deteriorated while held in inventory. The
directors are unsure whether to adjust the inventory figure downwards by $40,000or
allow the loss to fall in the period when deterioration was discovered.
(iii) The company’s warehouse was destroyed by fire with an uninsured loss of
inventory worth $180,000 and damage to the buildings also uninsured of
$228,000. The going concern is not affected. The financial statements currently
make no mention of the fire losses.
 PUBLISHED ACCOUNTS
This is when financial statements are prepared for external use. When financial statements are
prepared for external use they have to be prepared in accordance to international financial
reporting standards. IAS 1 lists the required content of a company’s statement of financial
position, statement of comprehensive income , statement of changes in equity, the notes to the
financial statements. Statement of cash flows are covered by IAS 7 .

1. IAS1 –Presentationof Financial Statements

1. Objective of financial statements

Prescribe the basis for the presentation of general purpose financial statement
2. To ensure comparability with own entity’s financial statements of previous periods and
with other entities

1.1 Purposes of financial statements:

They provide information about the financial position , financial performance, and cash flows of
an entity that is useful to users for economic decision making.

Financial statements provide information about the entity’s

 Assets
 Liabilities
 Equity
 Income and expenses, including gains and losses
 Transactions with owners
 Cash flows

The financial statements include the following

 Statement of financial position

 Statement of comprehensive income
 Statement of changes in equity
 Statement of cash flows
 Accounting policy and explanatory notes
 A statement at the beginning of the earliest comparative period when making

1.2 General features:

 Fair presentation and compliance with IFRS

 Going concern
 Accrual basis of accounting
  Materiality and aggregation
 Offsetting
 Frequency of reporting
 Comparative information
 Consistency of presentation

1.3Structure and content :

Identification of the financial and distinguished

Each component of financials shall be identified clearly. The following information shall be
displayed prominently:

-name of the reporting entity or any other form of identification, as well as any change since the
previous statement of financial position.

-whether the financial statement cover the individual entity or group of entities.

- the reporting date or the period , whichever is applicable to the particular financial statement.

- the presentation currency and

-the level of rounding used in presenting amounts

1.4 Statement of Financial Statement

Line items to be included as a minimum

Current assets

 To be realized in the normal operating cycle

 Held primarily for trading
 Expected to be realized within 12 months after statement of financial position date
 Its cash and cash equivalent
 All other assets shall be classified as non current assets.

Current liabilities

 Expected to be settled in normal operating cycle

 It is held primarily for the purpose of being traded
 Liabilities to be settled within 12 months
 Liabilities other the above are non current liabilities
ABC COMPANY

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER

20X1
20X1 20X0
$'00 $'00
0 $'000 0 $'000
Assets
Non current assets
Property, plant and equipment x x
Goodwill x x
Other intangible assets x x x x

Current assets
Inventories x x
Trade and other receivables x x
Cash and cash equivalents x x x x
Total assets x x

Equity and liabilities

Issued capital x x
Reserves x x
Retained profits(losses) x x x x

Non current liabilities

Long -term borrowings x x
Long-term provisions x x x x

Current liabilities
Trade and other payables x x
Short term borrowings x x
Current portion of long term borrowings x x
Current tax payable x x x x
Total equity and liabilities x x

The above information should be presented on the face of the statement of financial position.

1.5 Statement of comprehensive income

 This is a single statement showing the profit and loss items and other comprehensive
income items separately or
  Two statements one showing profit and loss and the other showing other comprehensive
income.

ABC
STATEMENT OF COMPREHENSIVE INCOME FOR THE YAER
ENDED 31/12/20X2
20X2 20X1
Revenue x x
Cost of sales (x) (x)
Gross profit x x
Other income x x
Distribution costs (x) (x)
administrative expense (x) (x)
Other expenses (x) (x)
Finance costs (x) (x)
Profit before taxation x x
Income tax expense (x) (x)
Profit /loss for the year x x
Other comprehensive income
Gains on property valuation x x
Available for sale financial assets x x
Cash flow hedge x x
Actuarial gains /losses on defined benefit plans x x
exchange differences on translating foreign operations x x
Share of other comprehensive income of associates x x
Income tax relating to components of other comprehensive income (x) (x)
Total comprehensive income x x

1.6 Statement of changes in equity

Information to be presented either on the face of the statement of changes in equity or in the
note. Please refer to a GUIDE THROUGH IFRS for the format.

1.7 Statement of cash flows

Refer to IAS7

1.8 Notes to the financial statements

The notes shall:

 Present information on the basis of preparation of financial statements and specific

accounting policies used.
 Disclose the information required by IFRSs that is not presented on the face of the
statement of financial position , statement of comprehensive income , statement of
changes in equity or the statement of cash flow and
 Provide additional information that is not presented on the face of SFP,SOCI etc
 Notes shall be presented in a systematic manner
 Each item on the face of the statements shall be cross referenced to any related
information in the notes.
Questions

Question one

USB A Ltd Co had the following Trial Balance at 3/12/2009

CREDI
DEBIT T
$'000 $'000
Cash at bank 100
Inventory at 1 January 2009 2,400
Administrative expenses 2,206
Distribution costs 650
Non- current assets at cost :
Buildings 10,000
Plant and equipment 1,400
Motor vehicles 320
Suspense 1,500
Accumulated depreciation:
Buildings 4,000
Plant and equipment 480
Motor vehicles 120
Retained earnings 560
Trade receivables 876
Purchases 4,200
Dividend paid 200
Sales revenue 11,752
Vat payable 1,390
Trade payables 1,050
Share premium 500
$1 ordinary shares 1,000
22352 22352

The following additional information is relevant:

(a) Inventory at 31 December 2009 was valued at $1,600,000. While doing the inventory
count, errors in the previous year’s inventory count were discovered. The inventory
brought forward at the beginning of the year should have been $2.2m, not $2.4m as
above.
(b) Depreciation is to be provided as follows:
 (i) Buildings at 5% straight line, charged to administrative expenses
(ii) Plant and equipment at 20% on the reducing balance basis, charged to cost of
sales
(iii) Motor vehicles at 25% on reducing balance basis, charged to distribution costs.
(c) No final dividend is being proposed.
(d) A customer has gone bankrupt owing $76,000. This debt is not expected to be recovered
and an adjustment should be made. Allowance for receivables of 5%is to be set up.
(e) 1 million new ordinary shares were issued at $1.50 on 1 December 2009. The proceeds
have been left in a suspense account.

Required
Prepare the statement of comprehensive income for the year ended 31 December 2009, a
statement of changes in equity and a statement of financial position at that date in
accordance with the requirements of international financial reporting standards(IFRS)

Solution
Class exercise
Question two

EZ Trial balance at 31 March 2010

notes $'000 $'000
Administrative expenses 86
Cash and cash equivalent 22
Cost of goods sold 418
Distribution costs 69
Equity dividend paid (v) 92
inventory @ 31/03/2010 112
Land market value @31/03/2009 (i) 700
Lease (ix) 15
Long term borrowings (vii) 250
Equity shares ,$1 each fully paid at 31/03/2010 (vi) 600
Property, plant and equipment 31/03/2009 (iii) 480
Provision for deferred tax ,31/03/2009 (ii) 30
Provision for PPE depreciation 31/03/2009 (iv) 144
Retained earnings 31/03/2009 181
Revaluation reserve 31/03/2009 10
Revenue 720
Share premium 21/03/2010 (vi) 300
Suspense (iii) 2
Trade payables 32
Trade receivables (viii) 275
2269 2269

Additional information:

(i) Land is carried in the financial statement at market value. The market value of
land at 31/03/2010 was $675,000. There were no purchases or sales of land during
the year.
 (ii) The tax due for the year ended 31/03/2010 is estimated at $18,000. Deferred tax is
estimated to decrease by $10,000.
(iii) During the year EZ disposed of old equipment for $2,000. No entry has been
made in the accounts for this transaction except to record the cash received in
cash book and in the suspense account. The original cost of the equipment sold
was $37,000 and its book value at 31/03/2009 was $7,000.
(iv) PPE is depreciated at 10%per year straight line. Depreciation of PPE is
considered to be part of cost of sales. EZ’s policy is to charge a fulldepreciation in
theyear of acquisition and no depreciation in the year of disposal.
(v) During the year EZ paid a final dividend of $92,000 for the year ended
31/03/2009.
(vi) EZ issued 200,000equity shares on 30/09/2009 at a premium of 50%
(vii) Long term borrowing consists of a loan taken out on 1/04/2009 at 4% interest per
year. No loan interest has been paid at 31/03/2010
(viii) On 22/04/2010 EZ discovered that ZZZ had gone into liquidation. EZ has been
informed that it is very unlikely to receive any of the $125,000 balance
outstanding at 31/03/2010
(ix) On 01/04/2009 EZ acquired additional vehicles on a 2.5year (30 months operating
lease). The lease included an initial 6 months’ rent free period as an incentive to
sign the lease. The lease payments were $2,500 per month commencing on
01/10/2009.

Required

Prepare EZ’s statement of comprehensive income and statement of changes in equity for
the year to 31/03/2010 and a statement of financial position at that date, in a form suitable
for presentation to the shareholders in accordance with the requirements of International
Financial Reporting Standards ( IFRS)
Notes to the financial statements are not required as well as comparative figures
Solution

Class exercise
Question 3

At 01/07/2003 the statement of financial position of c ltd, a limited company contained the
following items:

$’000

100,00
Issued share capital ordinary shares of 50c each 0
140,00
Share premium 0
Revaluation reserve 60,000
120,00
Accumulated profits 0
420,00
0
During the year ended 30/06/2004 the following took place

(a) A fundamental error in calculating the inventory at 30/06/2003 was discovered. The
effect of the error was a reduction in inventory at that date from $30 million to $24
million.
(b) On 01/07/2003 the company issued 200 million ordinary shares, ranking equally with
those already in issue at $1, 40 per share.
(c) Some land held by the company as non-current was sold for $100 million. The land had
originally cost $25 million and was revalued to $85 million in 2002 giving rise to the
revaluation reserve of $60 million as shown above.
(d) The company’s draft pretax profit for the year ended 30/06/2004 was $40 million. In
calculating this figure the opening inventory was taken as $30 million and $15 million
was included as profit on the sale of the land (see items (i) (ii) above.
(e) Dividends totalling 2c per share were paid in the year on the enlarged capital.

Required

Prepare the company’s statement of changes in equity for the year ended 30/06/2004
 Solution

Class exercise

Question 4

Nust ltd entered into the following transactions during the year ended 28/02/2011

 On 01/03/2010 consignment sales with a sales value of $500,000 were sent to Uz ltd. By
28/02/2011 Uz ltd had already sold 60%of the consignment at a profit of 10%.
 On 01/02/2010 Nust ltd received $75,000 when goods were ordered that were only
delivered on 30/03/2010.
 On 20/02/2011, goods to the value of $50,000 were shipped to a customer subject to
installation process. The buyer accepted delivery on 26/02/2011. The installation was
completed on 01/03/2011. You can assume that the installation process is not simple.
 On 30/06/2010, goods to the value of $30,000 were sold by lay by. On this date $10,000
was received. On 22/02/2011, another $10,000 was received. The goods are on hand, but
are not ready for delivery.
 On 01/02/2011 Nust ltd received $100,000 (selling price) from its major customer for the
manufacturing of goods that must be delivered on 01/04/2011.
 Note that it is not the policy of the company to grant any settlement discount

Required

(a) Explain what is the primary issue in recognizing revenue

(b) Calculate the profit before taxation for the year ended 28/02/2011, after taking into
account the above transactions , if the profit amounted to $400,000 before the above
transactions. (assume that the cost of sales has already been taken into account in
determining the profit)
Question 5

The financial accountant of Nust ltd is not sure of how revenue is to be recognized in the
financial statements in accordance with IAS18. Upon hearing that you have just finished doing
IAS18 in class, he approached you to seek some advice on how to treat some items.

He supplies you with the following information in respect of the last three years:

2011 2010 2009

10,000,00 8,000,00 7,500,00
Revenue 0 0 0
2,300,00 2,000,00
Accounts receivable 31/12 3,000,000 0 0
4,000,00 3,750,00
Cost of sales 5,000,000 0 0
1,800,00 1,700,00
Other expenses 2,000,000 0 0
Included in the other expenses is discount allowed 150,000 120,000 100,000
If IAS 18 is applied correctly the accounts
receivable
2,250,00 1,980,00
would have been 2,960,000 0 0

Required
Prepare the statement of comprehensive income for the year ended 31/12/2011
N.B NOTES ARE NOT REQIRED
Statement of cash flowIAS7
These statements are a useful addition to the financial statements of a company because
accounting profit is not the only indicator of performance. Statement of cash flow concentrates
on the sources and uses of cash and is a useful indicator of a company’s liquidity and solvency.

Profit does not always give a meaningful picture of the company’s performance. Readers of the
company’s financial statements might be misled by a reported profit figure:

 If a company reports that it has made profits it might mislead shareholders into believing
that the company can pay a dividend in actual effect when it cannot maybe because of
insufficient cash resources.
 Employees might believe that since a company has made profits it can afford to pay
higher wages in actual effect when it cannot because of insufficient cash in the business.

From these examples it is apparent that the company’s performance and prospects does not
depend on the profits it earns but on the cash flows that it generates.

Statements of cash flow are governed by IAS 7 and their objectives are to provide users of
financial statements information about the ability of the company to generate cash equivalents, as
well as indicating the cash needs of the entity. The cash flows provide historical evidence about
cash and cash equivalents, classifying cash flows between:

 Operating activities
 Investing activities
 Financing activities
 Net change in cash and cash equivalent for the period
Statements of cash flows are an integral part of the company’s financial statement. All entities
are required by the standard to produce statement of cash flows.

Benefits of cash flow information

The benefits of statement of cash flows according to IAS 7 are that it:

 It provides further information about the liquidation and solvency

 It provides further information about the changes in net assets.
 It also gives information about the ability to adapt to changing circumstances and
comparability between entities.
 Cash flow information can be used as an indicator of the amount, timing and certainty of
future cash flows.
 Past forecast can also be used to check for accuracy as actual figures emerge
 It also helps management control costs by controlling cash flows.
Definitions of terms according to the standard

Cash: it comprises of cash in hand and demand deposits.

Cash equivalents: these are short term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to insignificant risk of
changes in value. The investments that are included in the definition are those that are
held for three months from the date of acquisition. Equity shares are not cash equivalents
but redeemable preference shares acquired with very close redemption date will be cash
equivalents. (That is a redemption date of three months or less). Loans and other
borrowings are treated as investing activities. Bank overdrafts are treated as cash and
cash equivalents.
Cash flows: are inflows and outflows of cash and cash equivalents.
Operating activities: these are the principal revenue producing activities of enterprise
and other activities that are not investing or financing. It the key part of the statement of
cash flows as it shows to what extent the companies generates cash from operations.
Examples:
1. Cash receipts from sale of goods and rendering of services.
2. Cash receipts from royalties, fees, commissions and other revenue
3. Cash payments to suppliers for goods and services.
4. Cash payments to and on behalf of employees.
5. It should be noted that certain items may be included in the net profit or loss for the
period which do not relate to operational cash flows, profit /loss on the sales of plant
but the purchase of plant is an investing activity

Investing activities: are the acquisition and disposal of non-current assets and other investment
not included in cash equivalents.
Examples:

1. Cash payment to acquire PPE, intangibles, and other non-current assets, including those
relating to capitalized development costs and self-constructed PPE.
2. Cash receipts from sales of PPE, intangibles and other non-current assets.
3. Cash payments to acquire shares or debentures of other companies.
4. Cash receipts from sale of shares or debentures of other companies.

Financing activities; these are activities that result in changes in size and composition of
the equity capital and borrowing of the entity. This is likely future interest and dividend
payments.
Examples
1. Cash proceeds from issuing shares
2. Cash payment to owners to acquire or redeem the enterprise’s shares
3. Cash proceeds from issuing debentures ,loans , notes ,bonds, mortgage and other
short or long term borrowings
4. Cash repayments of amounts borrowed.

Reporting cash flows from operating activities

The standard offers a choice of method for this part of statement of cash flows.

 The direct method: disclose major classes of gross cash receipts and gross cash
payments. It discloses information, not available elsewhere in the fin stats.
 Indirect method: net profit or loss before interest and tax and it is adjusted for effects of
a non-cash nature.
Extract of the statement of cash flows (indirect)

$
Profit before interest and tax x
Adjust for non-cash items::
Depreciation x
Loss(Profit) on sale of non-current assets x/(x)
Operating Profit before working capital adjustments X
(increase)/decrease in inventories (x)/x
(Increase)/decrease in receivables (x)/x
Increase /(Decrease) in payables (x)/x
Cash generated from operations x
Interest (paid )/received x/(x)
Income taxes paid (x)
Net cash flows from operating activities x
Question one [10 Marks]

(a) EJ publishes trade magazines and sells them to retailers. EJ has just concluded
negotiations with a large supermarket chain for the supply of large quantity of several of
its trade magazines on a regular basis. EJ has agreed a substantial discount on the
following terms:
 The same quantity of each trade magazine will be supplied each month.
 Quantities can only be changed at the end of six month period.
 Payment must be made six months in advance

The supermarket paid $150,000 on 1 September 2010 for six months supply of trade
magazines to 28 February 2011. In October 2010, EJ had supplied2 months of trade magazines.
EJ estimates that the cost of supplying the supermarket each month is $20,000.

Required

(i) State the criteria in IAS18 Revenue for income recognition.

(ii) Explain the above with reasons, how EJ should treat the above in its financial
statements for the year ended 31 October 2010. How much Revenue will be
recognized for the period? [5 Marks]

(b) The accounting records of AB included the following balances at 30 June

2009
Office buildings at cost 1,600,000
Accumulated depreciation (2% per annum) 320,000
Plant and Machinery at cost 840,000
Accumulated depre (25% straight line ) 306,000

During the year ended 30 June 2010 the following events occurred
1 July 2009 it was decided to revalue the office buildings to $2,000,000 with no change to the estimated
useful life
1 October 2009 new plant cost $200,000 was purchased.
1April 2010 , plant which had cost $240,000 and with accumulated depreciation at 30 June 2009 of
$180,000 was sold for $70,000
It is the policy of the company to charge to charge a full year's depreciation in the year of acquisition
and non in the year of disposal
Required
Prepare the PPE note in accordance with IAS 16 for the year ended 30 June 2010 [5 Marks]

Question two [20 Marks]

AF IS A Furniture manufacturing entity. The trial balance for AF at 31 March 2011 was as
follows:

Dr Cr
$,000 $,000
6% loan notes (redeemable 2015) 1,500
Accumulated profits at 31/03/2010 388
Administrative expenses 1,540
Available for sale investment at market value
31/03/2010 1,640
Bank and cash 822
Cost of sales 3,463
Distribution costs 1,590
Dividend paid 01/12/2010 275
Interest paid on loan notes half year to 30/09/2010 45
Inventory at 31/03/2011 1,320
investment income received 68
Land and buildings at cost 5,190
Ordinary share of $1 each fully paid 4,500
Plant and Equipment at cost 3,400
Provision for deferred tax 710
Provision for depreciation 31/03/2010: Buildings 1,500
Provision for depreciation 31/03/2010: Plant and Equipment 1,659
Revaluation Reserve 330
Sales Revenue 8,210
Share Premium 1,380
Trade payables 520
Trade receivables 1,480
20,765 20,765

Additional information

(i) Available for sale investment are carried in the financial statements at market value.
The market value of the available for sale investment at 31 March 2011 was
$1,750,000.
(ii) There were no sales or purchases of non-current assets or available for sale
investment during the year ended 31 March 2011.
(iii) Income tax due for the year ended 31 March 2011 is estimated at $250,000. There is
no balance outstanding in relation to the previous year’s income tax. The deferred tax
provision needs to be increased by $100,000.
(iv) Depreciation is charged on buildings using a straight line basis at 3% each year. The
cost of land included in land and buildings is $2,00,000. Plant and equipment is
depreciated using the reducing balance method at 20%. It is regarded as cost of sales.
(v) AF entered into a non-cancellable five year lease on 01 April 2010 to acquire
machinery to manufacture a new range of kitchen units. Under the terms of the lease
,AF will receive the first year rent free, then $62,500 is payable for four years
commencing in year two of the lease. The machine is estimated to have a useful
economic life of 20 years.
(vi) The 6% loan are 10 year loans due for payment in March 2015. AF incurred no other
finance cots in the year to 31 March 13, 2011.
Required

Prepare the Statement of Comprehensive Income for the year to 31 March 2011 and the
Statement of Financial Position at that date , in a form suitable for presentation to the
shareholders and in accordance with the requirements of International Financial Reporting
Standards.(IFRS)

NB notes to the financial statements are not required

Question three

The financial statements of YG are given below

Statement of financial position as at 31 October 2010
2010 2009
$,000 $,000
Non-current assets
PPE 4,676 4,248
Development expenditure 417 494
Current assets
Inventory 606 509
Trade receivables 456 372
Cash and cash equivalent 1,989 205
Total assets 8,144 5,828
Equity and liabilities
Equity
Equity shares of $1 each 3,780 2,180
Share premium 1,420 620
Revaluation reserve 560 260
Retained earnings 1,314 1,250
Non-current liabilities
Long term borrowing 360 715
Deferred tax 210 170
Current liabilities
Trade payables 425 310
Current tax 70 170
Accrued interest 5 3
Provision for redundancy cost 0 150
8,144 5,828

Statement of comprehensive income for the year ended 31 October

2010
Revenue 6,640
Cost of sales 3,530
Gross profit 3,110
Administrative expenses 2,040
Distribution costs 788
Finance costs 16
profit before tax 266
Income tax expense 120
Profit for the period 146
Other comprehensive income
Gain on revaluation of PPE 300
Total comprehensive income 446

Additional information
1. On 01 November 2009,YG issued 1,600,000 $1 ordinary shares at a premium of 50%.
No other finance was raised during the year.
2. YG paid a dividend during the

3. Plant and equipment disposed of in the year had a net book value of $70,000. Cash
received on disposal was $66,000. Any gain /loss on disposal has been included under
cost of sales
.
4. Cost of sales includes $145,000 development expenditure amortized during the year.
5. Depreciation charged for the year was $250,000.
6. The income tax expense for the year to 31 October is made up as flows:
$,000
Corporate income tax 80
Deferred tax 40
120
7. During the year to 31 October 2009 YG set a provision for redundancy costs arising from
the closure of one of its activities. During the year to 31 October 2010,YG spent $177,000 on
redundancy costs , the additional costs being charged to administrative expense

Required
(a) Prepare a Statement of Cash Flows, using the indirect method for the year ended 31
October 2010 in accordance with IFRS
. [20 Marks]

Question four

The financial statements of Global ltd for the year ended 31 December 2004 were presented to
the directors on 30 March 2005 to authorize for issue. You are the accountant of the company.
The following events have taken place:

1. On 28 February the directors of Global ltd decided to declare dividends of 10 cents per
share , to all ordinary shareholders registered on 31 December 2004. These dividends will
paid on 1 April 2005
2. On 31 December 2004 the board of directors of Global ltd decided to declare a dividend
of 10cents per share , to all ordinary shareholders registered on 31 December 2004. These
dividends will be paid on 5 January 2005.
3. During January 2005 a bomb exploded at one of the branches of Global ltd. Damage
amounted to R200.000, R80.000 of which was damage to inventory. The insurance claim
does not cover for this. A contract was concluded with ABC ltd to repair this and the cost
was R120,000.
4. Drogba , a customer of the company was placed in liquidation by his creditors on 15
January 2005 after having his contract terminated by Arsenal ltd. Drogba owes the
company ( Global ltd) $40.000 which was included at in debtors at reporting date.
Drogba notified all his creditors on 15 March 2005 .
Required

Identify each situation and briefly discuss the effect of each transaction in the Financial
Statement at 31 December 2004 [8 Marks]

Question five

State two examples of a change in accounting policy [2 Marks]

Question six

BG provides office cleaning services to a range of organizations in its local area. BG operates
through a small network of depots that are rented spaces situated in out of town industrial
developments. BG has a policy to lease all vehicles on a operating lease.

The trial balance for BG at 30 September 2010 was as follows;

$,000 $,000
10% Bonds (redeemable 2015) 150
Administrative expenses 239
Available for sale investment market value 30 September
2009 205
Bank and cash 147
Bond interest paid -half year to 31 March 2010 8
Cost of cleaning material consumed 101
Direct operating expenses (including cleaning staff) 548
Dividend paid 60
Equipment and fixtures cost at 30 September 2010 752
Equity shares $1 each , fully paid 200
income tax 9
Inventory of cleaning materials at 30 September 2010 37
Investment income received 11
Provision for deferred tax 50
Provision for depreciation at 30 September 2009 Equip&
fixtures 370
Provision for legal claim balance at 30 September 2009 190
Retained earnings at 30 September 2009 226
Revaluation reserve 30
Revenue 1017
Share premium 40
Trade payables 24
Trade receivables 141
Vehicle operating lease rentals 61
2,308 2,308

Additional information:

1. Available for sale investment are carried in the financial statements at Market value. The
market value of available for sale investment at 30 September 2010 was $225,000. There
were no purchases or sale of available for sale investment held during the year.
2. The income tax balance in the trial balance is as a result of under provision of tax for the
year ended 30 September 2009.
3. The taxation due for the year ended 30 September 2010 is estimated at $64,000 and the
deferred tax provision need to be increased by $15,000.
4. The 10% bonds were issued in 2005.
5. BG paid an interim dividend during the year, but does not propose to pay a final dividend
as profit for the year is below expectations.
6. At 30 September 2009,BG had an outstanding legal claim from a customer. BG then
made a provision that they will lose the case. During 2010 it was it was raveled that the
case was dropped. As there is no further liability the directors have decided that the
provision is no longer required.
7. Equipment and Fixtures are depreciated at 20% per annum straight line. Depreciation of
equipment and fixtures is considered to be part of direct cost of sales. BG’s policy is to
 charge a full year’s depreciation in the year of acquisition and no depreciation in the year
of disposal.

Required

Prepare the Statement of Comprehensive income and Statement of Changes in equity for the
year ended 30 September 2010 and Statement of Financial Position at that date , in a form
suitable for presentation to the shareholders and in accordance with the requirements of
IFRS. [20 Marks]

Question seven

The financial statements of Chelsea ltd are given

below
Statement of financial position as at 31 October 2010
2010 2009
$,000 $,000
Non-current assets
PPE 9352 8496
Research expenditure 834 988
Current assets
Inventory 1212 1,018
Trade receivables 912 744
Cash and cash equivalent 3978 410
16,28
Total assets 8 11,656
Equity and liabilities
Equity
Equity shares of $1 each 7,560 4,360
Share premium 2,840 1,240
Revaluation reserve 1,120 520
Retained earnings 2,628 2,500
Non-current liabilities
Long term borrowing 720 1,430
Deferred tax 420 340
Current liabilities
Trade payables 850 620
Current tax 140 340
Accrued interest 10 6
Provision for legal cost 0 300
16,28
8 11,656

Statement of comprehensive income for the year ended 31 October

2010
Revenue 13,280
Cost of sales 7,060
Gross profit 6,220
Administrative expenses 4,080
Distribution costs 1,576
Finance costs 32
profit before tax 532
Income tax expense 240
Profit for the period 292
Other comprehensive income
Gain on revaluation of PPE 600
Total comprehensive income 892

Additional information
7. On 01 November 2009,YG issued 3,200,000 $1 ordinary shares at a premium of 50%.
No other finance was raised during the year.
8. Chelsea paid a dividend during the year

9. Plant and equipment disposed of in the year had a net book value of $140,000. Cash
received on disposal was $132,000. Any gain /loss on disposal has been included under
cost of sales
.
 10. Cost of sales includes $290,000 Research expenditure amortized during the year.
11. Depreciation charged for the year was $500,000.
12. The income tax expense for the year to 31 October is made up as flows:
$,000
Corporate income tax 160
Deferred tax 80
240
7. During the year to 31 October 2009 Chelsea set a provision for legal costs arising from the
undecided cases. During the year to 31 October 2010,Chelsea spent $354,000 on legal costs ,
the additional costs being charged to administrative expense

Required
(b) Prepare a Statement of Cash Flows, using the indirect method for the year ended 31
October 2010 in accordance with IFRS

Ratio and trend analysis

The accounts of a business are designed to provide users with information about its performance
and financial position. The bare figures ,however are not particularly useful and it is only
through comparisons (usually in ratios) that their significance can be established. Comparisons
may be with previous financial periods, other similar businesses or with average of a particular
industry. The choice will depend on the purpose for which the comparison is being made and
information that is available.

User groups

Various groups are interested in performance and financial position of the company

(a) Management: will use comparisons to ensure that the business is performing efficiently
and according to plan.
(b) Employees trade unions and so on.
(c) Government
 (d) Present and potential investors will assess the company with a view to judging whether it
is a sound investment
(e) Lenders and suppliers will want to judge creditworthiness.

The following sources of information are readily available to external users

 Published accounts and interim statement

 Documents filed as required by company legislation
 Statistics published by the government
 Other published sources like Bloomberg, the economist and wall street journal

Financial analysis

The lack of detailed information available to the outsider is a considerable disadvantage in

undertaking ratio analysis. The first difficulty is that there may simply be insufficient data to
calculate all of the required ratios. A second concerns the availability of a suitable yardstick with
which the calculated ratios may be compared.

Trend analysis

This is the comparison for the same business over time and some of the problems include the
following:

 Changes in nature of the business

 Unrealistic depreciation rates under historical cost accounting
 The changing value of the currency unit being reported
 Changes in accounting policies

Cross-sectional analysis

When undertaking cross-sectional analysis the position is even made more difficult because of
the problem of identifying companies that are comparable. Comparability between companies
may be impaired due to the following reasons;
  Different degrees of diversification
 Different financing policies (e.g. leasing as opposed to buying)
 Different effects of government incentives
 Different accounting policies
 Different production and purchasing policies

The broad categories of ratios

When we look at the statement of financial position or the income statement , how would you
decide whether the company was doing badly or very well. Ratio analysis involves comparing
one figure against another to produce a ratio, and assessing whether the ratio indicates a
weakness or strength in the company’s affairs

Activity ratios: they measure how efficiently a company performs day to day tasks , such as
collection of receivables and management of inventories

Liquidity ratios: the measure the ability for the company to meet its short term obligations.

Solvency ratios: they measure the ability for companies to meet long term obligations. The
subset for these ratios is known as leverage or long term debt ratios.

Profitability ratios: they measure the ability for the company to generate profitable sales from
its resources (assets).

Shareholders’ investment ratios:

Activity /efficiency ratios

They measure how efficiently the company utilizes assets. They generally combine information
from the SOCI in the numerator and SFP in the denominator.

Activity ratios Numerator Denominator

Inventory turnover cost of goods sold inventory
inventory
Days of inventory on hand number of days in period turnover
Receivable turnover Revenue Receivables
 Receivables
Receivable collection period number of days in period turnover
Payables turnover Purchases /cost of sales trade payables
Accounts payable payment
period number of days in period Payables turnover
Working capital turnover Revenue Working capital
Fixed asset turnover Revenue Fixed assets
Total assets turnover Revenue Total assets

Inventory turnover period /Days of inventory on hand

Because the cost of goods sold measures the cost of inventory that has been sold , this ratio
measures how many times per year the entire inventory was theoretically turned over , or sold.
The higher the inventory turnover the shorter the period that the inventory is held. Generally the
turnover should be benchmarked against industry norms.

A high inventory turnover ratio relative to the industry norm might indicate a highly effective
inventory management. Alternatively, a high inventory turnover could possibly indicate the
company does not carry adequate inventory, so shortages could potentially hurt revenue. To
assess which explanation is more likely, you can compare the revenue growth with that of the
industry. Slower growth combined with higher inventory turnover could indicate inadequate
inventory levels. Revenue growth above that of the industry supports the interpretation that the
higher turnover reflects greater inventory management.

Receivables turnover and receivables collection period

The collection period represents the elapsed time between a sale and cash collection period ,
reflecting how fast the company is collects from customers it offers credit. Although limiting the
numerator to sales made on credit would be more appropriate , credit sales information is not
always made available therefore revenue reported in the financial statements can be used.

A relatively high receivables turnover ratio might indicate a highly efficient credit and collection
policy. A relatively low receivables turnover ratio would typically raise questions about
efficiency of the company’s credit and collection procedures.
Payables turnover and number of days of payables

This reflects the number of days the company takes to pay its suppliers. This ratio measures how
many times per year the company theoretically pays its suppliers. A payables turnover that is
high (low days) relative to the industry could indicate that the company is not making full use of
available credit facilities

Working capital turnover

This ratio indicates how efficiently the company generates revenue with its working capital. For
example a working capital turnover of 4. Times indicates that the company generates $4 of
revenue from every $1 of working capital. A higher ratio indicates that the company is using the
working capital efficiently

Fixed assets turnover

This ratio measures how efficiently the company generates revenues from its fixed assets.
Generally, a higher fixed assets turnover ratio indicates more efficient use of fixed assets in
generating revenue.

Total assets turnover ratio

It measures the company’s overall ability to generate revenues with a given level of sales. A ratio
of 1.20 times would indicate that the company is generating $1.20 of revenues for every $1 of
total assets.

(a) calculate the operating cycle for MB ltd based on the following information

Inventory ; raw materials 150,000

work in progress 60,000
Finished goods 200,000
Purchases 500,000
Trade accounts receivable 230,000
Trade account payables 120,000
sales 900,000
cost of goods sold 750,000

Example

FB INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2008

NOTE
S 2008 2007
$ $
3,095,57 1,909,05
Revenue 1 6 1
Operating profit 1 359,501 244,229
Interest 2 17,371 19,127
Profit before tax 342,130 225,102
Taxation 74,200 31,272
Profit after tax 267,930 193,830
Dividend 41,000 16,800
Retained profit for the year 226,930 177,030

Earnings per share 12.8c 9.3c

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2008

2008 2007
$ $
Assets
Non-current assets
Tangible non-current assets 802,180 656,071
Current assets
Inventory 64,422 86,550
1,002,70
Receivables 3 1 853,441
Cash at bank and in hand 1,327 68,363
1,870,63 1,664,42
Total assets 0 5
Equity
Ordinary Shares 10c 5 210,000 210,000
Share premium 48,178 48,178
Revenue reserve 630,721 393,363
Non-current liabilities
10% loan stock 2004 100,000 100,000
Current liabilities 881,731 912,456
1,870,63 1,664,42
0 5

Notes to the accounts

1. sales revenue and profit

3,095,57 1,909,50
Revenue 6 1
2,402,60 1,441,95
Cost of sales 9 0
Gross profit 692,967 467,101
Admin expe 333,466 222,872
operating profit 359,501 244,229
Depreciation charged 151,107 120,147

2. interest
Payable on bank overdrafts and other loans 8,115 11,909
Payable on loan stock 10,000 10,000
18,115 21,909
Receivable on short term deposits 744 2,782
Net payable 17,371 19,127

3. Receivables
Amount falling due within one year
Trade receivables 884,559 760,252
Prepayments and accrued income 97.022 45,729
981,581 805,981

Amounts falling due after more than one year

Trade receivables 21,120 47460
1,002,70
1 853,441

4. Current liabilities
Trade payables 627,018 545,340
Accruals and deferred income 81,279 280,464
Corporate taxes 108,000 37,200
Other taxes 44,434 32,652
Dividend 21,000 16,800
881,731 912,456

5. Called -up share capital

1,000,00 1,000,00
Authorized ordinary shares at 10c each 0 0
Issued and fully paid o/shares of 10c each 210,000 210,000

Prepare an analysis of all the ratios.

Liquidity ratios

Liquidity ratios which focus on the cash flows , measures a company’s ability to meet short term
obligations. It measures how quickly assets are converted to cash, it also measures the
company’s ability to meet short term obligations.

Calculation of liquidity ratios

LIQUIDITY RATIO NUMERATOR DENOMINATOR

Current ratio Current assets Current liabilities
Quick ratio Current assets-inventory Current liabilities
Cash ratio Cash + short term marketable Current liabilities
 investments

It uses data from the statement of financial position. The above three ratios measures the ability
of the company to pay its current liabilities

Interpretation of liquidity ratios

Current ratio

 It expresses current assets in relation to current liabilities

 A higher ratio indicates a higher level of liquidity ie greater ability yo meet short term
obligations.
 Current ratio of 1.0 would indicate that the book value of current assets exactly equals the
book value of liabilities.
 A lower ratio indicates less liquidity implying a greater reliance on operating cash flow
and outside financing to meet short term obligations.
 This ratio assumes that inventories and accounts receivables are liquid.

Quick ratio

This ratio is more conservative than the current ratio because it includes only liquid assets in
relation to current liabilities.

Like the current ratio a higher ratio indicates greater liquidity.

This ratio indicates that the inventory cannot be easily converted into cash. In companies where
inventory is illiquid this ratio is a better indicator of liquidity.

Cash ratio
The cash ratio normally represents a reliable measure of liquidity in cash crisis situation. only
highly marketable short term and cash are included.

Solvency ratios

They represent the ability of the company to meet long term debt obligations. It is an assessment
for a company to pay its long term debts.

Calculating solvency ratios

Debt ratios.

SOLVENCY RATIO NUMERATOR DENOMINATOR.

DEBT TO ASSET TOTAL DEBT TOTAL ASSETS
DEBT TO CAPITAL TOTAL DEBT TOTAL DEBT + TOTAL
SHAREHOLERS EQUITY
DEBT TO EQUITY TOTAL DEBT TOTAL SHAREHOLDERS
EQUITY

Total debt will include all interest bearing borrowing debt.

Coverage ratios

INTEREST COVERAGE EBIT INTERREST PAYMENTS

Interpretation of solvency ratios

Debt to asset ratio

It measures the total percentage of assets financed with debt to assets. For example a debt to
asset ratio of 0.40 or 40% indicates that 40% of the company’s assets are financed with debt.
Generally a higher ratio indicates that more of the assets are financed by debt.

Debt to capital ratio

It measures the percentage of a company’s capital that is represented by debt. A higher ratio
indicates that there is higher financial risk therefore weaker solvency.

Debt to equity ratio

It measures the amount of debt capital relative to equity capital. A ratio of 1.0 indicate that equal
amount of debt and that of capital.

Interest coverage

This ratio measures the number of times a company’s EBIT could cover its interest payments. A
higher ratio indicates stronger solvency.

Profitability ratios

The ability for the company to generate profit on capital invested is a determinant of company’s
overall value and the value of the securities it issues. Profitability reflects the company’s
competitive position in the market and extension the quality of management. The income
statement reveals the sources of earning and the components of revenue and expenses.

Calculation of profitability ratios

PROFITABILITY NUMERATOR DENOMINATOR

RATIOS
GROSS PROFIT GROSS PROFIT REVENUE
MARGIN
OPERATING OPERATING REVENUE
PROFIT MARGIN INCOME
PRETAX MARGIN EBT REVENUE
NETPROFIT NET INCOME REVENUE
MARGIN

Interpretation of profitability ratios

Gross profit margin

It indicates the percentage of revenue available to cover operating and other expenditures. Higher
gross profit margin indicates some combination of higher product pricing and lower product cost.
The ability to charge a higher price is considered by competition, so gross profits are affected by
competition (usually inversely related).

Operating profit margin

Operating profit is calculated as gross margin minus operating costs. So an operating margin
increasing faster than the gross margin indicate improvements in controlling operating costs ,
such as administrative overheads.

Pretax margin

Pretax income also called earnings before tax is calculated as operating profit minus interest, so
this reflects the effects on profitability of leverage and other non -operating income and
expenses.

Net profit margin

Net profit is calculated as revenue minus all expenses. Net profit includes recurring and non -
recurring components.

Return on investments

Return on investment
RETURN ON CAPITAL OPERATING PROFIT CAPITAL EMPLOYED
EMPLOYED
RETURN ON EQUITY PROFIT AFTER TAX AND ORDINARY SHARE AND
PREFERRED DIVIDEND OTHER EQUITY

Return on capital employed

It is not possible to assess the profits or growth properly without relating them to the amount of
capital that were employed in earning those profits. The most important profitability ratio is the
return on capital employed (ROCE) which states the profit as a percentage of the amount of
capital employed.

The underlying principle is to compare like with like and so if capital means share capital and
reserves plus non-current liabilities and debt capital, profit must mean the profit earned by all
this capital together.

What does company’s ROCE tell us? What should we be looking for? There are three
comparisons that can be made

 The change in ROCE from one year to the next can be examined.
 For example there can be an increase in the ROCE from previous periods.
  The ROCE earned by other companies, if this information is available, can be compared
with ROCE of this company.

A higher ROCE indicate that can company is utilizing its assets well to earn a higher return.

We often sub-analyze ROCE to find more about why the ROCE is high or low or better or worse
than last year. There are two factors that contribute towards a ROCE that is profit margin and
asset turnover. Profit margin x asset turnover = ROCE

CAPITAL EMPLOYED = Shareholders equity plus non -current liabilities or total assets
less current liabilities.

Return on Equity

Not widely used ratio, NB can you write notes on the return on equity.

Investment ratios

NUMERATOR DENOMINATOR
EARNINGS PER SHARE NET PROFIT /LOSS WEIGHTED NUMBER OF
ATTRIBUTABLE TO ORDINARY SHARES
ORDINARY OUTSTANDING
SHAREHOLDERS
DIVIDEND COVER EPS DIVIDEND PER SHARE
DIVIDEND PER SHARE DIVIDEND PAID NUMBER OF ORDINARY
SHARES
PRICE EARNINGS RATIO MARKET PRICE EPS
DIVIDEND YIELD DPS CURRENT MARKET
PRICE
EARNINGS YIELD EPS CURRENT MARKET
PRICE

Earnings per share

It is the amount of profit that is attributable to ordinary shareholders. Measured in cents

Dividend per share and dividend cover

Dividend per share is self-explanatory. Dividend cover it shows the proportion of profit for the
year that is available for distribution to shareholders that has been paid and what proportion will
be retained in the company. A dividend cover of 2 times would indicate that the company had
paid 50%of its distributable profit as dividend and retained 50%.

P/E ratio
It is the ratio of the company’s current share price to the earnings per share.

A high PE ratio indicates strong shareholder’s confidence in the company and in future e.g profit
growth and a lower P/E ratio indicates lower confidence.

The P/E ratio of one company can be compared with the P/E ratios of

 Other companies in the same business

 Industry average

Dividend yield

It is the return a shareholder is currently expecting on the shares of the company

Shareholders look for both dividend yield and capital growth.

RST CO is considering purchase an interest in its competitor XYZ. The managing director of
RST co has obtained the 3 most recent income statement and statement of financial position of
XYZ as shown below.

Income statement

2006 2007 2008

$,000 $,000 $,000
Revenue 18,000 18,900 19,845
Cost of sales 10,440 10,340 11,890
Gross profit 7,560 8,560 7,955
Distribution costs 1,565 1,670 1,405
Admin expe 1,409 1,503 1,591
interest payable on bank overdraft 104 215 450
interest payable on 125 debentures 600 600 600
Profit before taxation 3,882 4,572 3,909
Income tax expense 1,380 2,000 1,838
Profit after tax 2,502 2,572 2,071

STATEMENT OF FINANCIAL POSITION AT 31/12

2006 2007 2008
Land and buildings 11,460 12,121 11,081
Plant and machinery 8,896 9,020 9,130
current assets
Inventory 1,775 2,663 3,995
Trade receivables 1,440 2,260 3,164
Cash 50 53 55
23,621 26,117 27,425
Equity and liabilities
Share capital 8,000 8,000 8,000
Retained earnings 6,434 7,313 7,584
Non-current liabilities
12% debentures 5,000 5,000 5,000
Current liabilities
Trade payables 390 388 446
Bank 1,300 2,300 3,400
Taxation 897 1,420 1,195
Dividend payable 1,600 1,696 1,800
23,621 26,117 27,425

Required

Prepare a report for the managing director of RST CO commenting on the financial position of
XYZ and highlighting any areas that require further investigation

Due on Friday 16/04/2011

SHARE TRANSACTIONS