Financial Accounting: Organizations of Year 4 and 5 Trial Balance

Adjusting Entries

Following are the adjusting entries and narrations for each of the given cases:

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Inventory Value Adjustments

Following are the adjusting entries for inventory items:

Inventory Value Adjustments
Journal Voucher $ “000” $ “000”
Dr Cr
Inventory Revaluation $ 1,760,000
Raw Material $ 1,760,000
Finished Goods $ 2,000,000
Cost of Sales $ 2,000,000
Sales Returns $ 640,000
Sales $ 640,000
$ 2,640,000 $ 4,400,000

Other Sundry Adjustments

Following are the adjusting entries for other sundry items:

Other Sundry Adjustments
Journal Voucher $ “000” $ “000”
Dr Cr
Prepaid Insurance $ 656,000
Administration Expenses $ 656,000
Prepaid Rates $ 240,000
Administration Expenses $ 240,000
Prepaid Rent $ 640,000
Administration Expenses $ 640,000
Purchases $ 1,264,000
Accounts Payable $ 1,264,000
Administration Expenses $ 784,000
Accounts Payable $ 784,000
Administration Expenses $ 19,403
Bank and Cash $ 19,403
$ 1,536,000 $ 1,536,000

Dividend Payment

In order to make payment of dividends in the existing scenario, the company can make special dividend payments to its shareholders. In special dividends’ case, directors can use a portion of cash reserves of the business and pay them as dividends to shareholders. The underlying reasons for making special dividend payments to shareholders may vary depending on the situation and circumstances faced by the business. In the given scenario, however, The Business Plc. can make special dividend payments and thereby, bring down the pressure posed by shareholders for the dividend payment (Carmichael et al., 2007; Needles & Powers, 2010; Jiambalvo, 2010).

In addition the company can raise an amount of $ 10 million by issuing right shares, which will result in the following changes in the financial statements:

Dividend Payment

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As far as other methods of paying dividends to shareholders is concerned, the company’s directors can also make payment of dividend by way of passing a resolution at the time of approving financial statements that a certain amount of dividend will be paid to shareholders out of the profits earned by the company in Year 5. The remaining profit will be used to set off losses accumulated and brought forward from previous year (Warren et al., 2011; Noreen et al., 2011).

Property Plant and Equipment and Revaluations

Following are the adjusting entries for other sundry items:

Property Plant and Equipment and Revaluations

Finance or Operating Lease

Following are the adjusting entries for other sundry items:

Finance or Operating Lease

It is a finance lease, as risks and rewards have been transferred to the lesser. But the leased asset cannot be capitalized since it has not been delivered yet to the lesser. However, the amount of deposit already paid can be recorded under prepayments.

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Intangible Non-Current Assets

The fact that the company has expensed out costs associated with research and development is correct on the grounds that these costs are treated as operating expenses by the International Accounting Standards (IAS) and therefore, they are reported in the income statement. The company shall start amortizing the amount of research and development over the product life.

Organization of Year 4 Trial Balance

The items presented in the trial balance for Year 4 are organized in debit and credit amounts as follows:

The Business plc
Trial Balance for the year to 31 December Y4
Statement of Comprehensive Income (SOCI) $ “000” Dr Cr
Sales Revenue $ 874,712 $ 874,712
Other Income $ 15,760 $ 15,760
Cost of Sales $ 606,896 $ 606,896
Administration Expenses $ 129,976 $ 129,976
Selling and Distribution Costs $ 56,952 $ 56,952
Loss on Disposal of NCA $ 3,368 $ 3,368
Interest Expense $ 2,784 $ 2,784
Taxation $ 28,440 $ 28,440
Statement of Financial Position (SOFP)
Tangible Non-Current Assets (NCA) $ 520,968 $ 520,968
Inventory $ 56,352 $ 56,352
Accounts Receivable $ 21,520 $ 21,520
Bank and Cash $ 27,256 $ 27,256
Ordinary Shares of $ 1 Each $ 100,000 $ 100,000
Share Premium $ 32,000 $ 32,000
Revaluation Reserve $ 48,000 $ 48,000
Retained Losses b / fwd $ 278,232 $ 278,232
Short term borrowings $ 94,632 $ 94,632
Accounts Payable $ 179,200 $ 179,200
Tax Creditor $ 28,440 $ 28,440
Long term borrowings $ 360,000 $ 360000
$1,732,744 $1,732,744

Organization of Year 5 Trial Balance and Preparation of Trial Balance Reflecting Adjustments

The items presented in the trial balance for Year 5 are first organized as debit and credit amounts and then adjustments are made therein to derive the final amounts for each of the item presented in the trial balance as follows:

The Business plc
Extended Trial Balance for the year to 31 December Y5
STARTING TB JOURNALS FINAL TB
Statement of Comprehensive Income (SOCI) $ “000” Dr Cr Dr Cr Dr Cr
Sales Revenue $ 976,200 $ 976,200 $ 640 $ 975,560
Other Income $ 18,472 $ 18,472 $ 18,472
Gain on Disposal $ 2,848 $ 2,848 $ 2,848
Cost of Sales $ 677,856 $ 677,856 $ 3,024 $ 2,000 $ 678,880
Administration Expenses $ 137,520 $ 137,520 $ 983 $ 138,503
Selling and Distribution Costs $ 60,256 $ 60,256 $ 60,256
Loss on Disposal of NCA $ – $ – $ –
Interest Expense $ 3,352 $ 3,352 $ 3,352
Taxation $ 31,288 $ 31,288 $ 31,288
Statement of Financial Position (SOFP) $ –
Tangible Non-Current Assets (NCA) $ 536,452 $ 536,452 $ 80 $ 536,372
Inventory $ 63,648 $ 63,648 $ 2,000 $ 1,760 $ 63,888
Accounts Receivable $ 34,676 $ 34,676 $ 640 $ 34,036
Prepayments $ – $ – $ 2,268 $ 2,268
Bank and Cash $ 34,040 $ 34,040 $ 10,000 $ 2,387 $ 41,653
Ordinary Shares of $ 1 Each $ 100,000 $ 100,000 $ 10,000 $ 110,000
Share Premium $ 32,000 $ 32,000 $ 32,000
Revaluation Reserve $ 48,000 $ 48,000 $ 48,000
Retained Losses b / fwd $ 216,176 $ 216,176 $ 216,176
Short term borrowings $ 79,508 $ 79,508 $ 79,508
Accounts Payable $ 146,948 $ 146,948 $ 2,048 $ 148,996
Accruals $ – $ – $ –
Tax Creditor $ 31,288 $ 31,288 $ 31,288
Long term borrowings $ 360,000 $ 360,000 $ 360,000
$ 3,590,528 $ 1,795,264 $ 1,795,264 $ 18,915 $ 18,915 $ 1,806,672 $ 1,806,672

Preparation of Financial Statements

Following are the financial statements for The Business Plc., which have been prepared on the basis of extended trial balance for Year 5 and organized trial balance for Year 4.

Statement of Comprehensive Income

The Business plc
Statement of Comprehensive Income Year 4 Year 5
Sales Revenue $ 874,712 $ 975,560
Other Income $ 15,760 $ 18,472
Gain on Disposal $ 2,848
Cost of Sales $ 606,896 $ 678,880
Gross Profit $ 283,576 $ 318,000
Administration Expenses $ 129,976 $ 138,503
Selling and Distribution Costs $ 56,952 $ 60,256
Loss on Disposal of NCA $ 3,368 $ –
Operating Expense $ 190,296 $ 198,759
Operating Profit $ 93,280 $ 119,241
Interest Expense $ 2,784 $ 3,352
Net Profit After Interest $ 90,496 $ 115,889
Taxation $ 28,440 $ 31,288
Net Profit After Interest and Taxation $ 62,056 $ 84,601

Statement of Financial Position

The Business plc
Statement of Financial Position (SOFP) Year 4 Year 5
Tangible Non-Current Assets (NCA) $ 520,968 $ 536,372
Inventory $ 56,352 $ 63,888
Accounts Receivable $ 21,520 $ 34,036
Prepayments $ – $ 2,268
Bank and Cash $ 27,256 $ 41,653
Current Assets $ 105,128 $ 141,845
Total Assets $ 626,096 $ 678,217
Ordinary Shares of $ 1 Each $ 100,000 $ 110,000
Share Premium $ 32,000 $ 32,000
Revaluation Reserve $ 48,000 $ 48,000
Retained Losses b / fwd $ (216,176) $ (131,575)
Total Equity $ (36,176) $ 58,425
Short term borrowings $ 94,632 $ 79,508
Accounts Payable $ 179,200 $ 148,996
Accruals $ – $ –
Tax Creditor $ 28,440 $ 31,288
Current Liabilities $ 302,272 $ 259,792
Long term borrowings $ 360,000 $ 360,000
Total Liabilities $ 662,272 $ 619,792
Total Equity and Liabilities $ 626,096 $ 678,217

Analysis and Comparison of Year 4 and Year 5

Based on the information presented in the income statement and balance sheet of The Business plc, following ratios have been calculated.

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Ratio Year 4 Year 5
Current Ratio 0.348 0.546
Acid Test Ratio 0.161 0.300
Return on Capital Employed 0.192 0.202
Return on Ordinary Shareholders’ Funds 0.419 0.535
Operating Profit Margin 0.071 0.087
Gross Profit Margin 0.306 0.304
Average Inventory Turnover Period 10.770 10.626
Average Settlement Period for Trade Receivables 8.980 12.734
Average Settlement Period for Trade Payable 107.775 80.108
Gearing Ratio (9.951) 6.162
Interest Cover Ratio 33.506 35.573
Sales Revenue to Capital Employed Ratio 2.701 2.332

Based on the ratios determined, it can be stated that the liquidity position of the company has improved in year 5 in comparison to year 4. This is because there has been a large inflow of cash owing to the issuance of the right shares by the company. Similar is the case using acid test ratio, which also shows significant improvement in the liquidity position of the company due to the increase in the cash inflow resulting from the right issues.

Apart from this, the profit returns for the company have also improved in year 5 due to an increase in its sales revenue. However, there is a slight decrease in the gross margin of the company due to the fact that there has been a comparatively higher increase in the cost of sales in contrast to the increase in sales revenues.

The first six ratios are being graphically shown as follows:

The first six ratios

On the other hand, the inventory turnover ratio does not show any significant variation in year 5 as compared to the previous year. However, there have been unfavourable changes noted in the settlement periods for receivables and payables. The gearing ratio of the company has increased considerably as compared to the previous year. The major reason behind this is that the value for total equity in year 4 was negative due to retained losses, which in turn resulted in a decline in the gearing ratio. The interest cover ratio has also shown a slight improvement due to improvements shown in the profitability of the company. Lastly, the sales revenue to capital employed ratio shows a slight decline primarily due to increase in the capital after issuance of right shares.

The last six ratios are shown graphically as follows:

The last six ratios

Conclusion and Recommendations

Based on the analysis presented in this report, the company “The Business plc” appears to be on track as far as the profitability is concerned. However, losses that are still accumulated in the balance sheet of the company under retained losses are a matter of concern that requires attention from the board of directors. Moreover, the company has a satisfactory performance as far as liquidity and efficiency ratios are concerned.

Based on the analysis presented in this report, it is recommended that the directors of the company shall find out ways to make payments to shareholders so that the company can raise new capital. As mentioned in the report, the most suitable method of paying dividends to shareholders is appropriating a particular amount of profit at the time of approving financial statements (Warren et al., 2011).

In addition, it is also recommended that the company shall seek other sources of finance, which may be debentures or other instruments. Since the company has been able to successfully complete its research and development and has devised a successful product, it is viable that investors will seek opportunities for investing in the company (Warren et al., 2011; Needles & Powers, 2010).

Reflection Statement

This section of the report deals with the personal learning and experience that has been gained during and after the completion of the original exercise. While performing the original exercise I came across many hurdles which led me to commit several mistakes. Lack of understanding of accounting transactions and my inability to find relevant information from various books and online sources were the biggest hurdles in the successful completion of the original exercise. From this exercise, I have learned that one transaction can affect various accounting heads and it is important to understand the flow of information. The Journal entry system of accounting transactions is considered to be one of the earliest concepts that an accounting student must learn and practice. A double-entry system allows a better understanding of transactions and how each transaction affects the debits and credits of a company. If mistakes are made in the recognition and recording of accounting transactions in the journal entry system then there will be errors in the final reporting of a business. It has been noted that adjusting entries are also crucial when errors and omissions are noted in the company’s accounting records and therefore, one must have the ability to make alterations to already recorded transactions. This would subsequently affect financial reporting made by a business. For me, this was the most difficult part of learning. The complexity of transactions and decisions that a business faces must be understood and solved to ensure that the true picture of the business can be drawn for better informational value.

Moreover, another area where I felt my weakness was related to the calculation and interpretation of financial ratios which allows understanding of trends in the financial performance of businesses. To improve my skills I have gone through different books and by comparing information related to different types of financial ratios I was able to eradicate my confusion. I became much more knowledgeable and improved my skills to find relevant information from the company’s annual reports and other sources of information to highlight reasons for changes in the accounting data over the last period of reporting. I have understood that financial ratios analysis is the core technique for a financial analyst to compare the performance of a company with previous periods of reporting and also it can be useful for comparison with other companies in the same industry or market sector.

Another area in which I feel that I need to improve is pertaining to my writing skills. I felt while completing the original exercise that my control over accounting languages is weak and I needed to improve my professional writing skills. To improve on my writing skills I sought help from my colleagues to read my text and highlights areas of weaknesses which I was able to improve by repeated attempts.

References

Carmichael, D R, Whittington, O R & Graham, L 2007, Accountants’ Handbook, Financial Accounting and General Topics, John Wiley & Sons, Hoboken.

Jiambalvo, J 2010, Managerial Accounting, John Wiley & Sons, Inc., Hoboken.

Needles, B E & Powers, M 2010, Financial Accounting, Cengage Learning, Mason.

Noreen, E W, Brewer, P B & Garrison, R H 2011, Managerial Accounting for Managers, McGraw Hill, New York.

Warren, C S, Reeve, J M & Duchac, J 2011, Financial and Managerial Accounting, South-Western Cengage Learning, Mason.

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NerdyTom. (2022) 'Financial Accounting: Organizations of Year 4 and 5 Trial Balance'. 3 June.

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