IP - Tutorial 3 Questions

What is the role of an auditor?

To provide reassurance on the accuracy of financial statements.

What is the main balance sheet equation?

Total Assets = Equity + Liabilities.

What is accrual-based accounting?

Recognising income when earned and expenses when incurred, rather than when cash is received or paid.

What does capitalising expenditure mean?

Recording qualifying expenditure as an asset on the balance sheet rather than immediately as an expense.

How is goodwill treated under IFRS?

It is capitalised as a balance sheet asset and subject to an annual impairment test.

What is the straight-line depreciation equation?

(Cost − Residual Value) ÷ Useful Life.

How is operating profit calculated?

Revenue − Cost of Goods Sold − Operating Expenses.

How is gross margin calculated?

Gross Profit ÷ Revenue × 100%.

How is operating margin calculated?

Operating Profit ÷ Revenue × 100%.

How is net profit margin calculated?

Net Profit ÷ Revenue × 100%.

How is Return on Equity (ROE) calculated?

Net Profit ÷ Net Equity × 100%.

What is the three-stage DuPont equation for ROE?

Net Profit Margin × Asset Turnover × Financial Leverage.

How is total asset turnover calculated?

Revenue ÷ Average Total Assets.

How is financial leverage (equity multiplier) calculated?

Total Assets ÷ Net Equity.

What is the main risk of high financial leverage?

Greater financial risk due to debt obligations, interest payments and vulnerability to falling profits.

What is the cash conversion cycle (CCC) equation?

CCC = DSO + DOH − DPO.

What does a negative cash conversion cycle indicate?

The company receives cash from customers before it pays its suppliers.

How is Days Sales Outstanding (DSO) calculated?

Average Trade Receivables ÷ Revenue × 365.

How is Days of Inventory on Hand (DOH) calculated?

365 ÷ Inventory Turnover.

How is Days Payables Outstanding (DPO) calculated?

Average Trade Payables ÷ Annual Inventory Purchases × 365.

How is the current ratio calculated?

Current Assets ÷ Current Liabilities.

How is the quick ratio calculated?

(Current Assets − Inventory) ÷ Current Liabilities.

How is the interest cover ratio calculated?

Operating Profit (EBIT) ÷ Interest Expense.

What does a high interest cover ratio indicate?

A stronger ability to meet interest payments from operating profit.

What is the difference between FIFO and LIFO?

FIFO assigns the oldest inventory costs to goods sold first; LIFO assigns the newest inventory costs first.

When purchase prices are rising, how does FIFO affect COGS and gross profit compared with LIFO?

FIFO generally produces lower COGS and higher gross profit.

What is a subsidiary?

A company controlled by another company.

What happens to ordinary shareholders in a liquidation?

They receive any residual value after creditors and other prior-ranking claims have been satisfied.

Why might management manipulate financial statements?

To raise the company's share price.

Why might a company with high ROE still face financial distress?

Its ROE may be driven by high financial leverage, leaving it vulnerable to debt obligations and falling cash flows.