Accrual basis accounting Sample Assignment

FunkieVideo.com, a hypothetical start-up, opened for business on April 1 this year. FunkieVideo.com allows anyone to upload short personal videos, on which viewers then vote each month. The videos with the most votes will receive cash and other rewards, with a "grand prize" in a runoff among the winning monthly videos each year.

You are the founder and president. You have not yet hired an accountant but your bank is asking for an income statement and balance sheet for the first month of operation.

Based on the given information, enter the transactions in the Worksheet and complete statements on the basis of accrual accounting.

Depict revenue and expenses in the Income Statement

Create a Balance Statement that shows assets, liabilities, equity items in correct categories; retained earnings number is same number shown for profit or loss.

Business Information

FunkieVideo.com, a hypothetical start-up, opened for business on April 1 this year. FunkieVideo.com allows anyone to upload short personal videos, on which viewers then vote each month. The videos with the most votes will receive cash and other rewards, with a “grand prize” in a runoff among the winning monthly videos each year.

You are the founder and president. You have not yet hired an accountant but your bank is asking for an income statement and balance sheet for the first month of operation.

Transactions:

  1. You started your company with $100,000 that you raised by selling stock in FunkieVideo.com, Inc. to your family and friends.
  2. You purchased 26 high end servers you will need for $3,000 each, paying cash. You believe these devices will last five years before you replace them. At the end of the 5 years, you think you can sell them all for a total of $3,000.
  3. Knowing that you would need additional funds, you took a $50,000 loan at 12% annual interest rate from the bank, using the servers as collateral.
  4. At the start of the month you spent $2,000 on enough materials used in the production process for sample videos, for which you were invoiced. This is a one-month supply of materials.
  5. A PR agency charges you $500 for the promotion services (they hope for more business as you grow). You plan on paying the bill next month.
  6. Rent for the space you have leased is $1,000 a month, which you paid.
  7. The first month, you bill 10 charter clients $200 each for home page ads.
  8. You pay your freelance programmer $2,000 at the end of the month.
  9. One of your advertisers paid the $200 invoice you sent earlier in the month.
  10. You write the check for the interest on the loan owed for the month.
  11. You send payment of $300 towards the supplies that you bought earlier in the month.
  12. You record one month of depreciation on the servers.
Assets Liabilities Equity
Cash Accounts Receivable Materials Equipment (Accum.Deprec.) = Notes Payable Accts. Payable Common Stock Retained Earnings Revenue (Expense)
100000 100000
(78000) 78000
(1250) (1250)
50000 50000
2000 2000
(500) (500)
500 (500)
(1000) (1000)
2000 2000
(2000) (2000)
200 (200)
(300) (300)

FunkieVideo.com, Inc.
Income Statement
Month ended April 30, 20xx

Revenues $ 2000
Operating Expenses
Rent 1000
Wages 2000
Advertising 500
Materials 2000
Depreciation 1250
Total operating expenses (6750)
EBIT (Loss) (4750)
Interest expense (500)
Net Profit (Loss) $ (5250)

FunkieVideo.com, Inc.
Balance Sheet
April 30, 20xx

ASSETS
Current Assets
Cash $68400
Accounts Receivable 1800
Materials 2000
Total Current Assets 72200
Fixed Assets
Servers 78000
Less accumulated depreciation 1250
Net Fixed Assets 76750
Total Assets $148950
LIABILITIES
Current Liabilities
Accounts Payable 2200
Total Current Liabilities
Long term Liabilities
Bank Loan Payable
Total Liabilities
2200

50000

$52200
STOCKHOLDERS’ EQUITY
Common Stock 98750
Retained Earnings (Loss) (5250)
Total Stockholders’ Equity 93500
Total Liabilities & Stockholders’ Equity $145700

Using the financial ratio worksheets provided below, compute the following for the years ending Jan 31, 2004 and 2005:

  • Current ratio
  • Quick ratio
  • AR Collection Period in days
  • Inventory Turnover in days and times per year
  • Net Profit Margin

Write a one-page memo advising the reader what these numbers tell us about the financial health and trend of this company.

FINANCIAL RATIOS CALCULATIONS

RATIO FORMULA 2003-04 2004-05 Notes
Current Ratio currentassets/currentliabilities 1.552:1 1.637:1
Average collection period averagereceivables*365/creditsales 67.87 days 59.65 days Average receivables= opening+closingreceivables/2
Inventory turnover (in days) averageinventory*365/costofrevenue 36.53 days 32.21 days Average inventory= opening+closinginventory/2
Inventory turnover (in times per year) costofrevenue/averageinventory 9.99 times 11.33 times Average inventory= opening+closinginventory/2
Net profit margin netprofit/totalrevenus *100 12.64% 17.95%

CURRENT RATIO

It shows the short term liquidity of the firm. It is a measure of the firm’s capacity to meet its current liabilities. The ideal current ratio is 2:1.

Since the current ratio of the firm is below this ideal figure, it shows poor liquidity of the firm. However, the slight improvement in the ratio over the 2 years shows that the firm’s liquidity position is improving. This provides positive signals for future operations of the firm.

QUICK RATIO

Quick assets are those current assets which can be easily converted into cash and cash equivalents. Therefore, it excludes inventory and prepaid expenses. The ideal ratio is 1:1. A ratio higher than this ideal ratio shows that the firms can quickly meet its current liabilities, while a lower ratio shows that the firm has too much reliance on inventory in order to meet current liabilities.

The firm shows positive signs as its quick ratio is above the ideal ratio. This is further represented by the fact that its quick ratio has declined over the years to come closer to the ideal ratio. This firm thus has good growth prospects and efficient functioning.

AVERAGE COLLECTION PERIOD

This depicts the time duration within which the firm is able to make collection from its debtors (credit customers) on a regular basis.

The firm’s collection period is reasonably acceptable. This shows that the firm’s resources are not tied up with the debtors for a long duration. Also, the collection period has reduced over the 2 years showing that the firm’s collection strategy has further improved.

INVENTORY TURNOVER RATIO

It represents the number of times inventory is converted into sales within a year by the firm. While a very low ratio may show too much of cash tied up in inventory, a very high ratio may either show inefficient purchase management or, on the contrary, it may show strong sales.

The firms time lag between purchases (or manufacturing) and sales has decreased from 36 days to 32 days. This shows improvement in inventory management which is further supported by increase in inventory turnover ratio from 9.99 times to 11.33 times. However, other aspect of sales and purchases of the firm have to be considered to comment on the sales efficiency. Also, the firm should keep a check that the increase in the ratio is not due to inefficient purchases, rather, it should be supported by an improvement in sales.

NET PROFIT MARGIN

It shows the efficiency of the firm in converting the sales revenue into profits. In other words, it is the measure of a firm’s efficiency on controlling costs. The higher this margin, the more efficient is the firm.

This firm has quite low net profit margin, however, this has increased by about 5% within a year. This points towards better controlling of costs and improvement in efficiency of operations of the firm.

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