5 REPORTING FINANCIAL RESULTS - University of Waikato · “Depreciation accounting is a system of...

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5 REPORTING FINANCIALRESULTS

IntroductionAccounting For Depreciation

- What is Depreciation- Why do Assets Lose Value?- Depreciation Methods- What Determines the Best Method?- Accounting Entries

Accounting for AdjustmentsIncome Statements

- Manufacturing StatementsBalance SheetsStatement of Changes in Financial Position

(or Funds Statement)- Funds Statement Objective- Definition of Funds- Example of a Statement of Cash Flows

Summary

IntroductionAs previously outlined, financial transactions are summarised according to apredetermined system. The output from the system at this point is a listing of ledgerbalances, called a Trial Balance. Following the initial processing, financial reportsare prepared for owners, managers and other interested parties. Financialstatements will normally include an Income Statement matching revenue andexpenses for a period, and a Balance Sheet showing the Assets, Liabilities andOwners’ Equity at the end of a period. To accurately prepare these statements anumber of end of year adjustments need to be made. These adjustments takeaccount of the arbitrary twelve month time period covered by the accounts and theeffect this cut-off has on part completed transactions. End of year adjustmentstypically cover depreciation, accrued income and expenses, prepaid expenses, andunearned revenues. This procedure ensures that expenses are matched with therevenue generated.

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68 Financial Management and Decision Making

Accounting For DepreciationThe term assets of a firm are capitalised at the time of purchase in recognition thatthey have a value which extends beyond the current accounting period. This meansthat the purchase price of the asset is recorded in the Balance Sheet and is notcharged against revenue in the period of purchase. The term assets of a firm arecharged against revenue over their useful life. This allocation of asset cost againstrevenue is termed depreciation.

What isDepreciation?

“Depreciation accounting is a system of accounting which aims to distributethe cost or other basic value of tangible capital assets less salvage value (ifany) over the estimated useful life of the unit ... in a systematic and rationalmanner. It is a process of allocation not of valuation.” (AICPA, 1953).

Thus, depreciation is an attempt to spread or allocate the cost of the asset to eachaccounting period over the life of the asset. Depreciation is not part of a valuationprocess but is merely an accounting procedure that in many cases bears little or norelationship to economic reality. Many small businesses will use taxationdepreciation rates in the accounts whereas larger firms will frequently use a morerealistic measure of the use of the asset.

Why doAssets LoseValue?

There are a number of reasons why assets lose value over time. It may be due toobsolescence as new and improved models have been introduced, or due todeterioration with the passage of time. An asset may become inadequate because itis no longer suitable for the volume of business. For example, a computer may stillbe workable but will no longer cope with the volume of material to be processed.An asset may lose value due to production volume or depletion. For example, it isknown with reasonable certainty how long an aircraft engine is useable beforemajor overhauls are required. Term assets may of course lose value largely due touse and while it is possible that some of this loss in value may be made good byrepairs, eventually the asset must be replaced or scrapped.

DepreciationMethods

It is very important that the method used to depreciate a fixed asset has regard to thefactors which caused the asset to lose value. For example, an asset such as a leasewhich loses value equally in each accounting period should be depreciated by equalamounts. An asset which is likely to lose value more quickly initially is more likelyto be depreciated by a form of the declining balance method.

Some common methods used to account for depreciation are:

1. Diminishing Value (or Reducing Value) MethodThis method attempts to charge a higher amount for depreciation againstrevenue in the early years of the life of an asset. The depreciation charge for aparticular accounting period is found by taking a set percentage of the bookvalue of the asset. This book value is the purchase price of the asset plus anyinstallation charges, less accumulated depreciation. The depreciation chargeand the book value of the asset over its life are shown graphically in Exhibit 5.1.

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Chapter 5: Reporting Financial Results 69

Exhibit 5.1Depreciation Charge

Time Time

Book Value

Using an example to demonstrate this method:

Given:Asset cost $500,000Estimated scrap value $50,000Depreciation Rate 20% DV

The depreciation charge for the first three years would appear as:

Year 1 Cost 500,000 Less 20% depreciation 100,000

400,000Year 2 Less 20% depreciation 80,000

320,000Year 3 Less 20% depreciation 64,000

256,000

One justification for the use of accelerated depreciation is that in later yearsrepairs and maintenance will increase, thus offsetting the lower depreciationcharge and ending to result in a similar annual total charge to the IncomeStatement over the life of the asset. This may be seen graphically in Exhibit 5.2.

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Exhibit 5.2

Depreciation

Time

Charge Charge

Time

R&M

Charge

Time

Total

Depreciation

R&M

Exhibit 5.3

2. Straight Line MethodIn this method the same depreciation charge is made each year, calculated bytaking the cost of the asset less its salvage value and dividing this by the usefullife of the asset. The depreciation charge and book value of the asset over timeare shown graphically in Exhibit 5.3.

Time

Depreciation Charge

Time

Book Value

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Using the above example and assuming the asset has a useful life of ten yearsthen the depreciation charge for each year would be $45,000, from:

500,000 - 50,000

10

This method is frequently used for buildings and the amortisation of patents,copyrights etc. (Note that the writing off of patents and copyrights is not strictlydepreciation).

3. Units of Use (Depletion) Method

This method is used where it is considered that an asset loses value mainly dueto use (or depletion in the case of an asset, such as a mine). This is illustrated byan example:

Asset Cost $500,000Salvage Value $50,000Estimated life capacity 2,500 shiftsNumber of shifts in a year 500

Depreciation for year = 500,000 - 50,000 x 500 1 2,500

= $90,000

This method does not take account of obsolescence. If an asset is not used at allduring a particular period, then under this method no depreciation will bewritten off. However, if the asset was not used at all then perhaps an evenhigher depreciation charge should be made to account for the fact that the assetis no longer of the same service potential to the firm as previously thought.

WhatDeterminesthe BestMethod?

In selecting the depreciation method bear in mind the following:

1. The method chosen should take into account those factors which cause assets tolose value over time.

2. In some cases taxation may influence the depreciation method. It should bemade clear, however, that the depreciation methods and practices which aredesirable from a taxation point of view will not normally be the same as thosethat are desirable from an accounting point of view.

3. The recommendation of professional accounting bodies. In most professionalrecommendations the preferred method is generally the Straight Line Method.

It is the authors’ view that if the financial accounts are to be used for managementpurposes (which in small business situations is frequently the case) then the methodthat is used should be the one that most closely reflects economic reality.

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AccountingEntries

The entries to record depreciation irrespective of the method are:

Year 31 March Dr Depreciation - Plant xxxxx

Cr Provision for Depreciation - Plant xxxxx

The first line is the depreciation charge for the current accounting period which willappear in the firm’s Income Statement for the period. The credit to the Provisionfor Depreciation account will be added to the accumulated depreciation for thatparticular class of asset and will be deducted from the asset in the Balance Sheet.Provision for Depreciation is also referred to as a ‘contra asset’, since it has a creditbalance and is deducted from the asset.

Accounting for AdjustmentsThe life of all businesses is divided into separate accounting periods, usually oneyear. At balance date it is necessary to make adjusting entries in order to ensurethat the firm has all the revenue and expenses in its accounting records which relatesto the period. This is referred to as matching, whereby expenses are matched withthe period in which the related income is earned. In most businesses you will findthat the receipts and payments for the period under review do not coincide preciselywith the revenue and expenses earned or incurred for the period. For example:

• expenses may have been incurred but not yet paid for,• expenses may have been incurred in this period which relate partly to the

next accounting period,• revenue may have been earned in this accounting period but not yet

received,• revenue may have been recorded in this accounting period but not yet

earned. If the above examples are not taken into account by a business, then it would seemthat the business is using a cash basis method of profit measurement. Under thecash basis method of accounting:

• revenues are recorded in the period in which cash is received, and,• expenses are recorded in the period in which cash is paid.

In this system, Net Profit is the excess of cash inflows (revenues) over cashoutflows (expenses).

However, the accrual basis method of accounting for measurement of net profit isrecommended under GAAP (generally accepted accounting principles). Under theaccrual basis, revenue is recognised in the period in which the inflow of economicbenefits can be reliably measured and is recognised normally in the business inwhich there is a contractual arrangement whereby the business has sold goods orperformed services. Expenses are recognised when the costs of operating abusiness are capable of reliable measurement. Costs are normally recognised whenincurred in that particular accounting period. In this system, Net Profit isdetermined by subtracting expenses incurred from revenues earned for theparticular period.

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Therefore, it is necessary at balance date to incorporate adjustments for thesedifferences in order to ensure a proper matching of cost and revenue. Eachadjusting entry will affect both an Income Statement item as well as a Balance Sheetitem. Thus, the adjustment will affect both the profit for a period and the financialposition at balance date.

Some commonly found adjusting entries include:

1. Expenses AccruedIt is normal for a firm to incur expenses during the period which have not beenpaid at balance date; for example, a power account relating to the last months ofthe accounting period will not be paid until the next accounting period. Theeffect of this difference in timing is that the particular expense account and theBalance Sheet item for liabilities is understated. This is illustrated in thefollowing example.

At balance date 31 March power expense of $2,000 has been incurred but notyet paid. The adjusting entry at 31 March is:

31 March Dr Power 2,000Cr Accounts Payable 2,000

2. PrepaymentsThese are expenses that have been paid for in this current accounting period butwhich relate, at least in part, to the next accounting period, for example,insurance or rates. The effect of this is that there exists an asset which is notrecorded in the financial statements at balance date and the expense account isoverstated for the period. Illustrating this:

A firm has paid rates of $12,000 covering the year to 31 December 19A9. Atbalance date, 31 March 19A9, it is necessary to adjust for the expense which isprepaid. The adjusting entry at 31 March 19A9 is:

31 March Dr Expenses Prepaid 9,000Cr Rates 9,000

3. Accrued RevenueAt balance date a firm has earned revenue that has not yet been received. It istherefore necessary to incorporate the income which is due at balance date intothe financial records of the firm and to record the revenue due in the IncomeStatement. For example:

A landlord is owed rent of $2,500 at balance date. The adjusting entry wouldbe:

31 March Dr A/c Receivable - Rent 2,500Cr Rent Revenue 2,500

4. Revenue Received in AdvanceIt is possible that at balance date a firm will have received revenue which relatesto the next accounting period. Therefore, at balance date the Income Statement

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would be overstated and liabilities in the Balance Sheet understated. Using anexample to illustrate:

An advertising agency received $3,000 in advance for the next months work. The adjusting entry would be:

31 March Dr Advertising Revenue 3,000Cr Revenue Rec’d in Advance 3,000

Income StatementsIn order to arrive at the net profit or loss of a business for a period it is necessary totransfer all items of revenue and expense for the period to an Income Statement.The traditional approach to this process is by way of a closing entry to a tradingaccount and profit and loss account in the firm’s ledger (refer to preceding chapter).The balance in the Income Statement is the net profit or loss for the period and it isthis amount which is transferred to proprietorship in the Balance Sheet. In practiceit is normal to present an Income Statement in vertical form as shown in Exhibit 5.4.

It is desirable that income and expense items are classified in the Income Statementin a manner which is appropriate and helpful to users. It is also desirable thatnon-operating revenue and expenses are kept distinctly separate from operatingrevenue and expenses. Operating expense classifications typically includeadministration, maintenance and selling. Financial charges and depreciation are notgenerally considered as operating expenses. The use of appropriate classificationsof groups of items should provide the reader/user with a more meaningful andunderstandable report, remembering that the purpose of financial reporting iscommunication.

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Exhibit 5.4Mark Wilkinson

Income Statementfor year ended 31 December 19X9

Sales 8,357,200Less: Returns 6,700

Net Sales 8,350,500

Less: Cost of Goods SoldInventory 1.1.X9 815,000Purchases 7,238,200Less: Returns 40,300 7,197,900

8,012,900Less: Closing Inventory 964,500

7,048,400Gross Profit from Trading 1,302,100

Less: ExpensesOccupancy CostsInsurance buildings 20,300Rates 11,200Lighting & heating 10,200Depreciation on premises 10,000

51,700

Selling & Distribution CostsAdvertising 13,800Depreciation - motor vehicle 30,000Bad debts 24,000

67,800Administration & General Costs

Telephone 4,500Salaries & Wages 278,200Postage 14,900Depreciation - furniture 11,100

308,700Financial Costs

Bank Charges 650Interest 21,000

21,650Loss on Sale - Motor Vehicle 10,000

Total Expenses 459,850NET PROFIT $842,250

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ManufacturingStatements

The previous exhibit illustrates an Income Statement of a retailing or wholesalingoperation where goods are purchased and then resold in the same form. Withmanufacturing businesses, it is necessary to prepare an additional financialstatement covering manufacturing operations for the period. This statement dealswith manufacturing units dealt with under the headings of Direct Materials, DirectLabour, Factory Overheads, as well as Work In Process at the beginning and end ofthe period. By bringing together production costs the Manufacturing Statementsummarises a number of items that would otherwise make the Income Statementcomplicated and excessively long. Thus, the Manufacturing Statement allows for amore simplified and meaningful Income Statement. A manufacturing statement isshown in Exhibit 5.5.

Exhibit 5.5 Progressive Manufacturing LimitedManufacturing Statement

for year ended 31 December 19X1

Opening Work in Process 49,000Direct Materials:Opening Inventory 67,000Purchases 480,000

547,000Less: Closing Inventory 70,000Direct Materials Used 477,000Direct Labour 820,000Factory Overheads:

Indirect Labour 95,000Electricity 58,500Rent 72,000Insurance 7,500Depreciation 42,000Total Factory Overheads 275,000

Total Manufacturing Costs 1,621,000Closing Work in Process 61,000Cost of Goods Manufactured $1,560,000 The cost of goods manufactured appears in the trading section of a firm’s IncomeStatement and is shown below using the same example.

Progressive Manufacturing LimitedIncome Statement

for year ended 31 December 19X1

Revenue 2,850,000Less: Cost of Goods SoldOpening Finished Inventory 120,000Cost of Goods Manufactured 1,560,000

1,680,000Less: Closing Finished Inventory 150,000

1,530,000GROSS PROFIT 1,320,000Less: Expenses etc.

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An additional Manufacturing Statement is presented in Appendix 5.1 although itshould be noted that the overall format and classification of items remain the sameas in the example above.

Balance SheetsThe balances which remain in a firm’s financial records after the Income Statementhas been prepared will be the assets, liabilities and proprietorship of the firm. It isfrom these balances that the Balance Sheet (or Statement of Financial Position) isprepared. It is important to stress that the Balance Sheet is not a statement of assetvaluation. Rather, it shows the assets of the business at their cost less depreciationto date. A Balance Sheet in vertical form and in the more traditional ‘two sided’form is shown in Exhibits 5.6 and 5.7.

Exhibit 5.6 Vertical Form Balance Sheet

Mark WilkinsonBalance Sheet

as at 31 December 19X9

Proprietorship:Capital 801,650Plus: Net Profit 842,250

1,643,900Less: Drawings 100,000

1,543,900

Represented by:Current Assets

Bank 416,600Inventory 964,500A/c Receivable 469,500

1,850,600Term Assets

Premises 610,000Motor Vehicles 153,700

763,700Total Assets 2,614,300

Less:Current Liabilities

A/c Payable 960,400Term Liabilities

Bank Loan 110,000Total Liabilities 1,070,400

$1,543,900

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Exhibit 5.7 Two Sided Form Balance Sheet

Mark WilkinsonBalance Sheet

as at 31 December 19A9

Current Assets ProprietorshipBank 416,600 Capital 801,650Inventory 964,500 plus Net Profit 842,250A/c Receivable 469,500 1,643,900

less Drawings 100,0001,850,600 1,543,900

Fixed Assets Current LiabilitiesPremises 610,000 A/c Payable 957,000Motor Vehicles 153,700 Exp. Accrued 3,400

763,700 960,400Term Liabilities Bank Loan 110,000

$2,614,300 $2,614,300

Statement of Changes in Financial Position (or Funds Statement)The other important financial statement which is commonly included in the set offinancial statements for a firm is a Statement of Changes in Financial Position. ThisFunds Statement explains the difference between two Balance Sheets and shows thefunds which have flowed into the business during the period and the uses to whichthese funds have been put.

FundsStatementObjective

The Funds Statement helps users understand the financial position of anundertaking and how changes in that financial position took place. In particular, itserves the following purposes:

- to indicate the method(s) and source(s) of funding for the business; - to reconcile profits and liquidity within the business; and

- to highlight the extent to which profits have been retained within thebusiness and where these have been invested.

Definition ofFunds

Three different concepts of funds are found in connection with Funds Statements.

1. CashThe Statement of Cash Flows is essentially a summary of cash receipts and cashpayments for the period. This view of funds is recommended by the NewZealand Society of Accountants.

Cash is defined as cash, and cash equivalents that are readily convertible intocash. Examples include cash, bank overdraft, commercial bills, and demanddeposits that an entity uses in its day to day operations.

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The general format of a Cash Flow Statement is as follows.

XYZ Co LtdStatement of Cash Flows

for the Year Ended 31 March 19XX

Cash Flows from Operating ActivitiesCash was provided from:

Cash was disbursed to:

Net Cash Flows from Operating Activities

Cash Flows from Investing ActivitiesCash was provided from:

Cash was applied to:

Net Cash Flows from Investing Activities

Net Cash Flows from Financing ActivitiesNet Increase (Decrease) in cashOpening Bank and DepositsClosing Bank and Deposits

An alternative presentation for cash flow statements is made in the ICANZ FRS-2 (Financial Reporting Standard Number 2)

Cash flows from operating activities

Cash flows from investing activities

Cash flows from financing activities

2. Working CapitalThe Statement of Changes in Financial Position emphasises how they havecontributed to a change in the working capital position of the firm at balancedate.

3. Total ResourcesThe Statement of Changes in Financial Position shows in summary formchanges in all assets, liabilities and proprietorship during the period.

The following steps are followed to produce a Statement of Cash Flows. Due to thecomplexity of the calculation an example of the Statement is provided fordiscussion, but you are not required to create a Statement.

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Step 1: Determine the cash inflows provided from the operating activities.

Step 2: Determine the cash outflows disbursed in the direct generation ofoperating activities.

Step 3: Determine the net cash flows from operating activities.

Step 4: Determine the cash flows provided from investing activities.

Step 5: Determine the cash flows applied to investing activities.

Step 6: Determine the net cash flows from investing activities.

Step 7: Determine the net cash flows from financing activities.

Example of Statement of Cash Flows:

Cash Flow CoStatement of Cash Flows

for the twelve months ended 31 March 1993

Cash Flows from Operating ActivitiesCash Receipts from Sales 549,000Cash Payments for Purchases and Operating Supplies 500,000

Net Cash Flow from Operating Activities 49,000

Cash Flows from Investing ActivitiesCash was provided from:Proceeds of Equipment Sale 50,000

Cash was applied to:Plant Asset Purchases (335,000)

Net Cash used in Investing Activities (285,000)

Cash Flows from Financing ActivitiesCash was provided from:New Debenture Issue 80,000Share Issue 187,000

Net Cash provided from Financing Activities 267,000

Net Increase in Cash held 31,000Add: Opening Balance (10,000)Ending Cash Balance $ 21,000

SummaryThis chapter concludes the coverage on the preparation and presentation offinancial statements and completes the discussion of reporting financial resultswhich started with preparing financial statements from initial transactions, journal

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entries, ‘T’ accounts and the ledger. The issues of depreciation and adjusting entriesare discussed. The drawing up of an Income Statement and Balance Sheet for abusiness illustrated the manner in which the financial reporting system works, fromcapturing transactions, manipulating them, to the presentation of the data for users.The treatment of this topic has of necessity ‘glossed over’ some technical and detailelements, but if you have followed and understood the material you will have asound idea of how the financial bookkeeping system works. The accuracy of theinitial capture and analysis of information is critical since all further manipulationsare based on these primary entries and thus the accuracy of management and futuredecisions are dependent on them. It is for this reason that a sound workingknowledge of the accounting system and the ways in which it can be manipulated isessential for anyone involved in business decision making.

Glossary ofKey Terms

DepreciationThe spreading of the cost of an asset for accounting purposes.

Income StatementA summary of revenue and expenses for an accounting entity for a given period.

Balance SheetThe listing of assets, liabilities, and equity for a company at a point in time.

Funds StatementAn analysis of funds flows over a given period of time.

Statement of Cash FlowsAn analysis of the sources and uses of cash over a given period of time.

SelectedReadings

American Institute of Certified Public Accountants, Committee on AccountingProcedures, ‘Revision and Restatement of Accounting Research Bulletins’,Accounting Research Bulletin, No. 43, AICPA, 1953.

Glautier, M.W.E. & Underdown, B., Accounting Theory and Practice, Pitman, 2ndEdition, 1982.

Martin, C., An Introduction to Accounting, McGraw Hill, Sydney, 1984.

Popoff, B., Accounting Essentials, Butterworths, Australia, 1991.

Renwick, W.M., The Accounting Equation, Butterworths, Australia, 1991.

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Questions

5.1What is the purpose of the Income Statement?

5.2What are ‘operating expenses’ and what are the difficulties in determining which costs constituteoperating expenses?

5.3Define ‘net profit’.

5.4Which of the following would you expect to find under the ‘Finance’ classification of an IncomeStatement?a. Interest on debtb. Loans made to the proprietor and drawingsc. Interest on debt onlyd. Drawings onlye. Interest paid to partners on their current accounts and interest on debt

5.5From the Trial Balance given below, draw up an Income Statement and Balance Sheet, withappropriate classifications.

Trial Balanceas at 31.3.19X8

Dr $ Cr $Purchases 200,000 Sales 530,000Cash 13,000 Creditors 24,500Advertising 17,000 Long term debt 80,000Freight inward 15,000 Equity 254,400Freight outward 8,000Stationery, phone & power 2,600Plant & equipment 360,000Rent 18,500Salaries 60,000Interest 16,000Audit fees 800Inventory at 1.4.X7 160,000Debtors 18,000

$888,900 $888,900

Additional Information:- inventory at 31.3.X8 is $170,000- depreciation allowable on Plant & Equipment, 10% per annum straightline.

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5.6The assets and liabilities of Bob’s Biscuit Barn at March 31 are listed below. Arrange them in verticalBalance Sheet form, and determine the owner’s (Bob Brown) equity figure.

Accounts payable 3,000Accounts receivable 2,100Bank overdraft 900Petty cash on hand 50Premises 23,000Rates payable 300Mortgage 14,000Plant and equipment 5,000Inventory 3,200Insurance paid in advance 140Accumulated depreciation on premises 2,300

5.7From the Trial Balance for Horace Hardware presented below, draw up an Income Statement andBalance Sheet for the firm as at 31 March (note: the firm’s profits are taxed at 45%).

Horace HardwareTrial Balance

as at 31 MarchDr Cr

Cash at bank 450Accounts receivable 840Accounts payable 1,250Cost of goods sold 17,400Inventory 6,000Sales 36,300Wages paid to employee 8,000Advertising 310Land & buildings 24,000Plant & equipment 8,200Power & phone 910Rates 400Interest expense 840Mortgage 7,600Accumulated depreciation on plant and equipment 600Depreciation expense on plant & equipment 200Horace Hill - Capital 23,200

- Drawings 1,400 $68,950 $68,950

5.8What is the function of the Balance Sheet?

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5.9Ma’s Chocolate Cave has the following balances at the end of the accounting period:

Expenses for the year $140,000Revenue for the year $185,000Total assets $370,000Total liabilities $243,000

What is the owner’s equity?a. $82,000b. $127,000c. $172,000d. $312,000e. ($82,000)

5.10Information available for Dave’s Diner at 31 December is given below. From this prepare the firm’sIncome Statement and Balance Sheet (note: the firm pays income tax of 45%).

Cash on hand 420Bank overdraft 1,200Accounts receivable 70Accounts payable 1,340Inventory 2,800Cost of goods sold 29,000Equipment 17,600Rent 1,000Sundry expenses 3,000Wages 6,000Sales 47,000Dave Dodge - Capital ?

5.11What is the purpose of a Statement of Cash Flows?

5.12Explain how the following transactions would be reported in the Statement of Cash Flows for the yearended 31 March 19X6.a. Equipment was purchased for $100,000 on 30 November 19X5 and is to be depreciated at 20%

per annum straight line.b. The owner contributed $3,000 in cash and an $18,000 car which was previously used by the

owner as a private vehicle.c. The building, purchased on 30 March 19W8 for $90,000 and depreciated on a straight line basis

at 10% per annum, was sold for $25,000 on 30 March 19X6.d. The bank overdraft was increased by $12,000.e. A term loan of $30,000 was taken out.

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5.13 (difficult)Henderson Company Ltd had the following Balance Sheet:

Henderson Company LtdBalance Sheet

as at 31 March 19X5

Cash 75,000 Accounts payable 35,000Accounts receivable 26,000 Accruals 20,000Inventory 31,000 Bank overdraft 30,000Total current assets 132,000 Total current liabilities 85,000Fixed assets 190,000 Term loan 150,000less acc. depreciation (30,000) Shareholders’ funds 224,000Land 75,000Investments 92,000

$459,000 $459,000

The following transactions occurred during 19X6:1. The company purchased a block of land for $30,000.2. The company sold investments for $53,000 representing a gain on sale of $3,000.3. $20,000 was paid in dividends to shareholders.4. The bank overdraft was repaid.5. Bonds were issued to the value of $50,000 - $30,000 was used to repay part of the term loan

and $20,000 to finance an expansion in inventory.6. An additional $30,000 of ordinary shares were issued at par value.7. Net income for 19X6 was $26,000 after allowing for depreciation of $22,500.

Required:Prepare the Balance Sheet as at 31 March 19X6.

5.14Explain the basic differences between the inventories of a manufacturing firm and those of a retailfirm. What effect do these differences have on the Income Statement of the two types of businesses?

5.15Apparel Ltd incurred the following manufacturing costs during the year:

Direct Materials $280,000Direct Labour $700,000Factory Overheads $420,000

Required:a. Assume that the company had no work in process inventory at the beginning or end of the year.

How much was the firm’s cost of goods manufactured?b. Assume that the company had a work in process inventory of $40,000 at the beginning of the year

but none at the end of the year. How much was the firm’s cost of goods manufactured?c. Assume that the company had a work in process inventory of $40,000 at the beginning of the year

and $80,000 at the end of the year. How much was the firm’s cost of goods manufactured?

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5.16The following details are taken from the completed worksheet of Wilson Manufacturing CompanyLtd:

Advertising 84,000Bad Debt Expense 22,000Depreciation - Factory Machinery 30,000Depreciation - Office Equipment 12,000Direct Labour 506,000Factory Light and Power 21,400Factory Rent 156,000Factory Supplies 100,000Finished Goods, 1/7/X0 184,000Finished Goods, 30/6/X1 170,000Freight Inwards 16,000Indirect Labour 108,000Machinery Repairs 24,000Office Rent 42,000Officer’s Salaries 308,000Rates - Factory 12,000Rates - Administration 26,000Discount Received 24,000Raw Materials Inventory, 1/7/X0 88,000Raw Materials Inventory, 30/6/X1 106,000Raw Materials Purchases 900,000Sales 2,502,000Sales Returns 44,000Sales Commissions 80,000Work in Process, 1/7/X0 34,000Work in Process, 30/6/X1 42,000

Required:Prepare an Income Statement and a Manufacturing Statement for the year ended 30 June 19X1.

5.17The following costs were incurred by Parklands Ltd in its manufacturing activities during 19X4:

Factory insurance 40,000Direct labour 240,000Raw material purchases 306,000Factory light & power 86,000Repairs to factory equipment 34,000Indirect labour 108,000Factory supplies 68,000

The beginning and ending inventory values were:

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Beginning inventory Ending inventoryRaw materials 54,000 48,000Work in process 82,000 90,000Finished goods 66,000 62,000

Required:Prepare a Manufacturing Statement for the year ending 31 December 19X4.

5.18The Armchair Furniture Company Ltd has compiled the following details for the preparation of itsannual financial statements:

Work in Process, 1/1/X4 54,000Raw Materials, 1/1/X4 70,000Finished Goods, 1/1/X4 150,000Indirect Labour 134,000Sales Commissions 375,280Sales 2,254,000Raw Material Purchases 720,000Freight Inwards 30,000Discount Received 14,000Factory Rent 34,400Advertising 50,000Finished Goods, 31/12/X4 124,000Sales Returns 32,000Factory Supplies 69,000Depreciation - Office Equipment 99,000Raw Materials, 31/12/X4 78,000Direct Labour 394,000Factory Light & Power 27,400Officer’s Salaries 304,400Work in Process, 31/12/X4 63,200Factory Insurance 18,200Depreciation - Factory Equipment 32,200

Required:Prepare an Income Statement and a Manufacturing Statement for the year ending 31 December 19X4.

5.19Supercorp had the following transactions during May 19X0. Record the Journal entries, post these to‘T’ accounts, complete a Trial Balance and prepare an Income Statement and Balance Sheet (includedescription of items).

May1. Paid savings to business account at trading bank 15,0002. Purchased plant and equipment for cash 5,0005. Purchased inventory on credit from A. Supplier 6,0006. Cash sales (cost price $1,200) 3,000

10. Sold goods costing $1,600 on credit to B. Customer 3,800

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10. Paid shop wages 80014. Received cash from B. Customer on account 1,50016. Paid personal life insurance with bank cheque 70021. Cash sales (cost price $800) 1,40022. Discount allowed to customer 20027. Purchased inventory with cash 3,10027. Received discount from supplier 60028. Paid A. Supplier on account 4,00030. Paid shop rent 2,000

Balance day adjustments to be made:- Depreciate plant and equipment 20% straight line- Rent prepaid of $500- Wages owing at balance date of $400

5.20The following data relate to an engineering machine:

Purchase price $29,500Estimated years of life 8Estimated scrap value at end of life $1,700Installation cost $500Estimated cost of dismantling at end of period $300Estimated cost of routine maintenance per year $200Estimated operating hours during life 60,000

Required:a. Calculate the annual depreciation charge by straight line.b. Calculate the depreciation charge by the units of use method for a year in which the operating

hours are 11,000.

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Appendix 5.1An Example of a Detailed Manufacturing Statement

Opening Work in Process 105,000

Direct MaterialsOpening Inventory 120,000Purchases 300,000

420,000Less: Closing Inventory 115,000

Direct Materials Used 305,000Direct Labour 390,000Factory Overheads

Indirect Labour 90,000Heating, Light & Power 30,000Factory Repairs 33,000Insurance of Plant 4,000Factory Supplies 4,000Miscellaneous Factory Costs 2,000Depreciation of Equipment 90,000Depreciation of Buildings 10,000

Total Factory Overhead 263,000Total Work in Process 1,063,000Less: Closing Work in Process 140,000Cost of Goods Manufactured $ 923,000

The cost of goods manufactured will be transferred to the Income Statement and treated like‘purchases’ in a retailing operation. For example:

Sales 2,000,000Less: Cost of Goods Sold

Opening Finished Goods Inventory 80,000Cost of Manufactured Goods 923,000

1,003,000Less: Closing Finished Goods Inventory 87,000

Total Cost of Goods Sold 916,000GROSS PROFIT 1,084,000

Less: Expenses etc.

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5 REPORTING FINANCIAL RESULTS - University of Waikato · “Depreciation accounting is a system of...

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