Accounting For Management Decision Accounting Policy

Question: Describe about the Report for Accounting For Management Decision of Accounting Policy. Answer: (a): Computation of Ratios for Tom Ltd and Jerry Ltd for financial year 2014-15 Ratio Formula Tom Ltd Jerry Ltd. Working Figure Working Figure Profit Margin Net Profit/ Revenue 55000/300000 18.33% 65000/300000 21.67% Return on Equity Net Profit/ Equity 55000/330000 16.67% 65000/230000 28.26% Return on Assets Net Profit/ Total assets 55000/410000 13.41% 65000/310000 20.97% Current Ratio Current assets/Current liabilities 110000/30000 3.67 110000/30000 3.67 Asset Turnover Revenue/ Total assets 300000/410000 0.73 300000/310000 0.97 Debt Ratio Total debt/ total assets (410000-330000)/410000 0.20 (310000-230000)/310000 0.26 (b): Report on the performance and position of Tom Ltd and Jerry Ltd The financial performance of a company can be evaluated by analysing the profit margin and return on equity (Tracy, 2012). Thus, in order to analyse the financial performance of Tom and Jerry Ltd., the profit margin and return on equity ratios have been computed as shown below: Ratio Tom Ltd Jerry Ltd. Profit Margin 18.33% 21.67% Return on Equity 16.67% 28.26% From the data depicted above, it can be observed that Jerry Ltd has higher profit margin and return on equity than Tom Ltd, which indicates that it is performing better in comparison to Tom Ltd. Further, the management of Jerry Ltd. has also been found to be more efficient than that of Tom Ltd. This managements efficiency is depicted in the return on assets and the asset turnover ratio, which are presented below: Ratio Tom Ltd Jerry Ltd. Return on Assets 13.41% 20.97% Asset Turnover 0.73 0.97 The figures shown in the table presented above, it can be observed that Jerry Ltd. earning a return of 20.97% on the total assets deployed in the business, whereas, Tom Ltd. has only been able to manage a return of 13.41% on the assets. Moreover, the assets turnover ratio of Jerry Ltd. is also better than Tom Ltd., signifying the efficiency of the management in utilising the assets. The assets turnover ratio depicts that Jerry Ltd. generates $0.97 revenues by utilising the assets worth $1, whereas, Tom Ltd. generates only $0.73. Thus, the management of Jerry Ltd. can be said to be more efficient than Tom Ltd. Apart from analysing the profitability and management efficiency, it is also crucial to analyse the liquidity of the business. Current ratio is considered the most effective tool to evaluate the liquidity of a business (Tracy, 2012). In essence of this, the current ratio of Jerry Ltd. was computed and the figure has been found to be 3.67 times, which depicts the company reserves $3.67 in current assets to pay off current liabilities worth $1. Tom Ltd. was also found to be having the same current ratio as that of Jerry Ltd. Thus, on the part of liquidity, both the companies have been found to be well positioned. Evaluating solvency of the business, the debt ratio has been computed for Jerry and Tom Ltd. It has been found that debt ratio of Jerry Ltd. was 0.26 times and of that Tom Ltd. was 0.20 times. The debt ratio depicts the proportion of total assets being financed by debt (current as well as non-current), therefore, higher than ratio worse it will be for the business (Tracy, 2012). Both the companies have low debt ratio, therefore, there is no concern of the solvency for any of the companies. However, comparing them with each other, Tom Ltd. is better positioned as it has lower debt ratio compared to Jerry Ltd. Thus, the comparison of Jerry and Tom Ltd., based on the profitability, liquidity, efficiency, and solvency parameters, it has been analysed that Jerry Ltd is performing better than Tom Ltd. Further, leaving apart the slight difference in solvency measurement, Jerry Ltd. has outperformed Tom Ltd. in every aspect of business. The inventors evaluating Jerry and Tom Ltd. as an investment option are advised to opt for Jerry Ltd (Papadopoulos, 2011). (c): Importance of Identifying Accounting Policies in Ratio Analysis The ratio analysis is conducted on the basis of the information gathered from the financial statements of the business. Various accounting policies are applied in preparation of the financial statements, which may be different from organisation to organisation and period to period for the same organisation (Alayemi, 2015). The stock valuation, depreciation, goodwill amortisation, and investment valuation are some areas where different accounting policies could observed in different organisations. Further, an organisation could also change these accounting polices depending upon the importance and use over time (Alayemi, 2015). The impact of difference in accounting policies is observed on the items of the financial statements, which are used in ratio computations. Thus, before computing the ratios for analysis of the financial performance, one is needed to eliminate the impact of difference in accounting policies; else the interpretations drawn from ratio analysis would not be correc t (Rich et al., 2009). References Alayemi, S.A. 2015. Choice of Accounting Policy: Effects on Analysis and Interpretation of Financial Statements. American Journal of Economics, Finance and Management, 1(3), pp. 190-194. Papadopoulos, P. 2011. Investment report - fundamental analysis/ ratio analysis: comparative approach between two FTSE 100 corporations Vodafone plc and British telecom group. GRIN Verlag. Rich, J., Jones, J., Mowen, M., and Hansen, D. 2009. Cornerstones of financial accounting, current trends update. Cengage Learning. Tracy, A. 2012. Ratio analysis fundamentals: how 17 financial ratios can allow you to analyse any business on the planet. RatioAnalysis.net.