Question

Question 1 (35 marks) Presented here are a Statement of Income and Retained Earnings and Comparative Balance Sheets for Madison Gardens Pty Ltd, which operates a national chain of sporting goods stores.

Statement of Income and Retained Earnings for the Year ended ended 31 December 2016

Net sales R48000 Cost of goods sold R36000 Gross profit 12000 Selling, general and admin expense 6000 Operating income 6000 Interest expense 280 Income before tax 5720 Income tax expense 2280 Net income 3440 Preference dividends 100 Income available to ordinary shareholders 3340 Ordinary dividends 500 To retained Earnings 2840 Retained Earnings 1/1/2017 12000 Retained Earnings the end of the year 14840

Comparative Balance Sheets as at December 31 2016 and 2015. Cash 840 and 2700, Accounts receivable 12500 and 9000, Inventory 8000 and 5500, Prepaid insurance 100 and 400, Total current Assets 21440 and 17600, Land 4000 and 4000, Buildings & Equipment 12000 and 9000, Accumulated Depreciation (3700) and(3000), Total long-term Assets R12300 and R10000, Total Assets R33740 and R 27600, Accounts Payable 7300 and 5000, Taxes Payable 4600 and 4200, Notes Payable 2400 and 1600, Current portion of mortgage bond 200 and 200, Total current Liabilities 14500 and 11000, Mortgage Bond 1400 and 1600, Total liabilities 15900 and 12600, Preference shares 1000 and 1000, Ordinary shares 2000 and 2000, Retained earnings 14840 and 12000, Total 17840 and 15000, R33 740 (2016) and R 27600 (2015)

Required

A. Prepare a statement of cash flows for Madison Gardens Pty (Ltd) for the year ended December 31, 2016, using the indirect method in the Operating Activities section of the statement. (15)

B. Madison Gardens (Pty) Ltd’s management is concerned with its short-term liquidity and its solvency over the long run. To help management evaluate these, compute the following ratios, rounding all answers to the nearest one-tenth of a percent:

1. Current ratio 2. Acid-test ratio 3. Cash flow from operations to current liabilities ratio 4. Accounts receivable turnover ratio 5. Number of days' sales in receivables 6. Inventory turnover ratio 7. Number of days' sales in inventory 8. Debt-to-equity ratio 9. Debt service coverage ratio 10. Cash flow from operations to capital expenditures ratio (10)

C. Comment on Madison gardens’ liquidity and its solvency. What additional information do you need to fully evaluate the company? (10)

question 2 (15 marks)

Overstatement of net income might have dire consequences on the financial position of a company. Financial results are made available to users of financial information for decision making therefore the misinformation might lead to improper financial decisions. Depreciation is one of the expenses that affect net income. The following extract from two employees of Mzansi (Pty) Ltd, Sihle, who is the accounts payable clerk and Ntombi, the cashier, went as follows: Sihle: Ntombi, could I get your opinion on something? Ntombi: Sure, Sihle. Sihle: Do you know Mavis, the fixed asset clerk? Ntombi: I know who she is, but I do not know her very well, why? Sihle: Well, I was talking to her at lunch last week about how she liked her job, etc. You know, the usual….and she mentioned something about having to keep two sets of books … one for taxes and another for the financial statements. That can’t be good accounting, can it? What do you think? Ntombi: Two sets of books it doesn’t seem right to me Sihle: It doesn’t seem right to me either. I was always taught that you must use generally accepted accounting practice (GAAP) or IFRS to write up a set of books. What can be the difference between the two sets of books? If you were Ntombi how would you respond? Do you think this is ethical?

Answer 1

Madison's gardens PTY LTD Cash flow Statement 53 54 (Indirect method) For the period ending December 31, 2017 55 56 Details $ Particulars Amount $ 57 Cash flows from operating Activities 58 Net Income 3,440 59 Add Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 60 61 700 62 Increase in Accounts receivable (3,500) (2,500) 63 Increase in Inventory Decrease in Prepaid Insurance Increase in Accounts Payable Increase in Notes Payable Increase in income tax payable Net Cash provided by Operating Activities 64 300 65 2,300 66 800 67 (1,500) 1,940 400 68 69 70 Cash Flows from Investing Activities Purchase of Building & equipment Net cash used in Investing Activities 71 (3,000) 72 (3,000) 73 74

Cash Flows from Financing Activities Decrease in Mortgage Bonds payable Payment of Dividend Net cash used by Financing Activities Net Decrease in Cash & its equivalents Add Opening Balance of Cash Closing Balance of Cash 75 (200) (600) 76 77 (800) (1,860) 2,700 78 79 80 840 81 82 21440 83 B Current Ratio 84 14500 85 86 1.5 87 Acid Test Ratio 88 13340 89 14500 90 91 0.9 92 Cash flow from operations to current liabilities Ratio 93 1,940 94 14500 95 13.4% 96 97

Accounts Receivable turnover ratio 98 48000 99 10750 100 101 4.5 102 Number of days' sales in receivables 103 365 104 4.5 105 106 81,7 107 Inventory turnover ratio 108 36000 109 6750 110 5.3 111 112 Number of days' sales in inventory 113 365 114 5.3 115 116 68.4 117 Debt-to-equity ratio 118 15900 119 16840 120 94.4% 121 122

Debt service coverage ratio 123 6000 124 480 125 126 12,5 127 Cash flow from operations to capital expenditures ratio 128 1,940 129 3,000 130 131 64.7% 132 133 c) Madison's garden liquidity position is considered as satisfactory. It was taking more W time in getting their receivables back and converting inventory into sales. Debt % as 134 135 compared to equity was high .Cash flow from Operations as compared to Capital expenditure 136 was also high. Therefore, the position is not very good as the cash also decreases from the previous year. 137