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ACCA F9 Overcapitalisation and Overtrading
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Sir, I am confused about 100 overdrawn in the stage 2 in your example. The basic balance is assets = liabilities + equity. Therefore, I understand that 100 in overdrawn (liabilities) would make the balance of SoFP. However, in general, I usually read a couple of examples and it has double-entry accounting such as Dr Cash and Cr Overdraft. For that reason, I haven’t understood the 100 overdrawn in your example properly to make that balance (like Cr 100 overdrawn and what is the Dr ?). Can you explain more details about this or can you give a process for an example? Thank you.
Double entries are irrelevant for Paper FM – they are all examined in Paper FA. However there is no such entry as Dr Cash Cr Overdraft.
If, for example, they buy more inventory, the entry is Dr Purchases Cr Cash. An overdraft is a credit balance on the cash account.
Sir. If I consider the accounting entry, I think the process when buying inventory with bank overdraft might be like this: 1. Dr Cash Cr Bank Overdraft -> 2. Dr Purchases Dr Cash
In this process, I am understanding that when cash comes to zero and a company might expect more money to charge for inventory (example). Therefore, the cash is raised in Debit and Bank Overdraft is also a Credit right? When the company has money, therefore, it will buy Inventory (Dr Purchase or Dr Inventory) and Cr Cash to make the balance. Do you think my example is correct?
However, I also understand your example because the nature of bank overdraft is when money comes to zero, the company can extend the credit with the bank via contract which might have between company and the bank before. Therefore, when money comes to zero and the company needs money simultaneously for purchasing inventory, it will ignore the entry Dr Cash Cr Bank Overdraft and come to Dr Purchases and Cr Cash right away (cash in this situation is like the negative balance or overdraft).
If I were wrong, could you explain for me more details? Thank you sir.
I repeat double entry bookkeeping is not relevant for Paper FM. The cash account refers to cash at the bank (if they do have ‘loose’ cash then this is recorded in the petty cash account. Companies will not pay for inventory with ‘loose cash’ they will pay through the bank and the entry is Dr Purchases and Cr Cash. If the cash is a credit balance then it means they are overdrawn at the bank.
If you have more problems relating to double entry then please watch the Paper FA free lectures.
Thank you Sir.
how can I download your videos?
The videos can only be watched online – it is the only way we can keep this website free of charge.
Ok then. Thank you.
You are welcome 馃檪
Sir what is happening to the cash of 50 in that example? why wont it double as well?
How can it double unless they raise more finance – it would have to come from somewhere!!
That is the whole point about over-trading, unless they raise more long-term finance to cover the need for extra working capital, then they will be forced into using short-term finance i.e. going overdrawn.
Dear sir,
Why don’t we keep it at 50 then just overdraft 50.
Thank sir.
But read my previous reply!!
Going overdrawn by 50 is again being forced into using short-term finance because they had not planned ahead.
Thank you, sir
You are welcome 馃檪
Sir,
What would you consider to be a high working capital?
You cannot look at the level of working capital on its own and say that it is too high or too low – it depends on the type of business and the size of the company. You can only comment by comparing it with similar companies, or with previous years.
Noted with many thanks.
You are welcome 馃檪
Dear Sir,
why would overcapitalization be a problem?
Because working capital would be higher than needed. Working capital does not earn money for the business, but because of having raised more long-term capital to finance it they will be paying more interest than needed.
I understand now. Thank you for your reply.
There would be no point in doubling the working capital if they were not doubling the non-current assets – it would be more sensible to do it in proportion.
However it israthler academic in that you will not be asked calculations on this – it is more understanding the potential problem of over-trading.
Thanks for the reply (Y)
Helps alot!
You are welcome 馃檪
Sir,
If the Company not been able to generate an additional investment of $700, instead it can only generate an additional investment of $500. In such case is it better to add $300 to Non current assets, so NCA will be $800(500+300) and long term capital will be $1200(700+500) and that leaves the company with a working capital of $400.
Is it better that way, rather than investing the entire $500 into NCA
Thankyou.