The chairman of a family business has been examining the following summary of the accounts of the company since it began three years ago.

The company’s products are popular in the locality and in the first two years sales could have been higher if there had been extra machine capacity available.
On 1 January 2006, additional share and loan capital was obtained which enabled extra machinery to be purchased. This gave an immediate increase in sales and profits.
Although 2005/06 showed the best yet results, the chairman is not very happy; the accountant has suggested that a dividend should not be proposed this year (2006) because of the overdraft.
The accountant has proposed, however, that the directors consider a dividend of £14,000 (£2,000 up on last year).
Naturally, the chairman is displeased and wants some explanations from the accountant regarding the figures in the accounts. He specifically asks:

(i) Why, if profits are the best ever and considering the company has obtained extra capital during the year, has the company gone into overdraft? Can there really be a profit if there is no cash left in the bank to pay a dividend next year?
(ii) Why is the freehold still valued at the same price as in 2004? The real value seems to be about £225,000. Why is this real value not in the balance sheet?

Required:
Write a report to the chairman:

(a) commenting on the state and progress of the business as disclosed by the accounts and the above information, supporting your analysis by appropriate key accounting ratios; and

(b) giving reasoned answers, in the context of recognised accounting law, rules and practices, to each of the questions raised by the chairman.

Transcribed Image Text:

Balance Sheet (at 30 June) 000 2004 Actual 2005 Actual 2006 Actual Freehold land and buildings 150 150 150 Plant 150 150 Less Depreciation (15) (30) 135 120 285 270 Inventory: goods and work in progress 20 45 Accounts receivable 33 101 Bank and cash 10 63 15 161 348 431 Accounts payable Taxation Overdraft Loan Deferred tax 20 80 4 17 24 24 97 10 ' 450 (75) 375 525 85 124 209 734 35 6 25 99 66 200 (31) Net assets 317 Ordinary share capital (1 shares) 300 General reserve 17 317 (106) g 23 223 (289) 445 400 45 445