BAO6504Accounting for Management Lecture 3

Assets, Liabilities and EquityReference: Chapters 4,8, 9 and 10

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Current Assets

Inventory Cash Accounts Receivables Notes Receivables

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CLASSIFYING INVENTORY

In a manufacturing business, inventories are usually classified into three categories:

Raw materials: materials that will be used but have not yet been placed in the production process

Work in process: manufactured inventory that has been started but not yet completed in the production process

Finished goods: completed manufactured items that are ready for sale

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Cash

Cash is the most desirable asset because it is readily convertible into any other asset

Cash consists of Cash on hand (notes and coins) Cash at bank Cheque accounts

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Managing and monitoring cash

Operating cycle of a retail business

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Accounts Receivable

Accounts receivable are amounts owed by customers on account

3 accounting problems associated with accounts receivable are: Recognising accounts receivable Valuing accounts receivable Accelerating cash receipts from

receivables

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Accounting for receivables continued

Ageing of Accounts Receivable

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Managing receivables

1. Determine to whom to extend credit

2. Establish a payment period3. Monitor collections4. Evaluate the receivables balance5. Accelerate cash receipts from

receivables when necessary

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RECEIVABLES

Notes receivable are claims for which formal instruments of credit are issued evidencing the debt

Other receivables include non-trade receivables such as interest receivable, loans, advances and GST receivable

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Accounting for receivables continued

Notes receivable A note receivable is a formal credit

instrument It does not always arise from

transactions with customers It is included as an asset in the

financial statements

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Non-current Assets

Property, Plant and Equipment

Intangible assets

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PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment (PPE) are physical assets used in the business to provide future economic benefits for a number of years

According to AASB 116, economic benefits derived from the use of an asset must be recognised on a systematic basis over the asset’s useful life

This decline is recognised as depreciation expense in the income statement

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PROPERTY, PLANT AND EQUIPMENT continued

Two classes of PPE assets: Property

Includes land and buildings Plant and equipment

Includes cash registers, computers, office furniture, factory machinery, motor vehicles

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Determining the cost of PPE continued

The cost of an asset Consists of the fair value of all expenditure necessary to acquire the asset and make it ready for use

e.g. For property, Cost of land includes purchase price, settlement costs (e.g. solicitor’s fees), stamp duty, property taxes assumed by purchaser

e.g. For equipment, cost includes purchase price, freight costs paid, installation costs

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Depreciation

Depreciation is the process of allocating to

expense the cost of a PPE asset over its useful

(service) life in a rational and systematic

manner

Carrying amount equals cost less accumulated

depreciation

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Depreciation continued

Factors in calculating depreciation Cost

All expenditures necessary to acquire the asset and make it ready for intended use

Useful life Estimate of the expected life based on intended use,

need for repair, vulnerability to obsolescence and legal life

Residual value Estimate of the asset’s value at the end of its useful life

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Depreciation continued

Depreciation methodsStraight lineReducing balanceUnits of production

ExampleDelivery truck purchased by Bill’s Pizzas

Cost $13 000Expected residual value $ 1 000Estimated useful life (in years) 5Estimated useful life (in kms) 100 000

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Depreciation continued

1. Straight-line method Depreciation expense same each year as benefits are

consumed at same rate each year Calculation for annual charge:

cost of asset – residual value useful life of the asset

Bill’s Pizzas example: Annual depreciation ($13 000 - $1 000) / 5 = $2 400

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Depreciation continued

Straight-line depreciation schedule

BILL’S PIZZAS

Calculation End of year Depreciable Depreciation Depreciation Accumulated CarryingYear amount x rate = expense p.a. depreciation amount2010 $12 000 20% $ 2 400 $ 2 400 $10

600 *2011 12 000 20 2 400 4 800 8

2002012 12 000 20 2 400 7 200 5

8002013 12 000 20 2 400 9 600 3

4002014 12 000 20 2 400 12 000 1

000Total $12 000

* Cost $13 000 – Year 1 depreciation $2400 = Carrying amount $10 600

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INTANGIBLE ASSETS

Intangible assets: non-monetary assets that have no physical substance1. Patents2. Research and development costs3. Copyright4. Trademarks and brand names5. Franchises and licences6. Goodwill

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Accounting for intangible assets continued

Amortisation This is the term used to describe

the allocation of the cost of an intangible asset to expense

Intangible assets are assumed to have a limited life and are amortised

Patents are amortised over legal or useful life, whichever is shorter

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Accounting for intangible assets continued

Example Patent costs $60 000 and has an estimated

useful life of 8 years

Annual amortisation expense$60 000 ÷ 8 = $7500

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Current and Non-current Liabilities

CURRENT LIABILITIES A current liability is an obligation that can

reasonably be expected to be paid within one

year or within the operating cycle, whichever is

the longer.

Examples of current liabilities include: notes payable

accounts payable

revenue received in advance

accrued liabilities

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Notes Payable

Notes payable record obligations in the form of written notes

Usually require borrower to pay interest or borrowing costs

Frequently issued to meet short-term financing needs

Issued for varying periods of time

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Payroll and payroll deductions payable

Employers deduct amounts from employees’ wages

and salaries if they are required to be paid to other

parties

These include deductions for: Tax (pay-as-you-go or PAYG)

Superannuation

Trade union fees

Health insurance

Employers are responsible to remit these withheld

funds to the appropriate parties

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Revenues received in advance

Occurs when customers pay ahead

of time for goods or services

e.g. Purchase of plane tickets

Magazine subscriptions

Season passes to sporting

events

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Accrued Liabilities

Occurs when the firm has incurred

expenses that have not been paid

for, and for which no specific

invoice / claim has been made by

the relevant party.

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NON-CURRENT LIABILITIES

Obligations expected to be paid after

1 year or outside normal operating cycle

Common forms of these obligations are: Bank loans

Long-term notes

Debentures are notes that are subject to a secured

charge on the issuers assets

Unsecured notes are not subject to a security over

assets

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LOANS PAYABLE BY INSTALMENT

Entities may borrow money from a single borrower in the form of loan

It is common for such loans to be repayable by instalment, e.g. mortgages

A mortgage is a loan secured by a charge over property

If the borrower is unable to repay the loan, the lender may sell the property and use the proceeds to repay the loan

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Current and non-current components of long-term debt

Entities often have a portion of long-term debt that falls due within the coming year

This portion of the long-term debt should be classified as a current liability

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Why issue long-term notes?

Advantages of Debt Financing

Shareholder control is not affected

Current owners retain full control of company

Tax savings result

Interest is deductible for tax purposes; dividends on shares are not

Earnings per share may be higher

Although interest expense reduces net profit, earnings per share may be higher because no additional shares are issued

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Why issue long-term notes? continued

Disadvantage of Debt Financing

Company is locked into fixed payments.

These must be made in good and bad times

Interest must be paid on periodic basis

Principal must be paid at maturity

Company with fluctuating earnings and relatively weak cash flow may experience difficulty in meeting interest payments in periods of low earnings

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Equity

A company is owned by its shareholders

Different classes of shares carry different ownership rights Ordinary shares Preference shares

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Shareholder rights continued

Ordinary shares have 3 major ownership rights: Right to vote Right to share in company’s profit Right to a residual claim if company is

liquidated

Preference shares have priority over ordinary shares with respect to dividends and claims at liquidation

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DIVIDENDS

A dividend is a distribution of profit by a company to its shareholders on a pro rata basis

Forms of dividends: Cash Property Shares

Public companies often pay 2 dividends: Final dividend determined at end of year Interim dividend paid during the year

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Cash dividends

A cash dividend is a pro rata distribution of profit paid in cash to shareholders

To pay a cash dividend, a company needs: Adequate retained earnings Adequate cash available to avoid

insolvency Dividends declared by directors

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Share dividends

A share dividend is a pro rata distribution of the company’s shares to shareholders

Total shareholders’ equity does not change because:

Retained earnings decreases and Share capital increases

A share dividend signals that this amount of retained profits is not available to shareholders as cash dividends

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REPORTING ON SHAREHOLDERS’ EQUITY

Equity section of balance sheet of a corporation includes: Share capital: contributed equity (paid

and any outstanding amounts) Retained earnings: prior profits kept

within company and not distributed as dividends

Reserves: changes in equity not created through transactions with owners

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Reserves

Most reserves of Australian companies are classified as revenue reserves and can be distributed as dividends

Companies must:

Show the aggregate amount of reserves on the face of the balance sheet

Disclose the nature and purposes of reserves

Provide a reconciliation that explains movements in each reserve during year

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Retained earnings

Retained earnings represent accumulated

profits that have not been distributed to

shareholders as dividends

On the balance sheet, companies must

report:

The opening amount of retained earnings

Changes to retained earnings during the year

The amount of retained earnings at balance date