Case Study

Layla Bright has run a bicycle shop for several years in rented shop premises. She sells new and reconditioned second-hand bikes and runs a repair service, with the help of a part-time assistant. The business has been moderately profitable and has provided Layla with enough to live on. Her husband, Ian, works as a local government officer and between them, they have been able to afford to take out a mortgage on a house, and go on holiday at least once a year. Layla, however, is concerned that her business is in decline. Local parking restrictions near to her shop have increased and people are parking in a multi-storey at the other end of town. Before the restrictions were imposed they used to park in a large free car park in the next street to Laylas shop, and so many people would pass her shop on the way into town. This no longer happens and Layla thinks that general awareness of the existence of his business has declined. While she still gets a lot of trade from cycling enthusiasts, her sales of children's bicycles have declined and she did not sell as many as expected just before Christmas. Layla suspects that a lot of this trade has been transferred to the bicycle and car maintenance retailing chain store in the towns main shopping centre.

Sales of more expensive bikes to cycling enthusiasts are the more profitable end of Laylas business. Her inventory of this type of bike is at around the usual level at 31 December, which is Laylas year-end. However, the inventory room is crammed full of the cheaper bikes reflecting the fact that Christmas sales were lower than expected.

It is now early January 2022. Layla is anxious to get the annual accounts prepared so that she can assess the overall effects of the downturn in trade on her profitability. She is worried about both the immediate and the longer-term future of her business. The business bank account balance at 31 December 2021 is quite a bit lower than it was at the previous year-end.

Layla provides the following list of information for incorporation into the income statement and statement of financial position. Layla is keen to learn on how to prepare the statements, so she made an attempt, which she presented, to you.

Layla introduced 50,000 of capital, which was paid into a bank account opened in the name of the business.

Premises were rented from 1 January 2021 at an annual rental of 20,000. During the year, rent of 25,000 was paid to the owner of the premises.

Rates (a tax on business premises) were paid during the year as follows;

For the period 1 January 2021 to 31 March 2021 500

For the period 1 April 2021 to 31 March 2022 1,200

A delivery van was bought on 1January 2021 for 12,000. This is expected to be used in the business for four years and then to be sold for 2,000.

Wages totalling 33,500 were paid during the year. At the end of the year, the business owed 630 of wages for the last week of the year.

Electricity bills for the first three quarters of the year were paid totalling 1,650. After 31 December 2021, but before the financial statements had been finalised for the year, the bill for the last quarter arrived showing a charge of 620.

Inventories totalling 143,000 were bought for credit.

Inventories totalling 12,000 were bought for cash.

Sales revenue on credit totalled 152,000 (cost of sales 74,000).

Cash sales revenue totalled 35,000 (cost of sales 16,000).

Receipts from trade receivables totalled 143,000.

Payments to trade payables totalled 121,000.

Van running expenses paid totalled 9,400.

She took out government interest free loan of 33,500 in 1 December 2021.

At the end of the year it was clear that a trade debtor who owed 400 would not be able to pay any part of the debt. The business uses the straight-line method for depreciating non-current assets.

Layla Bright

Income statement for the year ended 31 December 2021

Layla Bright

Statement of Financial Position as at 31 December 2021

Since Layla could not balance the statement of Financial position, she inserted Income account and put the balancing figure.

Questions:

1. Prepare the correct Income Statement and Statement of Financial Position

2. Using your statement, identify the mistakes Layla had made in preparing the accounts

3. Prepare a brief report on the profitability of the business compared to the previous year with some recommendations as to possible course of action in the future. To help you, Layla provided the following information about the year ended 31 December 2020

You may use the following ratios for comparison

Gross profit margin = Gross profit / Sales x 100

Net profit margin = Net profit / Sales x 100

You may also use % changes for comparison

\begin{tabular}{|l|r|r|} \hline & & \\ \hline Sales revenue & & 152,000 \\ \hline Less Cost of Sales (74,000+16,000) & & 90,000 \\ \hline Gross Profit & & 62,000 \\ \hline Less & & \\ Rent & 20,000 & \\ Rates & 1,200 & \\ Wages & 33,500 & \\ Electricity & 1,650 & \\ Van expenses & 2,500 & \\ & & 58,850 \\ \hline Net profit for the year & & 3,150 \\ \hline \end{tabular} \begin{tabular}{|l|r|l|r|} \hline Assets & & Claims & \\ \hline Delivery van (12,0002,500) & 12,000 & Capital & 50,000 \\ \hline Inventories & 143,000 & Income account & 164,000 \\ \hline Trade receivables & 152,000 & Trade payables & 143,000 \\ \hline Cash at bank & 50,000 & & \\ \hline & 357,000 & & 357,000 \\ \hline \end{tabular} \begin{tabular}{|l|r|} \hline & \\ \hline Sale for the year 31 December 2020 & 190,000 \\ \hline Gross profit & 90,000 \\ \hline Total expenses & 70,000 \\ \hline Net profit & 20,000 \\ \hline \end{tabular}