Question – Net Assets, Change in Net Assets, Ratios & Inventory Valuation

On 31 December 2022, Maria’s statement of financial position was as follows:

Maria – Statement of Financial Position at 31 Dec 2022

Capital | 24 300
Current liabilities |
Trade payables | 3 300
Other payables | 960
Total liabilities | 4 260

At the end of 31 December 2023, her bookkeeper left unexpectedly. The following balances were available:

1. Fixtures & fittings are depreciated at 20% p.a. on net book value. No fixtures were bought or sold during the year.

2. A motor van costing $12 000 was purchased during the year and depreciated at 25% p.a. reducing balance. A full year’s depreciation is charged in the year of purchase.

3. Provision for doubtful debts to be maintained at the same 5% of receivables.

4. Year-end balances (2023):

5. Drawings during the year amounted to $13 000.

Required:

a) Calculate the net assets at 31 Dec 2023.
b) (i) Calculate the change in net assets between 31 Dec 2022 and 31 Dec 2023.
(ii) Explain why the change in net assets is not equal to the profit for the year.
c) State two ratios that could be calculated from an income statement to help assess profitability.
d) Explain how the following principles apply to inventory valuation:

1. Prudence

2. Realisation

Step-by-Step Solution

a) Net assets at 31 Dec 2023

Non-current assets:

Fixtures & fittings = 18 000 − (20% × 18 000) = 18 000 − 3 600 = 14 400
Motor van cost = 12 000 − (25% × 12 000) = 12 000 − 3 000 = 9 000
Total non-current assets = 14 400 + 9 000 = 23 400

Current assets:

Inventory = 6 000
Trade receivables = 5 400 − provision (5% × 5 400 = 270) = 5 130
Cash/Bank = overdraft means bank is a liability, so exclude from assets.

Total current assets = 6 000 + 5 130 = 11 130

Total assets = 23 400 + 11 130 = 34 530

Current liabilities:

Bank overdraft = 1 200
Trade payables = 4 100
Accrued wages = 350
Total liabilities = 5 650

Net assets = Total assets − Liabilities = 34 530 − 5 650 = 28 880

b) (i) Change in net assets

Net assets at 31 Dec 2022 = Capital from opening = 24 300
Net assets at 31 Dec 2023 = 28 880

Change = 28 880 − 24 300 = 4 580

b) (ii) Why change ≠ profit

Because drawings affect capital:
Profit for the year = Change in net assets + Drawings
= 4 580 + 13 000 = 17 580

So profit is greater than the change in net assets because drawings reduced capital.

c) Two profitability ratios

1. Gross profit margin = (Gross profit ÷ Revenue) × 100

2. Return on capital employed (ROCE) = (Profit before interest ÷ Capital employed) × 100

d) Inventory valuation principles

1. Prudence – Inventory is valued at the lower of cost and net realisable value to avoid overstating assets and profits.

2. Realisation – Profit is recognised only when goods are sold, so unsold inventory is carried at cost (or NRV if lower) and profit is deferred until sale.