Financial statement analysis

Question 1

A company has had a big advertising campaign, resulting in increased sales of its product, but it has not increased its selling prices. What is the effect on its gross profit margin?

Answer 1

Gross profit margin is unchanged, however the absolute gross profit will of course be higher the more units you sell.
NOTE: A company can have a drop in gross profit margin, but have an overall increase in profit.

Question 2

Two companies have similar activities and results. Company 1 uses historic cost accounting for PPE. Company 2 revalues its PPE to fair value. The value of PPE is higher than its original cost.
 Which company has a higher ROCE?
 Which company has higher gearing?

Answer 2

If a company revalues its PPE:
 Higher depreciation, therefore lower profits
 Higher equity (includes revaluation reserve)
Which company has a higher ROCE? Company 1
 ROCE = PBIT/(equity + net debt)
Which company has higher gearing? Company 1
 Gearing = net debt/equity

Question 3

Two companies sign similar leases as lessees. Company A accounts for it as an operating lease. Company B accounts for it as a finance lease.
Which company has higher gearing?

Answer 3

Company B has higher gearing, as the finance lease liability is included in its debt

Question 4

A company buys a subsidiary on the last day of its accounting period.
 How will the acquisition of the sub affect the consolidated P&L account?
 How will the acquisition of the sub affect the consolidated statement of financial position?

Answer 4

How will the acquisition of the sub affect the consolidated P&L account?
 No effect (time-apportion sub’s profits in the year of acquisition)
How will the acquisition of the sub affect the consolidated statement of financial position?
 Full consolidation. Add in all sub’s assets line by line.

Question 5

A company had a division that was loss-making. During the year it closed down the division and made the staff redundant.
 What is the effect on this year’s P&L account?
 What will be the effect on next year’s P&L account?

Answer 5

What is the effect on this year’s P&L account?
 Loss up to the date of closure
 Redundancy costs
 Profits/losses on disposal of assets
What will be the effect on next year’s P&L account?
 Higher profits (no losses or one-off costs)