Transcript Chapter 9

Slide 9.1
Chapter 9
Current assets
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.2
Definitions
• Assets are rights or other access to future
economic benefits controlled by an entity as a
result of past transactions or events.
• A current asset is an asset that is not intended
for use on a continuing basis in the company's
activities. It is an asset that has been acquired
with the intention of sale, or conversion into
cash, within a relatively short space of time,
usually less than twelve months.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.3
Examples
•
•
•
•
•
•
•
•
•
•
Raw materials
Work in progress
Finished goods
Trade receivables (debtors)
Amounts owed by other companies in the Group
Prepayments and accrued income
Investments held as current assets
Short-term bank deposits
Bank current account (also called 'cash at bank')
Cash in hand
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.4
Working capital cycle
The working capital cycle of a business is
the sequence of transactions and events,
involving current assets and current
liabilities, through which the business makes
a profit.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.5
Working capital cycle (Continued)
acquire goods for
use in production, for resale or
for use in providing a service
STOCK
pay
CREDITORS
suppliers
who have
allowed time to pay
CASH
sell goods or
DEBTORS service to
customers on
credit
collect cash
Figure 9.1
The working capital cycle for a manufacturing or service business
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.6
Working capital cycle (Continued)
Calculated as current assets minus current
liabilities.
If the working capital is low, then the
business has a close match between current
asset and current liabilities but may risk not
being able to pay its liabilities as they fall
due.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.7
Working capital cycle (Continued)
• If current assets are very much greater than
current liabilities, then the business has a
large amount of finance tied up in the current
assets when perhaps that finance would be
better employed in the acquisition of more
non-current (fixed) assets to expand the
profit-making capacity of the operations.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.8
Definition
• Working capital is the amount of finance,
which a business must provide to finance
the current assets of a business, to the
extent that these are not covered by current
liabilities. It is calculated by deducting
current liabilities from current assets.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.9
Recognition
• Inventories (stocks), receivables (debtors),
investments and cash are commonly
recognised in a statement of financial
position (balance sheet) but element of
doubt may be attached to the expectation of
economic benefit and the reliability of
measurement.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.10
Inventories – finished goods
• Finished goods: The future economic
benefit is selling price, which exceeds the
cost of purchase or manufacture. That
makes a profit and increases the ownership
interest but prudence dictates that profit
should not be anticipated.
• Finished goods are therefore measured at
the cost of purchase or manufacture.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.11
Finished goods (Continued)
• Where there is strong doubt about the
expected selling price, such that it might be
less than the cost of purchase or
manufacture, the asset of finished goods
inventory (stock) is valued at the net
realisable value.
• Defined as the estimated proceeds from sale
of the items in question, less all costs to be
incurred in marketing, selling, and
distributing these items.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.12
Work in progress
• Partly completed finished goods.
• Risks often greater than for finished goods
because of the risk of non-completion, to
add to all the risks faced when the goods are
completed and awaiting sale.
• There is a reliable measurement, in the cost
of work completed at the date of the financial
statements, but careful checking is required
by the managers of the business to ensure
that this is a reliable measure.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.13
Raw materials
The approach to recognition is the same as
that for finished goods. Raw materials are
expected to create a benefit by being used in
manufacture of goods for sale. On grounds of
prudence the profit is not anticipated and the
raw materials are recognised at the lower of
cost and net realisable value.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.14
Receivables (debtors)
Debtors are persons who owe money to a business.
Trade debtors are customers who buy goods on
credit but have not yet paid. In the statement of
financial position the trade debtors may be
described as trade receivables.
Other debtors
• Loans made to another enterprise to help that
enterprise in its activities.
• Loans to employees to cover removal and
relocation expenses or advances on salaries.
• Refund due of overpaid tax.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.15
Prepayments
Amounts of expenses paid in advance.
For example:
• Rental
• Insurance premiums
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.16
Recognition
• Trade receivables (debtors) meet the
recognition conditions because there is an
expectation of benefit when the customer
pays. Trade receivables (debtors) are
measured at the selling price of the goods.
• Profit is recognised in the income statement
(profit and loss account) when the goods or
services have been supplied to the
customer.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.17
Doubtful debts
There is a risk that the customer will not pay.
The risk of non-payment is dealt with by
reducing the reported value of the asset by
an estimate for doubtful debts.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.18
Investments
Held as current assets are-usually highly marketable
and readily convertible into cash. Expectation of
future economic benefit is therefore usually clear.
Two possible measures:
• Cost – prudent and reliable
• Market value (called marking to market) – more
relevant
The approach most often used is valuation at cost.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.19
Cash
• Cash at bank (e.g. current account, instant
access deposit account) or cash in hand.
• The amount is known either by counting
cash in hand or by looking at a statement
from the bank that is holding the business
bank account.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.20
Users’ needs for information
Example Safe and Sure (see text book)
Notes
Current
assets
Year 7
Year 6
£m
£m
Inventories (stocks)
5
26.6
24.3
Receivables (debtors)
6
146.9
134.7
107.3
90.5
280.8
249.5
Short term deposits and
cash
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.21
Measurement – inventories
Lower of cost and net realisable value
Consider the example of a container of coffee
beans purchased by a coffee manufacturer at
a cost of £1,000. The beans are held for three
months up to the date of the financial
statements. During that time there is a fall in
the world price of coffee beans and the
container of coffee beans would sell for only
£800 in the market.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.22
Asset acquired
When the asset is acquired, the impact on the
accounting equation is an increase of £1,000 in
the asset of inventory (stock) and a decrease of
£1,000 in the asset of cash.
Assets

–
Liabilities = Ownership Interest
+£1,000
inventory (stock)
–£1,000 cash
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.23
End of year
At the end of the year the asset is found to be
worth £800 and the ownership interest is reduced
because the asset has fallen in value. The asset is
reduced by £200 and an expense of loss of
inventory (stock) value is reported in the income
statement (profit and loss account).
Assets
 –
Liabilities
− £200 inventory (stock)
=
Ownership
interest 
− £200 expense
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.24
Meaning of cost
• The cost of any item of inventory (stock) or
work in progress is specified as the
expenditure, which has to be incurred in the
normal course of business in bringing the
product or service to its present location and
condition.
• Purchase price + transport and handling +
import duties – discounts – subsidies.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.25
Cost when input prices change
• Goods arrive at different times and at different
unit prices.
• What is the unit price to be charged to each job
when all the materials look the same once they
are taken into store?
• Ideal solution is to label the materials as they
arrive so that they can be identified with the
appropriate unit price.
• Often use a method that approximates to the
true price of the units used.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.26
Valuation with changing prices
• First-In-First-Out (FIFO)
− Assume that the goods, which arrived first
are issued first.
• Last-In-First-Out (LIFO)
− Assume that the goods, which arrived last
are issued first.
• Average cost
− Assume that all goods are issued at the
average price of the inventory held.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.27
Basic data for illustration
Date
Received
Unit price
Price paid
Issued to
production
Units
£
£
units
1 June
100
20
2,000
-
20 June
50
22
1,100
-
24 June
-
-
-
60
28 June
-
-
-
70
3,100
130
Total
Table 9.1
150
Pricing the issue of goods to production
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.28
Valuation with changing prices
Basis
Date
Quantity and unit Issued to
price
production
FIFO
Total
Table 9.1
Held in
inventory
(stock)
£
24 June
60 units at £20
1,200
28 June
40 units at £20
30 units at £22
1,460
30 June
20 units at £22
Total
£
£
440
2,660
440
3,100
Pricing the issue of goods to production (Continued)
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.29
Valuation with changing prices
(Continued)
Basis
Date
Quantity and unit Issued to
price
production
LIFO
Total
Table 9.1
Held in
inventory
(stock)
£
24 June
50 units at £22
10 units at £20
1,300
28 June
70 units at £20
1,400
30 June
20 units at £20
Total
£
£
400
2,700
400
3,100
Pricing the issue of goods to production (Continued)
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.30
Valuation with changing prices
(Continued)
Basis
Date
Quantity and
unit price
Average
Total
Issued to
production
Held in
inventory
(stock)
£
24 June
60 units at
*£20.67
1,240
28 June
70 units at
*£20.67
1,447
30 June
20 units at
*£20.67
Total
£
£
413
2,687
413
3,100
* Weighted average [(100 x 20) + (50 x 22)] / 150 = £20.67
Table 9.1
Pricing the issue of goods to production (Continued)
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.31
Comparison
• Totals are the same at £3,100. Allocations to
period are different.
• FIFO matches outdated costs against
current revenue.
• LIFO matches the most recent costs against
revenue, but the inventory (stock) value
becomes increasingly out of date.
• Average cost lies between the two. It is more
intricate to recalculate as more items come
into inventory.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.32
Importance for profit
• Assets – Liabilities = Ownership interest
• Overstating inventory (stock) values
overstates profit
• Understating inventory (stock) values
understates profit
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.33
Bad and doubtful debts
• Where there is doubt about the value of an
asset the directors should be invited to
consider making provision against the loss
of the asset.
• Where it is known that the debt is bad
(because the customer has declared
himself/herself bankrupt) the debtor should
be removed from the record as a bad debt.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.34
Example
• At the end of Year 1 the Garden Pond Company
has a statement of financial position comprising
£2,000 receivables (debtors), £7,000 other assets
and £9,000 ownership interest, consisting of
£1,800 ownership interest at the start of the period
and £7,200 profit of the period.
• On the date of the financial statements the
manager of the company reviews the debtors list
and decides that debts amounting to £200 are
doubtful because there are rumours of a customer
not paying other suppliers in the trade.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.35
Spread to analyse the effects of provision for
doubtful debts at the end of Year 1, using the
accounting equation
ASSETS
Transaction
or event
B/S first draft
Rec’bls Provision
debtors for D Ds
2,000
Recognition of
doubtful debts
Revised B/S
OWNERSHIP
INTEREST
Other
assets
7,000
Ownership Profit of the
interest at period
start
1,800
(200)
2,000
(200)
7,200
(200)
7,000
1,800
7,000
Spreadsheet to analyse the effect of provision for doubtful debts at the end
of Year 1, using the accounting equation
Table 9.2
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.36
Presentation in Statement of
Financial position
£
Debtor
2,000
Less Provision
(200)
‘good’ debts
1,800
The ‘Provision’ is the negative part of the asset.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.37
Change in a provision
• During Year 2 the customer who was
showing signs of financial distress pays the
amount of £200 owed.
• At the end of Year 2 this provision for
doubtful debts is now no longer required.
• At the end of Year 2 the receivables
(debtors) amount to £2,500. A review of the
list of debtors causes considerable doubt
regarding an amount of £350.
• A new provision of £350 is created.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.38
Spreadsheet to analyse the
doubtful debts
ASSETS
Transaction or
event
B/S
Rec’bles
debtors
2,500
provision no
longer required
Create new
provision
Revised B/S
2,500
OWNERSHIP
INTEREST
Provision for Other
DDs
assets
(200)
10,000
Ownership
interest at
start
8,800
Profit of
the period
3,500
200
200
(350)
(350)
(350)
10,000
8,800
3,350
Spreadsheet to analyse the effect of provision for doubtful debts at the end of
Year 2, using the accounting equation
Table 9.4
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.39
Presentation
The income statement (profit and loss
account) could show two separate entries:
• £200 increase in ownership interest.
• £350 decrease in ownership interest.
Most enterprises report a single line in the
income statement (profit and loss account):
• Increase in provision for doubtful debts of
£150.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.40
Prepayments
• A common example is the payment of an
insurance premium. The payment is made in
advance for the year ahead and the benefit
is gradually used up as the year goes along.
The statement of financial position
recognises the unexpired portion of the
insurance premium as an asset, while the
income statement (profit and loss account)
reports the amount consumed during the
period.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.41
Prepayment example
• On 1 October Year 1 a company paid
£1,200 for one year's vehicle insurance. At
the financial statement date of 31
December there have been three months'
benefit used up and there is a nine-month
benefit yet to come.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.42
Spreadsheet recording of
prepayment of Insurance
ASSETS
Date
Transaction or event
Year 2
Oct 1
Pay premium
Dec 31
Asset remaining as
prepayment
OWNERSHIP
INTEREST
Cash
Prepay
ment
Expense
£
£
£
(1,200)
(1,200)
(1,200)
900
900
900
(300)
Recognising the asset reduces the expense of the period from £1,200 to £300
Table 9.5
Spreadsheet recording prepayment of insurance at the financial year-end
date
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.43
Chapter 9
Bookkeeping supplement
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.44
Debit and credit entries in ledger
accounts
DEBIT ENTRIES
CREDIT ENTRIES
Increase
Decrease
Liability
Decrease
Increase
Ownership interest
Expense
Revenue
Capital withdrawn
Capital contributed
Left-hand side of the equation
Asset
Right-hand side of the equation
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.45
Debit and credit analysis
Date
Debit
Credit
P&L
£200
B/S Prov DD
£200
Yr 1
End of
year
Manager identifies doubtful
debts £200
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.46
Debit and credit analysis (Continued)
Date
Debit
Credit
Cash £200
Receivables
(debtors) £200
Yr 2
July
Customer who was doubtful
pays £200 in full
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.47
Debit and credit analysis (Continued)
Date
Debit
Credit
P&L
£350
Prov DD £350
Yr 2
End of
year
Manager identifies new provision
required £350
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.48
Debit and credit analysis (Continued)
Date
Debit
Credit
Prov DD
£200
P&L
£200
Yr 2
End of
year
Former provision no longer
required
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.49
Ledger accounts
L1 Receivables (debtors)
DATE
PARTICULARS
P
Year 1
Dec 31
DR
CR
£
BAL
£
Balance at end of year
£
2,000
Year 2
………………
July
Cash from customer
Dec 31
Balance at end of year
L3
…….
…….
200
.........
2,500
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.50
Ledger accounts (Continued)
L2 Provision for doubtful debts
DATE
PARTICULARS
P
Year 1
Dec 31
DR
CR
£
P&L a/c new provision
L4
Dec 31
P&L a/c old provision
L4
Dec 31
P&L a/c new provision
L4
BAL
£
£
200
(200)
Year 2
200
nil
350
(350)
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.51
Ledger accounts (Continued)
L3 Cash
DATE
PARTICULARS
P
Year 2
July
DR
CR
£
Cash from debtor
L1
200
BAL
£
£
.........
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.52
Ledger accounts (Continued)
L4 Profit and loss account
DATE
PARTICULARS
P
Year 1
Dec 31
DR
CR
£
BAL
£
Balance before provision
£
(7,200)
"
Provision for DD
L2
200
(7,000)
"
Transfer to ownership interest
L5
7,000
nil
Year 2
Dec 31
Balance before provision for
doubtful debts
(3,500)
"
Removal of provision no longer
required
L2
200
(3,700)
"
New provision for doubtful
debts
L2
350
(3,350)
"
Transfer to ownership interest
L5
3,350
nil
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.53
Recording a doubtful debt
July Year 2 Doubtful debt becomes bad.
Provision for doubtful debts is now used to match
the decrease in the asset. The analysis of the
transaction would be:
Yr2
July
Doubtful debt
becomes bad
Debit
Credit
Provision for
doubtful debts
£200
Receivables
(debtors)
£200
No impact on the income statement (profit and loss
account) of Year 2 of a bad debt which was known
to be likely at the end of Year 1.
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.54
Analysis of prepayment of
insurance, Year 1
Transaction or event
Debit
Credit
Oct 1
Payment of premium £1,200
Expense
(Insurance)
Cash
Dec
31
Identification of asset
remaining as a prepayment
£900
Asset (prepayment)
Expense
(Insurance)
Yr1
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.55
Analysis of prepayment of insurance,
Year 1 (Continued)
L6 Expense of insurance
DATE
PARTICULARS
P
Year 1
DR
CR
£
BAL
£
1,200
£
Oct 31
Cash
L3
1,200
Dec 31
Prepayment
L7
(900)
300
Dec 31
Transfer to profit and loss
account
L4
(300)
nil
Expense is reduced to £300 for this period
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011
Slide 9.56
Analysis of prepayment of insurance,
Year 1 (Continued)
L7 Prepayment
DATE
PARTICULARS
P
Year 1
Oct 31
DR
CR
£
Insurance expense prepaid
L6
900
BAL
£
£
900
Pauline Weetman, Financial and Management Accounting, 5th edition © Pearson Education 2011