Question

QUESTION FOUR

(a) Project A returns a net present value of $50,000 and generates an IRR of 9%. Interpret the meaning of these two results highlighting any connection between the NPV and IRR. (limit 80 words)

(b) Prepaid Insurance is considered a current asset. With reference to asset definition and recognition criteria describe why Prepaid Insurance is an asset and secondly why it is classified as a current asset. (limit 70 words)

(c) Compare the major purpose and informational content of the balance sheet, income statement and cash flow statement. (80 words limit)

(d) “The carrying amount of a fixed asset (Cost less accumulated depreciation) measures the market value of the asset.” Discuss, stating whether you agree or disagree with the statement and why. (40 words limit).

(e) Discuss the major considerations when choosing between using straight line, units of production and reducing balance methods of depreciation under accrual accounting (60 words)

(f) Organizations providing credit to a company structure, such as suppliers selling goods on credit and banks loaning money, take on greater risk due to limited liability of stakeholders. Describe the concept of limited liability and discuss three legal safeguards that assist such third parties to minimize their potential risk of not being repaid amounts owing. (60 words limit)

Answer 1

A. Both NPV AND IRR capital budgeting measures. Both tools reflects the feasibility of the project. However $50,000 NPV reflects that the projected discounted cash inflows over the period of investment is $50,000 higher than the actual investment made for the project. And 9% IRR means that the return on investment over the period of investment is 9% considering the fact that the cash inflows are discounted in the present values. Both of these measures determines whether a new investment or expansion opportunity is worthwhile.

B. Asset is any resource or thing a company owns, thus prepaid insurance gives a security cover to the insured thing for the time period insurance premium is prepaid. Thus the security cover obtained from such an expense becomes asset to the company in the name of prepaid insurance. And current assets are usually sold, consumed or exhausted in a short period of time usual with a year thus prepaid insurance is current asset as either it would turn into cash or it would be exhausted in a short time.

C. Balance sheet gives a purview of the various assets, liabilities and stockholder's equity real time value of the company which are furthur subcategorised to make a detail of the type of items belonging in. Thus it determines the strength of the company.

Income statement determines the profitability of the company over a period of time. It gives an overview of various revenues, expenses, income and earning thereby originating from the business operations.

Cash flow statement observes changes in balance sheet accounts, income and other cash and cash equivalent and makes the analysis down to operating activities, financing activities and financing activities.

D. Asset adjusted for depreciation is generally the book value of the asset and it may or may not be the market value for the asset. Market value of the asset is the price for which it is sold,though, book value sets the benchmark for the market value to be sold for the price thereby determining gain or loss over the sale.

E. Straight line method of depreciation deducts the same amount of depreciation every year over the asset life without considering it's maturity over the period of its useful life. It is considered by many companies as it does not affects the profit at unequal and unpredictable amount per year.

Units of production method charges depreciation in direct proportion to asset used. It assumes that an asset's life is related to its usage and do not necessary charges depreciation even if it is not used and it directly relates to the volume of production.

Reducing balance method of depreciation charges a fixed percentage of depreciation over the asset. It records larger depreciation expense during the earlier years of asset's useful life and lesser in later years

D. Limited liability safeguards the stakeholders to the financial liability restricted only to a person's investment in the company. This saves them from the risk of ceasing their personal assets of the company fails.

Legal safeguards for the organisations providing credit

Make a proper contract between the parties to ensure repayment on legal ground.

Keeping a proper credibility score of the parties lending credit to.

Keep some collateral to ensure the timely repayment of the credit.