Engineering Management Accounting – Lecture 8

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Engineering Management Accounting – Lecture 8

  1. 1. Engineering Management Accounting – Lecture 8 Revision(1) ELE 22EMT George Alexander [email_address] http://www.latrobe.edu.au/eemanage/ 15 October, 2004
  2. 2. Accounting for Engineers - because <ul><li>Engineers invariably operate in a managed business environment. </li></ul><ul><li>Accounting provides a means of measuring the viability and performance of organisations. </li></ul><ul><li>Accounting is closely linked to Engineering Economics in that it provides many of the analytical tools and data required for analysis. </li></ul>
  3. 3. So what is accounting? <ul><li>“ The process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information.” </li></ul><ul><li>Bazley et al </li></ul>
  4. 4. Financial Accounting <ul><li>“ That part of an accounting system that tries to meet the needs of various external users”. </li></ul><ul><li>Bazley et al </li></ul>
  5. 5. Management Accounting <ul><li>“ That part of an accounting system that tries to meet the needs of management and internal users”. </li></ul><ul><li>Bazley et al </li></ul>
  6. 6. Topics <ul><li>Financial Accounting </li></ul><ul><ul><li>Profit and Loss Statement </li></ul></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Cash Flows </li></ul></ul><ul><li>Capital assets/depreciation </li></ul><ul><li>Management Accounting </li></ul><ul><ul><li>Budget Process </li></ul></ul><ul><ul><li>Organisation Structure </li></ul></ul><ul><ul><li>Product Cost Calculation </li></ul></ul><ul><li>Business Ratios </li></ul>
  7. 7. Transformation Process Inputs Outputs Resources: Human Materials Equipment Financial Information managerial: Planning Organisation Leading Controlling Technology Outcomes: Products & services Profit & loss employees growth & satisfaction Bartol – Management: A Pacific Rim Focus, McGraw-Hill, 2001
  8. 8. The Firm –a simple model
  9. 9. Balance Sheet (Statement of Financial Position) <ul><li>Records the financial position of the organisation at a given point in time. </li></ul>
  10. 10. Telstra Balance Sheet
  11. 11. Profit and Loss Statement (Statement of Financial Performance) <ul><li>Reports receipts and expenditure over the period in question – the accounting period. </li></ul>
  12. 12. Telstra Profit and Loss Statement
  13. 13. Cash Flow Statement <ul><li>Is an indicator of the organisation’s ability to survive in the short term </li></ul>
  14. 14. Telstra Cash Flow Statement
  15. 15. Money Flows - IN <ul><li>Equity capital (Owners) </li></ul><ul><li>Debt capital (Lenders) </li></ul><ul><li>Revenue from sales (Customers) </li></ul><ul><li>Interest on reserves (Financial Institutions) </li></ul>
  16. 16. Money Flows - OUT <ul><li>Dividends (Owners) </li></ul><ul><li>Repayments/Interest (Lenders) </li></ul><ul><li>Purchases of assets (Suppliers) </li></ul><ul><li>General expenditure (Suppliers/employees) </li></ul><ul><li>Taxes/charges (Government) </li></ul>
  17. 17. Definition of Assets (Bazley) <ul><li>Assets – “Future economic benefits controlled by the entity as a result of past transactions or other past events” </li></ul><ul><li>Fixed assets – “… held for the purpose of generating income over a number of years.” </li></ul><ul><li>Current assets – “… cash or cash-equivalent, expected to be realised within 12 months of the reporting date”. </li></ul>
  18. 18. Types of Assets <ul><li>Fixed Assets </li></ul><ul><ul><li>Buildings </li></ul></ul><ul><ul><li>Plant </li></ul></ul><ul><ul><li>Equipment </li></ul></ul><ul><li>Current Assets </li></ul><ul><ul><li>Stock (inventory) </li></ul></ul><ul><ul><li>Cash on hand </li></ul></ul><ul><ul><li>Accounts receivable </li></ul></ul><ul><ul><li>Short-term investments </li></ul></ul><ul><li>Intangible assets e.g. patents, goodwill </li></ul>
  19. 19. Other Expenditure <ul><li>Salaries and wages </li></ul><ul><li>Rent and other building-related expenses </li></ul><ul><li>Insurance </li></ul><ul><li>Taxes and charges </li></ul><ul><li>Marketing and advertising </li></ul><ul><li>Communications </li></ul><ul><li>Motor vehicles and travelling </li></ul><ul><li>Entertainment </li></ul>
  20. 20. Liabilities <ul><li>What the firm owes as a result of past borrowings or expenditure – </li></ul><ul><li>Current </li></ul><ul><ul><li>Short-term borrowings e.g. overdraft </li></ul></ul><ul><ul><li>Accounts payable </li></ul></ul><ul><ul><li>Taxes </li></ul></ul><ul><li>Non-current </li></ul><ul><ul><li>Long term borrowings </li></ul></ul><ul><li>Other future commitments </li></ul>
  21. 21. Owners Equity/Net Worth = Assets - Liabilities
  22. 22. Relationship – Balance Sheet/ P&L statement <ul><li>Balance Sheet (Beg) </li></ul><ul><li>+ </li></ul><ul><li>Revenue/Expenditure/Depreciation </li></ul><ul><li>during accounting period </li></ul><ul><li>= </li></ul><ul><li>Balance Sheet (End) </li></ul>
  23. 23. Why capitalise/depreciate? <ul><li>Capital assets have an estimated useful lifetime. </li></ul><ul><li>Consequently, it would be misleading to account for the associated expenditure in just one accounting period. </li></ul><ul><li>As a result, the expenditure is accounted for over the asset’s lifetime through depreciation. </li></ul><ul><li>This also provides a basis for valuing the asset. </li></ul><ul><li>ATO requires that the asset expense deduction is claimed over the asset’s lifetime. </li></ul>
  24. 24. Depreciation - an introduction <ul><li>Capital investment in tangible assets - equipment, computers, vehicles, buildings, and machinery - are commonly recovered through depreciation. </li></ul><ul><li>Depreciation also referred to as capital recovery (US) and capital allowance (ATO) </li></ul><ul><li>Visit www.ato.gov.au - search for depreciation. </li></ul><ul><li>The depreciation amount itself is not an actual cash flow. </li></ul>
  25. 25. Introduction - cont. <ul><li>The process of depreciating an asset accounts for the decrease in an asset’s value because of age, wear, and obsolescence. </li></ul><ul><li>Depreciation is a tax-allowed deduction included in tax calculations. </li></ul><ul><li>Taxes = (income - deductions)(tax rate) </li></ul>
  26. 26. Book Depreciation <ul><li>Used for internal managerial decision making. </li></ul><ul><li>Management is free to use any method they so choose to compute book depreciation amounts. </li></ul><ul><li>Any method can be used: </li></ul><ul><ul><li>Straight Line, </li></ul></ul><ul><ul><li>Declining Balance; </li></ul></ul><ul><ul><li>Sum-of-the-years digits; </li></ul></ul><ul><ul><li>Other. </li></ul></ul><ul><li>Defines the reduced investment in an asset based upon usage pattern and an assumed life. </li></ul>
  27. 27. Tax Depreciation <ul><li>Must follow the current state and federal law pertaining to acceptable methods for computing depreciation for income tax purposes. </li></ul><ul><li>It may have nothing to do with the actual life of the asset or the usage pattern. </li></ul>
  28. 28. Different Depreciation Methods
  29. 29. Straight Line Depreciation <ul><li>The book value decreases linearly with time. </li></ul><ul><li>The depreciation rate, d = 1/n, is the same each year of recovery period n. </li></ul><ul><li>It is considered the standard against which any depreciation model is compared. </li></ul><ul><li>The annual SL depreciation is determined by: </li></ul><ul><li>(first cost - salvage value) d </li></ul>
  30. 30. Example <ul><li>B = $50,000; </li></ul><ul><li>“ n” = 5 years; </li></ul><ul><li>S = $10,000 at t = 5; </li></ul><ul><li>D t for each year is: </li></ul><ul><ul><li>($50,000 - $10,000)/5 = $8,000/year </li></ul></ul>
  31. 31. Table of Results 10,000 8,000 5 18,000 8,000 4 26,000 8,000 3 34,000 8,000 2 $42,000 $8,000 1 BV t D t t
  32. 32. Plot of SL Book Value
  33. 33. Accelerated Depreciation <ul><li>SL book values decline in a linear fashion down to a specified salvage value. </li></ul><ul><li>Declining Balance (DB) method allows the book value to accelerate faster. </li></ul><ul><li>The SL method writes off the asset in equal amounts over the recovery period. </li></ul><ul><li>The DB method permits greater depreciation amounts in the early years, and hence reduces the book value faster than the SL method. </li></ul>
  34. 34. Accelerated Depreciation - cont. <ul><li>More depreciation in the early years means more tax savings sooner. </li></ul><ul><li>Assumes a profitable firm. </li></ul><ul><li>Tax savings early in the life of an asset has a greater present value than tax savings out in time. </li></ul><ul><li>Larger depreciation amounts early on result in increased present worth of future tax savings to the firm. </li></ul>
  35. 35. What it means for the firm ? <ul><li>If the firm is profitable, then more depreciation amounts in the early years means: </li></ul><ul><ul><li>Lower tax liability; </li></ul></ul><ul><ul><li>Pay less taxes – more $$ available for reinvestment! </li></ul></ul><ul><ul><li>The firm can retain more after-tax funds if the depreciation is accelerated in the early years of an assets’ life. </li></ul></ul><ul><ul><li>Thus, more depreciation $$ early on are better! </li></ul></ul>
  36. 36. Refer ATO web site <ul><li>Refer description/examples on link below </li></ul><ul><li>http://www. ato . gov .au/individuals/content.asp?doc=/content/42787. htm &page=8#H23 </li></ul><ul><li>Note ATO terminology – </li></ul><ul><ul><li>DB =‘Diminishing Value’ </li></ul></ul><ul><ul><li>SL = ‘Prime Cost Method’ </li></ul></ul>
  37. 37. <ul><li>Thanks for your attention </li></ul>

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