Accounting for
Business
Assignment
Student ID: C100074921
Student Name: Elizabeth Monserrate Carvajal Garcia
BA(Hons) in Business Studies with Foundation Year
Canterbury Christ Church University
Date of Submission: 15 of May 2025
Word Count: 2200
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Table of Contents
1. INTRODUCTION .........................................................................................................4
2. TASK 1 .......................................................................................................................5
(a) Prepare an income statement for the year-ended 31st March 2024. (self-made) .............. 7
(b) Prepare a statement of financial position as of 31 st March 2024. (self-made) .................. 8
3. Task 2 ........................................................................................................................9
(a) Critically discuss the usefulness and limitations of the FOUR capital investment appraisal
measures in the table above. .................................................................................................. 10
(b) Make a recommendation, with justification, as to which option should be chosen. ....... 14
(c) Explain why the finance director was so confident that IRR would be well more than 8%
for both options. .................................................................................................................... 16
4. CONCLUSION ...........................................................................................................17
5. References ...............................................................................................................18
3
Table of Figures
Figure 1. ARR formula (Vipond, n.d.). ....................................................................................................10
Figure 2. Payback Period Formula (Hulatt, n.d.) ....................................................................................11
Figure 3. NPV Formula (CFI team, n.d.). ................................................................................................12
Figure 4. IRR (Lawler, 2024). ..................................................................................................................13
Figure 5. Internal Rate of Return (IRR) (Lawler, 2024). .........................................................................13
4
1. INTRODUCTION
The Balance Sheet and Income Statement are essential tools for assessing a company's
financial condition. Together, they provide a comprehensive view of profitability and financial
robustness. A detailed understanding of these financial statements is essential for making
informed decisions, as they increase transparency, attract investment, and despite any
challenges that may arise.
In a business context, capital planning is an essential element of strategic decision-making
and directly impacts a company's development and profitability. This essay will rigorously
evaluate four capital valuation metrics: accounting rate of return (ARR), payback period, net
present value (NPV), and internal rate of return (IRR). The objective is to identify their
advantages and disadvantages to determine the most cost-effective investment option for RD
plc, enabling decisive and profitable decision-making.
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2. TASK 1
The trial balance below is for RD plc as at 31/03/ 2024
£ £
£1 Ordinary share capital 720,000
10% Debentures 260,000
8% Long term bank loan 120,000
Retained profits 189,000
Land and buildings at cost 800,000
Equipment at cost 180,000
Equipment – accumulated depreciation 40,000
Vehicles at cost 320,000
Vehicles – accumulated depreciation 30,000
Debenture interest 15,000
Interest on long term bank loan 7,000
Payables 55,000
Receivables 80,000
Rates and insurance 49,000
Distribution expenses 40,000
Salaries 155,000
Utilities 88,000
Audit fee 38,000
Bad debt 14,000
Directors’ remuneration 66,000
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Selling expenses 34,000
Interim ordinary dividend 40,000
Cash 24,000
Bank overdraft 5,000
Sales 1,800,000
Opening inventory 322,000
Purchases 947,000
Totals 3,219,000 3,219,000
Notes as at 31/03/ 2024:
• Inventory was valued at £300,000
• Insurance prepaid £7,000
• Accruals:
o Salaries - £9,000
o Rates - £5,000
o Selling expenses - £8,000
• Depreciation of equipment by 25% on straight line
• Depreciation of vehicles by 20% on reducing balance
• The directors are to provide £48,000 for taxation
• The directors propose a final ordinary dividend of 12p per share
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(a) Prepare an income statement for the year-ended 31st March 2024. (self-made)
Income statement
RD PLC
For the year ended on March 31, 2024
Financial statements in £
Revenue
Gross sales 1800000
Net sales 1800000
Cost of goods sold
Beginning inventory 322000
Add: Purchases 947000
Inventory available 1269000
Less: Ending inventory 300000
Cost of goods sold 969000
Gross profit 831000
Less Expenses
Debenture Interest (15,000 + 11,000) 26000
Interest on Bank Loan (7000 + 2600) 9600
Equipment depreciation (180,000 x 0.25) 45000
Vehicles depreciation (320,000 – 30,000) x 0.20 58000
Rates and insurance (49,000 + 5,000 – 7,000) 47000
Distribution expenses 40000
Salaries (155,000 + 9,000) 164000
Utilities 88000
Bad Debt 14000
Audit Fee 38000
Directors Remuneration 66000
Selling Expenses (34,000 + 8,000) 42000
Total expenses 637600
Profit before Tax 193400
Less Tax Payable 48000
Profit After Tax 145400
LESS DIVIDENDS
Interim 40000
Dividend payable (720000 x 0.12) 86400
Less total dividends 126400
Retained Profit for the year 19000
Retained Profit brought forward 189000
Retained Profit carried forward 208000
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(b) Prepare a statement of financial position as of 31st March 2024. (self-made)
RD PLC STATEMENT OF FINANCIAL POSITION
Date: March 31,2024
Assets £ £
Current Assets
Cash 24000
Receivables 80000
Inventory 300000
Prepaid Insurance 7000
Total current assets 411000
Non-Current Assets
Land and Buildings 800000
Equipment 180000
(Less accumulated depreciation) 85000
95000
Equipment 320000
(Less accumulated depreciation) 88000
232000
Total non-current assets 1127000
Total Assets 1538000
Liabilities and Owner's Equity
Current Liabilities
Bank Overdraft 5000
Payables 55000
[42]
Income taxes payable 48000
Salaries and wages 9000
Rates and Insurances 5000
Selling expenses 8000
Interest on Bank Loan 2600
Debenture interest 11000
Dividend payable 86400
Total current liabilities 230000
Non-current Liabilities
10% Debentures 260000
8% Long Term bank loan 120000
Other
Total non-current liabilities 380000
Shareholder's Equity
£1 Ordinary Share Capital 720000
Retained profits Carried Forward 208000
Other
Total shareholder's equity 928000
Total Liabilities and Shareholder's Equity 1538000
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3. Task 2
Scenario
RD plc is a company based in the UK. It has its products available on the high street as well as
selling online.
You work for the company as a trainee accountant and have been asked to examine the
following information relating to two mutually exclusive capital budgeting decisions.
RD plc is considering production and sale of a new type of printer. This will allow them to
expand production over the next 6 years and support the drive to sell more of their successful
range of products for domestic use.
There are two investment options, D1 and D2, for printer and information about the initial
investment and four different capital investment appraisal measures are given in the table
below. The cost of capital is estimated at 8%.
Options Initial Accounting Payback Net present Internal rate
investment rate of period value @ 8% of return
return
D1 £1,400,000 15 % 2.9 years £160,100 11.7 %
D2 £1,900,000 18 % 3.2 years £184,000 10.8 %
The board of directors of RD plc is about to attend a meeting to consider which option to
choose. The IRR measure was added after the original board papers were released. When
asked to estimate the IRR before calculating it, the company’s Finance Director confidently
stated that it would be “well over 8% for both options.”
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(a) Critically discuss the usefulness and limitations of the FOUR capital investment
appraisal measures in the table above.
• ACCOUNTING RATE OF RETURN
The Accounting Rate of Return (ARR) is a key financial ratio that shows the average net
income expected to be earned from an asset compared to its average cost of capital,
expressed as an annual percentage. This formula is crucial for capital budgeting decisions,
as it acts as a guide for companies when determining whether to invest in an asset,
whether it be a project, an acquisition, or any other major investment.
When it comes to decision-making, if a company's required rate of return is equal to or
greater than the Target Acceptable Return (TAR), then the project is considered
acceptable because the company will achieve at least its required rate of return.
Conversely, if the required rate of return is lower than the TAR, the project should be
rejected. Therefore, a higher TAR indicates greater efficiency in the company's
profitability.
According to (Vipond, n.d.), the formula for ARR is:
ARR = Average Annual Profit / Average Investment
Where:
Average Annual Profit = Total profit over Investment Period / Number of Years
Average Investment = (Book Value at Year 1 + Book Value at End of Useful Life) / 2
Figure 1. ARR formula (Vipond, n.d.).
The use of accessible accounting information in ARR simplifies calculations, eliminating the
complexity of establishing discount factors. Managers can quickly understand the concept of
profit, and the results are presented in a clear and understandable manner. This method
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considers the entire project's evolution holistically, offering a more complete perspective
than other evaluation approaches that may ignore essential elements.
The accounting rate of return (ARR) approach has several limitations. First, it ignores the
sequence of cash flows, leading to inaccurate return calculations due to the changing value
of money. Additionally, it does not account for high investment risk, which can impact the
profitability of both high- and low-risk projects (Tutorchase.com, n.d.).
• PAYBACK PERIOD
The payback period measures the time required to recover the initial cost of an
investment through net income. Shorter payback periods are preferable because they
allow for a faster return on investment and lower financial risk. Conversely, longer
payback periods can delay the realization of profitability.
Payback Period Formula
Figure 2. Payback Period Formula (Hulatt, n.d.)
The payback period approach offers compelling benefits that make it a useful tool for
economic decision-making. Its simplicity makes it easy to understand, while its
effectiveness in liquidity management provides crucial data for cash flow. Furthermore, it
acts as an effective tool for risk assessment and represents an invaluable resource for
strategic planning.
The payback analysis method fails to account for the time value of capital and does not
consider cash inflows that occur after the payback period. This limitation makes it difficult
to accurately compare the profitability of different projects. Additionally, this approach
neglects important factors such as risk and economic considerations. As a result, it is often
used merely as an initial evaluation, necessitating further assessments, such as net
present value (NPV) or internal rate of return (IRR) analyses (MAVERICK, n.d.).
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• NET PRESENT VALUE
Net Present Value (NPV) is a crucial financial metric that allows investors to assess the
current value of future cash flows generated by an investment. As a powerful intrinsic
valuation tool, NPV is widely used to determine the true value of various financial assets,
from businesses to capital projects.
NPV Formula
Figure 3. NPV Formula (CFI team, n.d.).
The Net Present Value (NPV) analysis provides several important advantages. First, it
considers the time value of money, which enables realistic profitability projections and aids
in making better investment decisions by allowing for comparison of options and
prioritization of profitable projects. Additionally, NPV considers all cash flows, thereby
reducing the likelihood of calculation errors and offering a comprehensive financial
perspective.
Net present value (NPV) has several limitations. First, inaccurate cash flow estimates can
significantly affect the results. Additionally, using an incorrect discount rate can lead to
misinterpretations of profitability. NPV is also less suitable for short-term projects and does
not consider variations in project size when comparing different investments.
• INTERNAL RATE OF RETURN
The Internal Rate of Return (IRR) is a financial metric used to evaluate the profitability of
an investment. It provides a standardized method for assessing the profitability of
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different asset classes. The IRR is closely related to the concepts of Time Value of Money
(TVM), Net Present Value (NPV), and Return on Investment (ROI).
Calculating the IRR can be complex and has certain limitations. The formula generally
excludes considerations such as specific returns, capital expenditures, and inflation.
Therefore, profitability is evaluated solely based on internal factors. Understanding the
results of the IRR is crucial for making informed investment choices. A higher IRR indicates
a more profitable investment.
Internal Rate of Return Formula
Figure 4. IRR (Lawler, 2024).
The Internal Rate of Return (IRR) method offers an effective tool for comparing project
profitability, effectively incorporating the time value of money, and remaining independent
of variations in required rates of return. However, it is important to note that the IRR can
present significant challenges. For projects with unconventional cash flows, it may not offer
a unique solution. Furthermore, it assumes reinvestment at the IRR rate, which can be
unrealistic. Likewise, the IRR can generate discrepancies with Net Present Value (NPV)
classifications when evaluating projects of different natures. (Linkedin, n.d.).
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(b) Make a recommendation, with justification, as to which option should be
chosen.
• ACCOUNTING RATE OF RETURN (Self-made)
D1 D2 RECOMMENDATION
15% 18% D1 D2
ARR Rate of Return > Rate of Return >
Cost of capital Cost of capital
15% > 8% 18% > 8%
Although both alternatives are feasible,
D2 stands out for its excellent return on
investment. Since we can only select one
project, D2 is undoubtedly the most
suitable choice for our investment.
• PAYBACK PERIOD (Self-made)
D1 D2 RECOMMENDATION
2.9 years 3.2 years D1 D2
PP Payback Period < Payback Period <
Number of years Number of years
2.9 years < 6 years 3.2 < 6 years
Both options are reasonable; however,
the D1 model requires fewer years to
recover the initial cost. Therefore, the D1
model is a more advantageous
investment, as it recovers the initial cost
more quickly.
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• NET PRESENT VALUE (Self-made)
D1 D2 RECOMMENDATION
£ 160,100 £ 184,000 D1 D2
NPV Net Present Value > Net Present Value
£0 >£0
£ 160,100 > £ 0 £ 184,000 > £ 0
Both projects generate positive NPVs,
confirming their potential as profitable
investment opportunities. Since the NPV
of each project is greater than zero, they
are viable options. However, Project D2
stands out for its higher NPV than
Project D1. Therefore, it is essential to
prioritize investment in D2 to maximize
profitability and increase shareholder
value.
• INTERNAL RATE OF RETURN (Self-made)
D1 D2 RECOMMENDATION
11.7% 10.8% D1 D2
IRR Internal Rate of Internal Rate of
Return > Cost of Return > Cost of
capital capital
11.7% > 8% 10.8% > 8%
A higher Internal Rate of Return (IRR)
signifies a more profitable investment.
Both projects are viable, but D1 stands
out with a superior IRR compared to D2.
Therefore, D1 is the clear
recommendation for maximizing
returns.
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(c) Explain why the finance director was so confident that IRR would be well more
than 8% for both options.
Managers generally possess a solid understanding, or at the very least an intuitive grasp, of
the probability distribution concerning their cost of capital. The CFO confidently asserted that
the internal rate of return (IRR) would far exceed 8% for both alternatives. This is largely due
to the straightforwardness of measuring the project's benefits against personal loan rates,
which significantly overshadows any minor technical inaccuracies that may arise (Kelleher &
MacCormack, 2004).
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4. CONCLUSION
In conclusion, capital investment appraisal methods, such as the accounting rate of return,
payback period, net present value, and internal rate of return, are vital tools for making
strategic financial decisions. Each method presents unique advantages and challenges that
empower organizations to thoroughly evaluate potential investments. By mastering these
indicators, companies can effectively balance returns and risks, paving the way for robust and
sustainable development.
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5. References
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[Accessed 04 May 2025].
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[Accessed 02 May 2025].
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Available at: https://www.studysmarter.co.uk/explanations/business-studies/managerial-
economics/pay-back-period-method/
[Accessed 3 May 2025].
Kelleher, J. C. & MacCormack, J. J., 2004. Internal rate of return: A cautionary tale. [Online]
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[Accessed 11 May 2025].
Lawler, J., 2024. Tranding212. [Online]
Available at: https://www.trading212.com/learn/investing-101/internal-rate-of-return-irr
[Accessed 09 May 2025].
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Available at: https://www.linkedin.com/advice/0/what-advantages-disadvantages-internal-rate-
return-method-d511f
[Accessed 10 May 2025].
MAVERICK, J., n.d. Investopedia. [Online]
Available at: https://www.investopedia.com/ask/answers/062915/what-are-some-limitations-and-
drawbacks-using-payback-period-
analysis.asp#:~:text=Limitations%20of%20Payback%20Period%20Analysis,-
Despite%20its%20appeal&text=The%20first%20is%20that%20it,the%20present%20day'
[Accessed 04 May 2025].
Monga, S., n.d. Plutus Education. [Online]
Available at: https://plutuseducation.com/blog/net-present-value-advantages-and-
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[Accessed 9 May 2025].
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Raisin UK, n.d. Raisin UK. [Online]
Available at: https://www.raisin.co.uk/investments/payback-period/
[Accessed 03 May 2025].
Tutorchase.com, n.d. Tutorchase.com. [Online]
Available at: https://www.tutorchase.com/answers/ib/business-management/what-are-the-
limitations-of-using-the-accounting-rate-of-return--arr--method
[Accessed 2 May 2025].
Vipond, T., n.d. CFI. [Online]
Available at: https://corporatefinanceinstitute.com/resources/accounting/arr-accounting-rate-of-
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[Accessed 02 May 2025].
