Question

Coaltown is a wholesaler and retailer of office furniture. Extracts from the company’s financial statements are set out below:

Statements of comprehensive income for the year ended:

31 March 2009

31 March 2008

Revenue

Cost of sales

– cash – credit

$’000

12,800

53,000 –––––––

(380)

(220) ––––––

$’000

65,800

(43,800) ––––––– 22,000

(11,200)

$’000

26,500

28,500 –––––––

$’000

55,000

(33,000) ––––––– 22,000

(6,920)

(180) ––––––– 14,900

(4,400) ––––––– 10,500

1,200 ––––––– 11,700 –––––––

$’000 Total

26,800 12,900 12,000

(4,000) –––––– 47,700 ––––––

$’000

80,000 (48,000) ––––––––

32,000

7,900 ––––––– 39,900 –––––––

Gross profit

Operating expenses

Finance costs – loan notes

– overdraft

Profit before tax Income tax expense

Profit for period

Other comprehensive income Gain on property revaluation

Total comprehensive income for the year

(180) (600) nil ––––––– –––––––

10,200 (3,200)

–––––––

7,000

5,000 ––––––– 12,000 –––––––

Statement of changes in equity for the year ended 31 March 2009:

$’000

Equity

shares premium

8,000 500 8,600 4,300

––––– ––––––

16,600 4,800 ––––– ––––––

Statements of financial position as at 31 March:

$’000 $’000

Assets

Non-current assets (see note)

Cost 93,500 Accumulated depreciation (43,000)

––––––

50,500

Current assets

Inventory 5,200

Trade receivables 7,800

Bank nil 13,000

$’000 reserve

2,500

5,000

––––––

7,500 ––––––

$’000 earnings

15,800

7,000 (4,000)

Balances b/f

Share issue Comprehensive income Dividends paid

Balances c/f

––––––

18,800 ––––––

$’000

4,400 2,800 700 –––––

Total assets

–––––– ––––––

63,500 ––––––

2009

2008

$’000

Share Revaluation Retained

Equity and liabilities

Equity shares of $1 each 16,600 Share premium 4,800 Revaluation reserve 7,500 Retained earnings 18,800

––––––

47,700

Non-current liabilities

10% loan notes 4,000 Current liabilities

Bank overdraft 3,600

Trade payables 4,200

Taxation 3,000

nil 4,500 5,300 300 –––––

8,000 500 2,500 15,800 ––––––– 26,800

3,000

10,100 ––––––– 39,900 –––––––

Warranty provision

Total equity and liabilities

Note

Non-current assets

1,000 11,800 –––––– –––––– 63,500 ––––––

During the year the company redesigned its display areas in all of its outlets. The previous displays had cost $10 million and had been written down by $9 million. There was an unexpected cost of $500,000 for the removal a nd disposal of the old display areas. Also during the year the company revalued the carrying amount of its property upwards by $5 million, the accumulated depreciation on these properties of $2 million was reset to zero.

All depreciation is charged to operating expenses.

Required:

(a) Prepare a statement of cash flows for Coaltown for the year ended 31 March 2009 in accordance

with IAS 7 Statement of Cash Flows by the indirect method.

(b) The directors of Coaltown are concerned at the deterioration in its bank balance and are surprised that the amount of gross profit has not increased for the year ended 31 March 2009. At the beginning of the current accounting period (i.e. on 1 April 2008), the company changed to importing its purchases from a foreign supplier because the trade prices quoted by the new supplier were consistently 10% below those of its previous supplier. However, the new supplier offered a shorter period of credit than the previous supplier (all purchases are on credit). In order to encourage higher sales, Coaltown increased its credit period to its customers, and some of the cost savings (on trade purchases) were passed on to customers by reducing selling prices on both cash and credit sales by 5% across all products.

Required:

(i) Calculate the gross profit margin that you would have expected Coaltown to achieve for the year ended 31 March 2009 based on the selling and purchase price changes described by the directors;

(ii) Comment on the directors’ surprise at the unchanged gross profit and suggest what other factors may have affected gross profit for the year ended 31 March 2009;

(iii) Applying the trade receivables and payables credit periods for the year ended 31 March 2008 to the credit sales and purchases of the year ended 31 March 2009, calculate the effect this would have had on the company’s bank balance at 31 March 2009 assuming sales and purchases would have remained unchanged.

Note: the inventory at 31 March 2008 was unchanged from that at 31 March 2007; assume 365 trading

days.

Answer 1

(a) Coaltown cash fow statement for the year ended 31 march 2009

	$ ('000)	$ ('000)
operating profit		10,800
Add
depreciation of fixed assets(wn -1)	6000
loss on disposal of displays	1,500	7,500
increase in warranty provision	(1000-300)	700
Less
increase in stock	(5200-4400)	(800)
increase in debtors	(7800-2800)	(5000)
decrease in creditors	(4500-4200)	(300)
Net cash infow from operating activities		12,900
Cash flow from Investments
Servicing of finance - interest paid		(600)
Tax paid (Wn-2)		(5500)
Capital expenditure (wn-3)		(21,000)
Equity dividend paid		(4000)
Net cash flows from investing activities		(31,100)
Financing activities
Financing (Wn-4)		13,900
Net cash flows from Financing activities		13,900
Decrease in cash		(4300)

Wn-1

Fixed assets   

Cost

Balance b/f 80,000

Revaluation (5,000 – 2,000 depreciation) 3,000

Disposal (10,000)

Balance c/f   (93,500)

Cash flow for acquisitions   20,500

Depreciation

Balance b/f 48,000

Revaluation (2,000)

Disposal (9,000)

Balance c/f (43,000)

Difference – charge for year 6,00

Disposal of displays

Cost 10,000

Depreciation (9,000)

Cost of disposal 500

Loss on disposal 1,500

WN-2

Taxation:

Provision b/f (5,300)

Profit and loss account charge (3,200)

Provision c/f 3,000

Difference – cash paid (5,500)

WN-3

Purchase of fixed assets	(20,500)
Disposal cost of fxed assets	(500)
Capital expenditure	(21,000)

WN-4

Issue of equity shares (8600 capital+4300 premium)	12,900
Issue of 10% loan notes	1000
Financing	13,900

(B)

(i) Workings – all monetary figures in $’000

(Note: references to 2008 and 2009 should be taken as to the years ended 31 March 2008 and 2009)

The effect of a reduction in purchase costs of 10% combined with a reduction in selling prices of 5%, based on the figures from 2008, would be:

Sales (55,000 x 95%) 52,250

Cost of sales (33,000 x 90%) (29,700)

Expected gross profit 22,550

This represents an expected gross profit margin of 43·2% (22,550/52,250 x 100) The actual gross profit margin for 2009 is 33·4% (22,000/65,800 x 100)

(ii) The directors’ expression of surprise that the gross profit in 2009 has not increased seems misconceived.

A change in the gross profit margin does not necessarily mean there will be an equivalent change in the absolute gross profit. This is because the gross profit figure is the product of the gross profit margin and the volume of sales and these may vary independently of each other. That said, in this case the expected gross profit margin in 2009 shows an increase over that earned in 2008 (to 43·2% from 40·0%) and the sales have also increased, so it is understandable that the directors expected a higher gross profit. As the actual gross profit margin in 2009 is only 33·4% something other than the changes described by the directors must have occurred. Possible reasons for the reduction are:

The opening stock being at old (higher) cost and the closing stock is at the new (lower) cost will have caused slight distortion.

Stock write downs due to damage/obsolescence.

A change in the sales mix (i.e. from higher margin sales to lower margin sales).

New (lower margin) products may have been introduced from other new suppliers.

Some selling prices may have been discounted because of sales promotions.

Import duties (perhaps not allowed for by the directors) or exchange rate fluctuations may have caused the actual purchase cost to be higher than the trade prices quoted by the new supplier.

Change in cost classification: some costs included as operating expenses in 2008 may have been classified as cost of sales in 2009 (if intentional and material this should be treated as a change in accounting policy) – for example it may be worth checking that depreciation has been properly charged to operating expenses in 2009.

he new supplier may have put his prices up during the year; due to market conditions the company may have felt it could not pass these increases on to its customers.

(iii) Note – all monetary figures in $’000

Debtors’ collection period in 2008: 2,800/28,500 x 365 = 35·9 days

Applying the 35·9 days collection period to the credit sales made in 2009:

53,000 x 35·9/365 = 5,213, the actual debtors are 7,800 thus potentially increasing the bank balance by 2,587

A similar exercise with the trade creditors’ payment period in 2008: 4,500/33,000 x 365 = 49·8 days

Note the 33,000 above is the cost of sales for 2008. This was the same as the credit purchases as there was no change in the value of stock. However, in 2009 the credit purchases will be 44,600 (43,800 + 5,200 closing stock – 4,400 opening stock).

Applying the 49·8 days payment period to purchases made in 2009 gives:

44,600 x 49·8/365 = 6,085, the actual creditors are 4,200 thus potentially increasing the bank balance by 1,885.

Inevitably a shortening of the period of credit offered by suppliers and lengthening the credit offered to customers will put a strain on cash resources. For Coaltown the combination of maintaining the same credit periods for both trade receivables and payables would have led to a reduction in cash outflows of 4,472 (2,587 + 1,885), which would have eliminated the overdraft of 3,600 leaving a balance in hand of 872.