O Level Principles of Accounts Ratios Analysis Quiz

O-Level Principles of Accounts Quiz - Ratios Analysis (Answer Key)

Total Marks: 40

Section A: Knowledge and Basic Calculations

1. Formula for Gross Profit Margin: $\frac{\text{Gross Profit}}{\text{Revenue}} \times 100\%$ (1 mark for correct formula)

2. Formula for Current Ratio: $\frac{\text{Current Assets}}{\text{Current Liabilities}}$ (1 mark for correct formula)

3. Calculation of Current Assets: $\text{Current Assets} = \text{Current Ratio} \times \text{Current Liabilities}$ $\text{Current Assets} = 2.5 \times 20,000 = \$50,000$ (1 mark for correct answer)

4. Liquidity ratio excluding inventory: Quick Ratio (or Acid Test Ratio) (1 mark)

5. Interpretation of Inventory Turnover increase: Shorter period. (1 mark)

Section B: Application and Calculation

6. Working Capital: $\text{Current Assets} = 25,000 + 18,000 + 7,000 = 50,000$ $\text{Current Liabilities} = 12,000 + 3,000 = 15,000$ $\text{Working Capital} = 50,000 - 15,000 = \$35,000$ (1 mark for CA/CL identification, 1 mark for correct answer)

7. Current Ratio: $\frac{50,000}{15,000} = 3.33 : 1$ (1 mark for substitution, 1 mark for 3.33)

8. Quick Ratio: $\text{Quick Assets} = \text{Current Assets} - \text{Inventory} = 50,000 - 25,000 = 25,000$ $\text{Quick Ratio} = \frac{25,000}{15,000} = 1.67 : 1$ (1 mark for excluding inventory, 1 mark for 1.67)

9. Gross Profit Margin: $\text{Gross Profit} = \text{Revenue} - \text{Cost of Sales} = 200,000 - 120,000 = 80,000$ $\text{GPM} = \frac{80,000}{200,000} \times 100\% = 40.0\%$ (1 mark for GP calc, 1 mark for 40.0%)

10. Inventory Turnover Rate: $\text{Average Inventory} = \frac{15,000 + 25,000}{2} = 20,000$ $\text{Turnover} = \frac{\text{Cost of Sales}}{\text{Average Inventory}} = \frac{120,000}{20,000} = 6 \text{ times}$ (1 mark for Avg Inv, 1 mark for 6 times)

11. Days Sales in Inventory: $\frac{365}{6} = 60.83 \approx 61 \text{ days}$ (1 mark for formula/substitution, 1 mark for 61 days)

12. Net Profit Margin: $\text{Net Profit} = \text{Gross Profit} - \text{Expenses} = 150,000 - 80,000 = 70,000$ $\text{NPM} = \frac{70,000}{500,000} \times 100\% = 14\%$ (1 mark for NP calc, 1 mark for 14%)

13. Return on Capital Employed (ROCE): $\text{ROCE} = \frac{\text{Net Profit}}{\text{Capital Employed}} \times 100\%$ $\text{ROCE} = \frac{70,000}{400,000} \times 100\% = 17.5\%$ (1 mark for substitution, 1 mark for 17.5%)

14. Trade Receivables Collection Period: $\frac{\text{Trade Receivables}}{\text{Credit Sales}} \times 365$ $\frac{40,000}{365,000} \times 365 = 40 \text{ days}$ (1 mark for formula, 1 mark for 40 days)

15. Financial Risk: Beta Ltd (Higher gearing indicates higher reliance on debt, thus higher financial risk). (1 mark for Beta Ltd, 1 mark for reasoning)

Section C: Analysis and Interpretation

16. Current Ratio Decrease (2.0:1 to 1.2:1): (a) Deterioration in liquidity. (1 mark) (b) Possible reasons (Any one):

• Increase in Current Liabilities (e.g., took short-term loan).
• Decrease in Current Assets (e.g., used cash to buy non-current assets).
• Inventory write-down or loss. (1 mark for valid reason)

17. Expense Control Comparison:

• Business X has a high Gross Profit Margin (40%) but a low Net Profit Margin (5%). This indicates that while it makes good profit on sales, its operating expenses are very high relative to revenue. (2 marks)
• Business Y has a lower Gross Profit Margin (20%) but a higher Net Profit Margin (15%). This indicates that Business Y has tighter control over its operating expenses. (2 marks)

18. Effect of Switching from FIFO to AVCO (Rising Prices): (a) Closing Inventory value will decrease (AVCO averages out the lower older costs with higher new costs, resulting in a lower value than FIFO which keeps the newest/higher costs in inventory). (2 marks) (b) Gross Profit will decrease (because Cost of Sales will be higher under AVCO in a rising price environment). (2 marks)

19. High Inventory Turnover Evaluation:

• Disagree. (1 mark)
• Reason: While it indicates efficient sales, it may also mean the business is holding too little stock, leading to stockouts, lost sales opportunities, and inability to meet sudden customer demand. (1 mark for valid counter-point)
• (Note: Agree is also acceptable if justified by reduced holding costs/obsolescence, but Disagree is often the stronger analytical point for "always".)

20. Improving Quick Ratio (0.5:1): Suggest two actions (1 mark each, max 2 marks for suggestions, 2 marks for explanation/linkage):

1. Inject Capital: Owner introduces cash into the business. This increases Current Assets (Bank) without increasing Current Liabilities.
2. Pay off Current Liabilities: Use existing cash to pay Trade Payables. Note: This is tricky as it reduces CA and CL equally. If CR < 1, this actually improves the ratio mathematically, but reduces absolute liquidity. Better answer:
3. Convert Inventory to Cash: Sell inventory for cash (if sold at cost, Quick Assets increase as Inventory drops and Cash rises; Inventory is not in Quick Assets, Cash is).
4. Refinance Short-term Debt: Convert a bank overdraft (Current Liability) into a long-term loan (Non-Current Liability). This reduces the denominator (Current Liabilities).

(2 marks for two distinct, valid actions)