Costing and Finance

Fundamental Concept of Finance:

Sources of funds = Applications of funds Equity + Borrowing = Investment Net worth + Liabilities = Assets, or Assets Liabilities = Net worth What a company owns less what it owes is what it is worth Assets, Liabilities, Net Worth: a. Assets: Fixed Assets - land, building, furniture & fixture, machinery, etc. Current Assets - debtors, stock, receivable, cash, etc. The above assets are all tangible. Intangible Assets - good will, royalty, patent, etc. Goodwill: A company as a going concern whose total value in respect of earning power may exceed the actual asset value. The difference constitutes goodwill. It very seldom appears in balance sheet unless it is purchased (excess of the cost of an acquisition over the fair value) and even then it is often written off. e.g. Profit after tax $20,000 Net tangible asset value $150,000 Basis return for net tangible assets 10% Super profit to be capitalised @ 20% Normal profit $150,000 @ 10% $15,000 Super (extra-ordinary) profit $5,000 Goodwill =
$5,000 = $25 ,000 0.2

b. Liabilities: Long term Liabilities - long term loan, debenture, etc. Current Liabilities - short term loan, overdraft, creditor, payable, etc. Contingent Liability possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the company. A contingent liability is not recognised. It does not appear in the balance sheet itself but appears in the notes of the balance sheet. e.g. Guarantee, performance bond, contract, letter of credit, etc. When an outflow of economic resources is probable, it will be recognised as a provision. c. Net Worth/Equity: Share Capital, Reserve, etc. Share Capital - ordinary share, reserve - preference share - cumulative, non-cumulative.

Costing and Finance

Depreciation: r n vo vn = rate of depreciation = useful life in nos. of years = cost of asset = residual value of asset

Straight Line Method 1 v r = (1 n ) n vo

value

time

Reducing Balance Method

n

r = 1

vn vo

value

time

Costing and Finance

GAAP: Financial Accounting Conventions Generally Accepted Accounting Principles 1. Fundamental Convention: a. Entity convention - To distinguish the business affairs from the personal affairs. - financial accounting information relates to the activities of a business entity only and not to the activities of the owners. b. Money Measurement Convention - limits the recognition of activities to those which can be expressed in monetary terms. 2. Procedural Convention - treatment of data: a. Going Concern Convention - Valuation of assets in a business is based on the assumption that the business is a continuing business and not about to cessation. b. Cost Convention - Cost is used as a measure of the financial effort in acquiring resources and in earning revenue. e.g. historical cost vs current value. c. Realisation Convention - Recorded value of an asset to a firm is determined by the transaction which is necessary to acquire it. Any change in its value may only be recognised at the moment the company realises or disposes of that asset. There is no certainty of income until sale is made. Increase in value which has not been realised is not recorded. d. Accrual Convention - To distinguish receipt of cash and the right to receive cash. e.g. Sold on 15/12 and payment received on 15/1, Balance Sheet as at 31/12 should record the sale transaction. e. Periodicity Convention - Company requires periodic financial reporting normally every year. f. Conservatism Convention - Financial reporting tends to be conservative, we should not anticipate income or appreciation of value but should provide all possible losses. e.g. Provision of bad debt - If given 2 methods of valuing an asset, choose the one which gives a lesser value e.g. Cost Market value 100 120 100 80 g. Consistency - Comparison of financial statement of a year with that of the preceding years, or of one company to another. Procedures e.g. various methods of stock evaluation, allocating depreciation adopted by an organisation have to be consistent from year to year. h. Objectivity Financial statements cannot be fabricated to mislead the financial position and performance. Consequently accountants seek objectivity as one of their strengths and regard it as an essential characteristic of measurement. i. Disclosure Accountants are obliged to transmit all significant financial data in the body of the financial reports and also in explanatory footnotes. When they disagree about any item, they should disclose all the major facts so that the users can make his own judgement and comparisons. The need for ample disclosure is paramount. There is no rule against providing supplementary information on price level adjustments, depreciation methods or market values. A working rule should be when in doubt, disclose. j. Historical cost convention vs
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Costing and Finance

Current purchasing power basis (CPP) taking into consideration the effect of inflation Current cost accounting (CCA) fixed assets and closing stock stated in their current value rather than at their historical cost

Stock valuation: Item Opening stock 1st purchase 2nd purchase Closing stock No. of units 100 100 100 300 Unit price $1.00 $1.20 $1.30 Sub-total $100 $120 $130 $350

Sold 200 units 1. FIFO cost $220 (normally choose this scheme) 2. LIFO cost $250 3. Weighted average cost = 200
350 = $233.33 300