Secondary 4 Principles of Accounts Ratios Analysis Quiz

Secondary 4 Principles of Accounts Quiz - Ratios Analysis (Answer Key)

Total Marks: 45

Section A: Knowledge and Comprehension

1. Liquidity refers to the ability of a business to meet its short-term financial obligations (current liabilities) as they fall due using its current assets.
[1]

2. Current Ratio = Current Assets / Current Liabilities
[1]

3. Acid Test Ratio = (Current Assets - Inventory) / Current Liabilities
(Accept: (Cash + Receivables) / Current Liabilities)
[1]

4. The Acid Test Ratio excludes inventory because inventory is the least liquid current asset; it may take time to sell or may not be sold at full value. Therefore, it tests the ability to pay debts without relying on selling stock.
[2] (1 for identifying inventory exclusion, 1 for reason)

5. B) A decrease in the cost price of inventory purchased.
[1]

6. Profitability measures the ability of a business to generate profit relative to sales, assets, or equity (long-term success). Liquidity measures the ability to pay short-term debts (short-term survival).
[2] (1 for each definition/distinction)

7. Any one of:

• Historical data (past performance may not predict future).
• Inflation affects comparability over time.
• Different accounting policies (e.g., depreciation methods) make comparison difficult.
• Window dressing (manipulation of figures at year-end).
• Ignores non-financial factors (e.g., employee morale, brand reputation).
  [1]

8. Efficient. It indicates that stock is being sold quickly, reducing holding costs and risk of obsolescence.
[1]

Section B: Calculation and Application

9. Gross Profit Margin

• Formula: (Gross Profit / Revenue) × 100%
• 2025: ($180,000 /$450,000) × 100% = 40.00%
• 2026: ($182,000 /$520,000) × 100% = 35.00%
  [2] (1 for each year correct)

10. Net Profit Margin

• Formula: (Net Profit / Revenue) × 100%
• 2025: ($80,000 /$450,000) × 100% = 17.78%
• 2026: ($72,000 /$520,000) × 100% = 13.85%
  [2] (1 for each year correct)

11. Current Ratio

• Formula: Current Assets / Current Liabilities
• 2025 CA: 40k + 35k + 15k = 90,000. CL: 30,000.
  • Ratio: 90,000 / 30,000 = 3.00 : 1
• 2026 CA: 55k + 45k + 10k = 110,000. CL: 40k + 5k = 45,000.
  • Ratio: 110,000 / 45,000 = 2.44 : 1
    [2] (1 for each year correct)

12. Acid Test Ratio

• Formula: (Current Assets - Inventory) / Current Liabilities
• 2025: (90,000 - 40,000) / 30,000 = 50,000 / 30,000 = 1.67 : 1
• 2026: (110,000 - 55,000) / 45,000 = 55,000 / 45,000 = 1.22 : 1
  [2] (1 for each year correct)

13. Inventory Turnover Rate (2026)

• Formula: Cost of Sales / Average Inventory
• Average Inventory = (Opening 2026 + Closing 2026) / 2 = ($40,000 +$55,000) / 2 = $47,500
• Calculation: $338,000 /$47,500 = 7.12 times
  [2] (1 for avg inv, 1 for final answer)

14. Return on Capital Employed (ROCE)

• Formula: (Net Profit / Capital Employed) × 100%
• Calculation: ($20,000 /$100,000) × 100% = 20.00%
  [2]

15. Trade Receivables Turnover (Days)

• Formula: (Trade Receivables / Credit Sales) × 365
• Calculation: ($25,000 /$180,000) × 365 = 50.69 days (or 51 days)
  [2]

16. New Current Ratio

• Initial CA: $80,000. Initial CL:$50,000.
• Transaction: Pay $10,000 Payables using Cash.
• New CA: $80,000 -$10,000 = $70,000.
• New CL: $50,000 -$10,000 = $40,000.
• New Ratio: 70,000 / 40,000 = 1.75 : 1
  [2]

Section C: Analysis and Evaluation

17. TechGear GP Margin Analysis (a) Change: 35.00% - 40.00% = -5.00% (Decrease of 5 percentage points).
[1]

(b) Reasons for decrease in GP Margin:

1. Increased Cost of Sales: Suppliers may have raised prices, and the business did not pass this cost to customers.
2. Discounting: The business may have offered sales discounts to increase revenue volume, reducing the margin per unit.
3. Change in Sales Mix: Selling more low-margin products compared to high-margin products.
   [2] (1 mark per valid reason, max 2)

18. TechGear Liquidity Analysis (a) Comment: Liquidity has worsened. The Current Ratio dropped from 3.00 to 2.44, and the Acid Test dropped from 1.67 to 1.22. The emergence of a bank overdraft indicates cash flow pressure. However, the ratios are still above the general benchmark of 2:1 (Current) and 1:1 (Acid), so the business is not in immediate crisis but is trending negatively.
[2] (1 for identifying worsening trend, 1 for nuanced comment on benchmarks)

(b) Reason for lower Current Ratio:

• To improve efficiency: Holding excess current assets (like cash or inventory) earns low returns. Keeping a lower ratio allows funds to be invested in non-current assets for higher growth.
  [2]

19. Inventory Turnover Evaluation

• Efficiency: Alpha Ltd (8 times) is more efficient than Beta Ltd (4 times) because it sells and replaces its stock twice as fast. This reduces storage costs and the risk of inventory becoming obsolete or damaged.
• Risk of High Turnover: However, if turnover is too high, Alpha Ltd risks stockouts (running out of goods), which could lead to lost sales and dissatisfied customers. It may also indicate that inventory levels are too low to meet unexpected demand spikes.
• Conclusion: Alpha is generally more efficient, provided it maintains sufficient stock levels to meet demand.
  [4] (2 for efficiency argument, 2 for risk/evaluation)

20. Ratio Analysis Statement Evaluation

• Disagree/Partial Agreement.
• Strength: Ratios provide a quick, quantitative summary of performance and allow for easy comparison against competitors or historical data (Trend Analysis).
• Weakness: Ratios are based on historical financial statements which may be affected by inflation or different accounting policies (e.g., FIFO vs AVCO), making comparisons misleading. They also ignore qualitative factors like management quality or customer loyalty.
• Justification: Therefore, ratio analysis should not be the only tool; it must be used alongside non-financial information.
  [4] (1 for stance, 1 for strength, 1 for weakness, 1 for justification)