dear sir/mam, equipment which was purchased using OD as temporary measure then why adjustment in current ratio was changed to 1042+29)/185 as 29 is difference between 400-371 in OD and why not it is 1042/556? 2..and trade payables in jan 360/(175+200? why this 200 sales revenue which for charity added to jan ??
Regarding the 29: The £400,000 cost of the new non-current asset has reduced the amount of cash and resulted in an overdraft. The effect of the new asset could be removed from the accounts by adding back £400k of cash, eliminating the overdraft and leaving a positive bank balance of £29k. Regarding the 200, Examiner’s argument was: It might also be argued that the purchases figure can be best estimated by adding the cost price of the charity sale to January’s cost of sales and subtracting from February’s. The figures suggest that the company has built up inventory in January in advance of this sale. So they are saying that there is an unusually high inventory figure in January, so perhaps the corresponding purchase should be in January CoS – ie remove 200 from Feb CoS and put into Jan CoS.
On a related note, could we say that it is a common practice, when doing ratio analysis, to remove the effects of one-off transactions before doing so? Or should we only do this if the exam question asks us to. I ask because I am aware that, in some instances, the very reason for an abnormal ratio is some special activity (for instance, a decrease in asset utilisation ratio is the result of a purchase of new machinery). Thanks for any clarification.
Hi I would only start adjusting the accounting entries if it was clear from the question that this is what is intended. If you felt the need to do this, clearly state your assumptions so the Examiner can follow your logic and your numbers. Certainly, stating something like "one-off transactions may have the effect of distorting the ratios, and hence care should be taken when using ratio analysis for decision making" would be a valuable point to make when discussing the limitations of ratio analysis. Simon
