Question

Wisdom Learning is an e-learning business that specialises in providing online learning resources in accounting, economics, and marketing management. The adjusted trial balance of Wisdom Learning as at 30 June 2019 as follows.

Debit $	Credit $
Cash at Bank	17200
Accounts Receivable	3900
Office Supplies	900
Prepaid Rent	3000
Equipment	60000
Accumulated Depreciation - Equipment		300
Furniture	27000
Accumulated Depreciation - Furniture		450
Accounts Payable		12300
Salary Payable		1350
Interest Payable		150
Unearned Service Revenue		2400
Loan Payable		60000
Owner’s, Capital		4800
Owner’s, Drawings	1500
Service Revenue		39600
Rent Expense	2100
Salary Expense	4700
Supplies Expense	150
Depreciation Expense - Building	300
Depreciation Expense - Furniture	450
Interest Expense	150
	121350	121350

Required:

a)     Prepare Wisdom Learning’s Income Statement for the year ended 30 June 2019.

b)    Prepare Wisdom Learning’s Statement of Changes in Equity for the year ended 30 June 2019.

c)     Calculate Wisdom Learning’s Profit Margin and Return on Assets ratios (the total assets at 30 June 2018 was $109000). (Show all calculations, Round off the answers to the nearest 2 decimal places).

d)    (i) Calculate Wisdom Learning’s Current ratio and the Debt-to-total assets ratio at 30 June 2019. (Show all calculations, Round off the answers to the nearest 2 decimal places).

(ii) Discuss Wisdom Learning’s liquidity and solvency positions at 30 June 2019 as compared to 2018 (the Current ratio was 1.65:1 and the Debt-to-total assets ratio was 54.75% at 30 June 2018). (Total 20 Marks)

Answer 1

a)      Prepare Wisdom Learning’s Income Statement for the year ended 30 June 2019

.

Income statement for the year ended 30 June, 2019
Service Revenue	$39600
Expenses:
Rent Expense	2100
Salary Expense	4700
Supplies Expense	150
Depreciation Expense - Building	300
Depreciation Expense - Furniture	450
Interest Expense	150
Operating income	$31750

.

b) Prepare Wisdom Learning’s Statement of Changes in Equity for the year ended 30 June 2019

.

Changes in Equity for the year ended 30 June 2019
Owner’s, Capital		$4800
Owner’s, Drawings	1500
Ending Owner’s capital		$3300

.

c)     Calculate Wisdom Learning’s Profit Margin and Return on Assets ratios (the total assets at 30 June 2018 was $109000).

.

Profit Margin = Profit / Revenue

Where,

Profit = 31750

Revenue = 39600

Profit Margin = 31750 / 39600 = 0.8018 = 80.18%

.

Return on Assets ratios = operating income / Average assets

Where,

operating income = 31750

Average assets = (Beginning + ending ) / 2 = ( 109000 + 111250 ) 2 = 110125

Ending balance of assets

Cash at Bank		17200
Accounts Receivable		3900
Office Supplies		900
Prepaid Rent		3000
Equipment	60000
Accumulated Depreciation - Equipment	(300)	59700
Furniture	27000
Accumulated Depreciation - Furniture	(450)	265550
Total assets		111250

.

Return on Assets ratios = 31750 / 110125 = 0.2883 = 28.83%

.

c)     (i) Calculate Wisdom Learning’s Current ratio and the Debt-to-total assets ratio at 30 June 2019

.

Current ratio = Current Assets / Current liabilities

Where,

Current Assets =

Cash at Bank	17200
Accounts Receivable	3900
Office Supplies	900
Prepaid Rent	3000
Total current assets	25000

.

Current liabilities =

Accounts Payable	12300
Salary Payable	1350
Interest Payable	150
Unearned Service Revenue	2400
Total Current liabilities	16200

.

Current ratio = 25000 / 16200 = 1.54 : 1

.

Debt-to-total assets ratio = Total debt / Total assets

Where,

Total debt =

Total Current liabilities	16200
Loan Payable	60000
Total debt	76200

.

Total assets = 111250

.

Debt-to-total assets ratio = 76200 / 111250 = 0.6849 = 68.49%

.

(ii) Discuss Wisdom Learning’s liquidity and solvency positions at 30 June 2019 as compared to 2018 (the Current ratio was 1.65:1 and the Debt-to-total assets ratio was 54.75% at 30 June 2018)

.

Liquidity is the ability of a company to repay its short term obligation with in time. Solvency means the ability of a company to repay its long term obligation with in due date.

The current ratio is a liquidity ratio and it measure the company's ability to pay short-term obligations. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables. The standard current ratio is 2 : 1. in here the current ration is decreased compare to previous year current ratio. Because due to increase in current liabilities or decrease in current assets. In previous year the ratio was 1.65 : 1, but now it is decreased to 1.54 : 1. The company liquidity is reduced.

Debt to total assets ratio is a solvency ratio and it is an indicator of a company's financial leverage. It tells you the percentage of a company's total assets that were financed by creditors. In other words, it is the total amount of a company's debt divided by the total amount of the company's assets. Increase in the percentage of ratio means increase the portion of debt in capital and it increase the financial leverage and increase the solvency risk. Compare to previous year ratio of 54.75% to current year of 68.49%, we can understand the financial leverage are increased and it will increase the solvency risk.