The Realization Issue In Accounting Accounting Essay

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In the following pages the Cash Budget, Income Statement, and Balance Sheet of the holiday organizer "Gadabout Travel Ltd" are produced and discussed for the accounting year to come.

In the closing balance of each month significant differences are observed due to the seasonal fluctuation of demand for holiday packages.

Performance wise G.T could be described as a marginal performer since their expenses are relatively high in comparison to the provision of services they offer. This leaves little profit to be made.

Another problem the firm is facing are liquidity issues which will also persist in the future.

At the end of these pages the reason G.T. realizes profits at the time the holiday is due and not when it is booked will be described, this is known as the "realization issue" in accounting.

Gadabout Ltd. is a UK based company which produces both summer and winter holiday packages for the UK market. It is the nature of their job to book concentrated amounts of plain tickets, and hotel rooms. This allows G.T. to get these services at cheaper rates than privately organized holiday makers. Part of their deal is the policy they operate which states that when a holiday is booked it is also paid for up front. If a cancellation is made by the customer, no refund is made available. This policy will be discussed further on. The monthly cash budget, profit and loss statement, and balance sheet for the end of the following year have been produced, and will be discussed while more analytical detail will be made available through the use of ratios.

_____________________________________________________________________

January

February

March

April

May

June

Cash Collection

Winter

220,500

233,100

37,800

12,600

-

-

Summer

40,500

264,600

232,200

178,200

121,500

27,000

Total cash collection

261,000

497,700

270,000

190,800

121,500

27,000

Payments

Air Travel

57,200

56,000

84,600

24,600

21,600

39,400

Hotel Rooms

85,800

84,000

126,900

36,900

27,000

49,250

Other payments

Salaries

20,600

20,600

20,600

20,600

20,600

20,600

Electricity

1,500

-

-

1,500

-

-

Tax rate

-

-

-

1,000

-

-

Repairs

100

100

100

100

100

100

Traveling

3,500

3,500

3,500

3,500

3,500

3,500

Total Payments

168,700

164,200

235,700

88,200

72,800

112,850

Surplus (Deficit)

92,300

333,500

34,300

102,600

48,700

(85,850)

Opening Balance

21,200

113,500

447,000

481,300

583,900

632,600

Closing Balance

£113,500

£447,000

£481,300

£583,900

£632,600

£546,7501) Cash Budget in (£-GBP)

The cash budged reveals the seasonal demand of holiday packages, as each type of holiday is distinguished by the appropriate season; this effect is followed by the cash flow accordingly. Following this line of thought it is observed that from January till May surplus is shown while during the summer months -June till September- the closing balance shows deficit.

July

August

September

October

November

December

Cash Collection

Winter

--------

--------

22,050

34,650

113,400

126,000

Summer

21,600

21,600

13,500

-------

--------

-------

Total cash collection

21,600

21,600

35,550

34,650

113,400

126,000

Payments

Air travel

95,400

114,200

64,800

--------

--------

--------

Hotels Rooms

119,250

142,750

81,000

--------

--------

--------

Other payments

Salaries

20,600

20,600

20,600

20,600

20,600

20,600

Electricity

1,500

---------

---------

1,500

--------

---------

Tax rate

---------

---------

---------

1,000

--------

---------

Repairs

100

100

100

100

100

100

Traveling

3,500

3,500

3,500

500

500

500

Total Payments

240,350

281,150

170,000

23,700

21,200

21,200

Surplus (Deficit)

(218,750)

(259,550)

(134,450)

10,950

92,200

104,800

Opening Balance

546,750

328,000

68,450

(66,000)

(55,050)

37,150

Closing Balance

£328,000

£68,450

(£66,000)

(£55,050)

£37,150

£141,950

In both months September and October the closing balance is also deficit indicating liquidity issues as cash from previous months has been used up during the deficit period of summer.

As bookings for winter holidays follow from October it is evident that deficit drops, and surplus is shown again in November before it reaches almost four times as high in December, as a result of not having any air travel or hotel expenses during this period.

Profit and loss Statement

________________________________________________________________

Revenues

Winter Holidays £711,900

Summer Holidays £ 920,700

______________________________

Total Revenues £1,632,600

_________________________________________________________________

Expenses

Air travel £557,800

Hotels rooms

Summer Holiday Expenditures £419,250

Winter Holidays Expenditures £333,600

Other expenses

Depreciation (20%) £11,400

Electricity £6,000

Salaries/Wages £247,200

Tax rate £2,000

Travel expenses £33,000

______________________________

Total Expenses £1,611,450

___________________________________________________________________

Profit (loss) £ 21,150 GBP

Profit and loss statement analysis________________________________________

Having said that Gadabaout Travel Ltd. is a Marginal performing company it is easily verified in the Profit and Loss statement. The annual profits of the company are low especially in comparison to the companies overall cash flow. By conducting the Operational Profit Margin the percentage is given to indicate the company's profitability.

OPM= Sales revenue - Expenses x 100 =

Sales revenue

( 21,150 / 1,632,600) x 100 = 1.29%

(for the year to come)

While Depreciation is always expensed for, it is not actually deducted from the actual profit of the company. This means that 11,400 + 21,150 = £ 32,550 is the profit the company will gain from its operations.

By conducting the Working Capital Ratio…

WC= Current Assets - Current Liabilities=

WC= 142,450 - 297,600 = ( 155,150 )

…it becomes apparent that Gadabaout Travel Ltd. is not capable of taking care of their short term operational expenses.

_____________________________________________________________________

Balance Sheet ________________________________________________________

Non-current Assets

Freehold and Buildings £210,000

Equipment and Furniture £45,600

Total £255,600

_____________________________

Current Assets

Prepaid Rates £500

Cash £141,950

Total £142,450

Total Assets £398,050

_____________________________

Current Liabilities

Accrued Electricity £1,500

Trade Creditors £296,100

Total £297,600

_____________________________

Equity

Shared and Capital Reserve £100,450

________________________________________________________________

Total Liabilities £398,050 GBP

Balance Sheet Analysis_________________________________________________

With the use of the Acid Test Ratio it becomes apparent that G.T. Ltd. has been facing Liquidity issues in the past.

ATR=21,700 = 0, 1036 = 0.1:1 (for this year)

209,400.

ATR= 142,450 = 0.4786 = 0.47: 1 (for the year to come)

297,600

On the other hand it is observed that the liquidity issues faced by the company are slowly going to be minimized in the following year.

Profit realization plan of G.T Ltd.

Profit realization as per Gadabout Travel Ltd. is accounted for in the month the holiday is actually taken and not when it is paid for by the customer. Because G.T. Ltd. retain a " no refund" policy it is not possible to account for their profit when it is paid for as cancellations may apply. This would alter the amount made payable to G.T. Ltd. and also the expenses the company may have toward air travel and hotel rooms.

According to: Harold. B et al. (1965), it is firstly necessary to understand the nature of the receivable asset, then there should be evidence of a market transaction, and finally the service has to be performed, in order for profit realization to be considered. This basic three step theory is also recognized by Windal F. (1965) who states that Cash receiving always happens in conjunction with a revenue transaction, but in the case which the service provision has not been completed by the end of the current accounting period, then the amount associated with the transaction is not realized till the exchange service has been provided, and the transaction terminated.

Conclusion

G.T Ltd. is a borderline performing company. The general picture is that the company cannot operate efficiently during the deficit periods as they do not retain enough profits to support their expenses.

It is a still in need of better performance in order to allow the company to gain a better financial cycle as it passes from surplus to deficit and vice versa. Their annual profit margin indicates that the company is in need of gaining better rates from airlines and hotels as clients are present but Hotel and Airline rate expenditures are high.

Due to this financial vicious circle their liquidity problems could lead them out of business easily.

Alternatively G.T. Ltd should try and create small business during the deficit periods in order to support their expenses. Day trips at close by destinations could be the answer to their problems.

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