Exercises: Accounting obligations: balance sheet and income statement

Define a company's equity and liabilities structure, and explain in your own words what its three balance sheet categories represent: assets, equity, and liabilities.

Classify these balance sheet items as assets, equity, or liabilities: a van, a five-year bank loan, warehouse merchandise, capital contributed by partners, office computers, and a debt to a supplier.

The figure shows the balance sheet structure with its two columns. Identify the missing balance sheet category, marked with "?", explain what it represents, and write the fundamental accounting equation that relates the three categories.

Within assets, a distinction is made between non-current assets (items that remain in the company for more than a year) and current assets (those that turn into cash in less than a year). Classify these items of a company: an industrial warehouse, warehouse inventory, cash in the till, a patent, computers and the debts of some customers who will pay in three months.

Working capital is calculated as $FM = \text{current assets} - \text{current liabilities}$. A company has inventory worth $18.000\ \text{€}$, customers who owe it $12.000\ \text{€}$, cash of $6.000\ \text{€}$ and short-term debts of $25.000\ \text{€}$. a) Calculate its working capital. b) Interpret its sign.

A gym took in $95.000\ \text{€}$ from its members' fees and had expenses of $70.000\ \text{€}$ in the year. a) Calculate the profit for the financial year: $Resultado = Ingresos - Gastos$. b) State whether the company has made or lost money and in which accounting statement it is recorded.

A bakery buys an oven for $12.000\ \text{€}$ with a useful life of six years and no residual value. a) Calculate the annual depreciation using the straight-line method: $A = \frac{\text{purchase price}}{\text{useful life}}$. b) Explain what depreciation represents and why it is an expense even though it is not paid every year.

Current liabilities cover debts due in less than a year and non-current liabilities, those due in more than a year. Classify these items of a bookshop into equity, non-current liabilities or current liabilities: a ten-year loan, a debt to suppliers at 90 days, the share capital, a debt with the tax authority due next month, the accumulated reserves and a three-year credit.

A company has total assets of $150.000\ \text{€}$ and liabilities of $90.000\ \text{€}$. a) Calculate its equity. b) Interpret the result and explain what negative equity (a situation of technical insolvency) would mean instead.

An academy billed $80.000\ \text{€}$ for courses and incurred expenses of $65.000\ \text{€}$ (salaries, rent, utilities, and advertising). a) Calculate the profit for the financial year. b) Explain the difference between revenue and cash receipt, and between expense and cash payment, using an example from the academy.

The annual accounts include the balance sheet, the profit and loss account, and the notes to the accounts. Explain what information each document provides and why the law obliges companies to prepare them and file them at the Companies House / Commercial Registry.

A company presents these items: machinery $45.000\ \text{€}$, inventory $15.000\ \text{€}$, trade receivables $10.000\ \text{€}$, cash $5.000\ \text{€}$, share capital $30.000\ \text{€}$, reserves $12.000\ \text{€}$, long-term debts $18.000\ \text{€}$ and short-term debts $15.000\ \text{€}$. a) Arrange the items in the balance sheet by category (non-current and current assets; equity, non-current and current liabilities) and check that assets equal equity plus liabilities. b) Calculate the working capital and interpret it.

A logistics company has had this year: sales revenue of $260.000\ \text{€}$, purchases of $110.000\ \text{€}$, staff costs of $80.000\ \text{€}$, other operating expenses of $30.000\ \text{€}$, depreciation of $10.000\ \text{€}$ and debt interest of $4.000\ \text{€}$. a) Draw up the income statement calculating the operating profit and the profit for the financial year. b) Explain the difference between the two results.

A company has current assets of $48.000\ \text{€}$, current liabilities of $30.000\ \text{€}$, total liabilities of $90.000\ \text{€}$ and equity plus liabilities of $150.000\ \text{€}$. a) Calculate the liquidity ratio: $RL = \frac{\text{current assets}}{\text{current liabilities}}$. b) Calculate the gearing ratio: $RE = \frac{\text{liabilities}}{\text{equity} + \text{liabilities}}$. c) Interpret both values comparing them with their usual benchmarks (liquidity around $1,5$-$2$; gearing below $0,6$).

A shop chain has current assets of $40.000\ \text{€}$ and current liabilities of $65.000\ \text{€}$. a) Calculate its working capital. b) Explain what problem that value reveals and why the company is said to potentially have difficulties meeting its most immediate payments. c) Propose two measures to correct the situation (renegotiating debts to move them to the long term, selling assets, increasing capital, speeding up customer collections).

A company obtains earnings before interest and taxes (EBIT) of $36.000\ \text{€}$ with total assets of $240.000\ \text{€}$, and a net profit of $21.000\ \text{€}$ with equity of $140.000\ \text{€}$. a) Calculate the return on assets: $RE = \frac{BAII}{\text{assets}} \cdot 100$. b) Calculate the return on equity: $RF = \frac{\text{net profit}}{\text{equity}} \cdot 100$. c) Interpret what each of the two returns measures.

A computer equipment trading company closed the month of December with a net profit of $45.000\ \text{€}$. However, on January 5, its current account balance is only $2.000\ \text{€}$ and it must face the payment of payroll ($22.000\ \text{€}$), social security contributions ($7.000\ \text{€}$), and the maturity of a bank loan installment ($18.000\ \text{€}$). Its usual commercial policy consists of granting its customers 90-day payment terms, while paying its suppliers in cash; in addition, in December it purchased a delivery van in cash for $35.000\ \text{€}$. a) Technically justify why a profitable company can find itself at imminent risk of insolvency/suspension of payments, identifying the specific transactions that have caused this liquidity squeeze. b) Design an immediate action plan to face that week's payments without resorting to staff layoffs, and propose two structural measures for managing the operating cycle to prevent the situation from recurring.

The management team of an industrial company experiencing financial difficulties is debating two proposals before closing the financial year to avoid showing losses: 1) not to record the annual depreciation of machinery ($35.000\ \text{€}$) under the pretext that "it has been stopped for several months and has not worn out", and 2) to fully recognize as income for the year an advance payment of $80.000\ \text{€}$ made by a customer on account of an order that will be manufactured and delivered next year. a) Rebut both proposals by identifying which mandatory accounting principles and which aspects of the "true and fair view" principle would be violated in each case. b) Reasonably predict the equity, financial, and legal consequences this creative accounting would have for suppliers who decide to grant trade credit to the company based on these accounts, and for the directors who prepare them.

At the close of its first year, a public limited company presents the following pre-adjustment accounting balances: Sales of merchandise $120.000\ \text{€}$, Commercial premises $90.000\ \text{€}$ (non-depreciable land accounts for $30\ \%$ of its value), Final inventory of merchandise $20.000\ \text{€}$, Long-term debts with credit institutions $30.000\ \text{€}$, Suppliers $10.000\ \text{€}$, Wages and salaries $45.000\ \text{€}$, Share capital $50.000\ \text{€}$, Purchases of merchandise $30.000\ \text{€}$, Computer equipment $10.000\ \text{€}$, and Other operating expenses $15.000\ \text{€}$. The accountant forgot to record the annual depreciation of the premises ($2\ \%$) and the computer equipment ($20\ \%$), as well as the accrual of corporate income tax ($25\ \%$). a) Prepare the adjusted income statement, calculating the profit before tax and the profit for the year after correcting the accounting omissions. b) Prepare the final balance sheet grouped by accounting categories, calculating the cash balance required to balance the balance sheet and incorporating the profit obtained. c) Interpret the meaning of the resulting equity and determine whether the company has generated real self-financing capacity.

A company presents the following balance sheet breakdown: Land $60.000\ \text{€}$, Buildings $90.000\ \text{€}$, Machinery $30.000\ \text{€}$, Inventory $25.000\ \text{€}$, Accounts receivable $20.000\ \text{€}$, Cash $10.000\ \text{€}$, Share capital $100.000\ \text{€}$, Reserves $35.000\ \text{€}$, Long-term debt $70.000\ \text{€}$, and Short-term debt $30.000\ \text{€}$. The company plans to acquire a new packaging line for $40.000\ \text{€}$ and the finance department is considering two options: 1) apply for a 6-month bank loan at a very low interest rate, or 2) sell unproductive land for $40.000\ \text{€}$ in cash. a) Calculate the Working Capital and the short-term solvency (current ratio = $AC/PC$) and debt coverage/solvency ($Activo/Pasivo$) ratios for the initial situation, explaining their economic meaning. b) Predict the impact of each of the two financing options on the Working Capital and the current ratio following the purchase of the machine. c) Issue a reasoned report recommending one of the two options and justifying the risk of financial imbalance that the rejected option would entail.

A commercial company has total Assets of $400.000\ \text{€}$, financed $50\ \%$ by Equity and $50\ \%$ by Liabilities. During the financial year, it recorded sales of $500.000\ \text{€}$, purchases of $230.000\ \text{€}$, personnel expenses of $150.000\ \text{€}$, other operating expenses of $40.000\ \text{€}$, depreciation and amortization of $20.000\ \text{€}$, and financial expenses of $10.000\ \text{€}$ arising from its debt. The corporate income tax rate is $25\ \%$. a) Calculate the return on assets ($RE$) and analyze how the operating margin on sales and asset turnover contribute to it. b) Determine the return on equity ($RF$) and formally justify the existence of a positive financial leverage effect in the company. c) If a supply crisis increases operating costs, reducing EBIT by half ($30.000\ \text{€}$), predict how $RE$ and $RF$ will vary, justifying whether it will still be advantageous for shareholders to maintain the current level of indebtedness.

Two identical companies have assets of $200.000\ \text{€}$ and EBIT of $20.000\ \text{€}$, but company A finances itself with $80\ \%$ equity and company B only with $20\ \%$. The debt costs $5\ \%$ a year and the corporation tax is $25\ \%$. a) Calculate the net profit and the return on equity of each company. b) Explain why one of them obtains a higher return on equity and what risk it assumes in exchange (leverage effect).

A technology company makes profits, but its balance sheet shows inventory and receivables of $50.000\ \text{€}$ against short-term debts of $80.000\ \text{€}$, because it financed the purchase of equipment with one-year credit. a) Calculate its working capital. b) Explain how it can have profits and, at the same time, a risk of defaulting on payments. c) Propose a financial restructuring coherent with the problem and justify it.

A bank is considering granting a loan to a company with these figures: current assets of $70.000\ \text{€}$, current liabilities of $55.000\ \text{€}$, total liabilities of $130.000\ \text{€}$, total assets of $220.000\ \text{€}$ and EBIT of $18.000\ \text{€}$. a) Calculate the liquidity, solvency, gearing and return on assets ratios. b) Write a brief report recommending or advising against the loan, drawing on the calculated ratios.