IDENTIFY FOUR LIMITATIONS OF USING ACCOUNTING RATIOS FOR THE PURPOSE OF ANALYZING FINANCIAL STATEMENTS.

IDENTIFY FOUR LIMITATIONS OF USING ACCOUNTING RATIOS FOR THE PURPOSE OF ANALYZING FINANCIAL STATEMENTS.

Kiawara Enterprises prepares its financial statements on 31st October each year. Given below are the comparative profit and loss statements and balance sheets for the year ended 31st October 2009 and 2010.

Balance Sheet as 31st October

Assets:

2010

Kshs “Millions”

2009

Kshs “Millions”

Non- current assets

Land and buildings

560

630

Machinery and equipment

400

480

Furniture

300

240

1,260

1,350

Current assets

Stocks

240

130

Debtors

300

240

Prepayments

130

60

Cash in hand and bank

40

20

710

450

Total assets

1,970

1,800

Equity and Liabilities:

Capital and reserves

Ordinary share capital

500

500

Share premium

200

200

Genera reserve

150

150

Profit and loss account

670

450

1,520

1,300

Non-current liability

Long term loan

200

300

Current Liabilities

Trade creditors

180

140

Accruals

70

60

Total equity and liabilities

1,970

1,800

Profit and loss account for the year ended 31st October.

2010

Kshs

“Millions”

2009

Kshs

“Millions”

Sales

3,600

3,000

Cost of sales

2,400

2,400

Gross profit

1,200

600

Administrative expenses

300

180

Selling and distribution expenses

175

90

Interest

25

30

Total expenses

500

300

Profit before tax

700

300

Tax

(280)

(120)

Profits after tax

420

180

Dividend paid

200

100

Retained profit

220

80

Required:

The following ratios for the two years ended 31st October 2010 and 2009:

i.Gross profit to sales ratio

(2 marks)

ii.Net profit to fixed charges

(2 marks)

iii.Stock turnover (closing stock on 31st October 2008 was Kshs 110 million)
(2 marks)

iv.Current ratio

(2 marks)

v.Acid test ratio

(2 marks)

vi.Debtors collection period (Assume there are 360 days in a year and that all sales are made on credit. (2 marks)vii.Gearing ratio (2 marks) viii.Return on capital employed (2 marks)

(b)Identify four limitations of using accounting ratios for the purpose of analyzing financial statements. (2 marks)QUESTION FOUR


 

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