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Question

Difficulty: HardBalance Sheet Classification of Assets and Liabilities

Amaka, a sole trader, compiled the following list of balances at the end of her financial period:

- Motor Vans: ₦850,000\text{₦}850,000
- Trade Debtors: ₦180,000\text{₦}180,000
- Closing Inventory: ₦90,000\text{₦}90,000
- Prepaid Insurance: ₦15,000\text{₦}15,000
- Trade Creditors: ₦120,000\text{₦}120,000
- Accrued Rent: ₦25,000\text{₦}25,000
- Bank Overdraft: ₦50,000\text{₦}50,000
- 5-year Bank Loan: ₦300,000\text{₦}300,000

What is the correct figure for the working capital of the business?

  1. ₦90,000\text{₦}90,000Answer
  2. B
    ₦60,000\text{₦}60,000
  3. C
    −₦210,000-\text{₦}210,000
  4. D
    ₦940,000\text{₦}940,000

Answer

₦90,000\text{₦}90,000
Working capital is calculated as Current Assets minus Current Liabilities. Current Assets consist of Trade Debtors (₦180,000\text{₦}180,000), Closing Inventory (₦90,000\text{₦}90,000), and Prepaid Insurance (₦15,000\text{₦}15,000), totaling ₦285,000\text{₦}285,000. Current Liabilities consist of Trade Creditors (₦120,000\text{₦}120,000), Accrued Rent (₦25,000\text{₦}25,000), and Bank Overdraft (₦50,000\text{₦}50,000), totaling ₦195,000\text{₦}195,000. Subtracting current liabilities from current assets yields ₦90,000\text{₦}90,000. Motor Vans (non-current asset) and the 5-year Bank Loan (non-current liability) are correctly excluded.

Step-by-Step Solution

1
Classify and sum all Current Assets
Current Assets = Trade Debtors (₦180,000\text{₦}180,000) + Closing Inventory (₦90,000\text{₦}90,000) + Prepaid Insurance (₦15,000\text{₦}15,000) = ₦285,000\text{₦}285,000
Current assets comprise short-term resources expected to be converted into cash within one year. Prepaid insurance represents a short-term benefit receivable.
2
Classify and sum all Current Liabilities
Current Liabilities = Trade Creditors (₦120,000\text{₦}120,000) + Accrued Rent (₦25,000\text{₦}25,000) + Bank Overdraft (₦50,000\text{₦}50,000) = ₦195,000\text{₦}195,000
Current liabilities are short-term obligations payable within one accounting period. Long-term bank loans are excluded as they are non-current liabilities.
3
Calculate Working Capital
Working Capital = Current Assets - Current Liabilities = ₦285,000−₦195,000=₦90,000\text{₦}285,000 - \text{₦}195,000 = \text{₦}90,000
Working capital measures liquid operational financial strength by deducting current liabilities from current assets.

Key Concept

Working Capital Determination and Balance Sheet Asset/Liability Classification
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Topics

Balance Sheet Classification of Assets and Liabilities