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Engineering ManagementEngineering ManagementAccounting – Lecture 8Accounting – Lecture 8
Revision(1)Revision(1)
ELE 22EMTELE 22EMT
George [email protected]://www.latrobe.edu.au/eemanage/
15 October, 2004
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Accounting for Engineers - becauseAccounting for Engineers - because
• Engineers invariably operate in a managed business environment.
• Accounting provides a means of measuring the viability and performance of organisations.
• Accounting is closely linked to Engineering Economics in that it provides many of the analytical tools and data required for analysis.
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So what is accounting?So what is accounting?
• “The process of identifying, measuring and communicating economic information to permit informed judgement and decisions by users of the information.”
Bazley et al
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Financial AccountingFinancial Accounting
“That part of an accounting system that tries to meet the needs of various external users”.
Bazley et al
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Management AccountingManagement Accounting
“That part of an accounting system that tries to meet the needs of management and internal users”.
Bazley et al
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TopicsTopics
• Financial Accounting– Profit and Loss Statement– Balance Sheet – Cash Flows
• Capital assets/depreciation• Management Accounting
– Budget Process– Organisation Structure– Product Cost Calculation
• Business Ratios
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TransformationProcess
InputsOutputs
Resources:HumanMaterialsEquipmentFinancialInformation
managerial:PlanningOrganisationLeadingControllingTechnology
Outcomes:Products & servicesProfit & lossemployees growth & satisfaction
Bartol – Management: A Pacific Rim Focus, McGraw-Hill, 2001
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The Firm –a simple modelThe Firm –a simple model
The Firm
Owners
Lenders
Client
Suppliers
Government
Reserves
Capital
Profit
Dividends
Revenue
Goods/Services Goods/Services
Expenditure
Tax
Infrastructure
Loans
Interest
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Balance SheetBalance Sheet(Statement of Financial Position)(Statement of Financial Position)
• Records the financial position of the organisation at a given point in time.
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Telstra Balance SheetTelstra Balance Sheet
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Profit and Loss StatementProfit and Loss Statement(Statement of Financial Performance)(Statement of Financial Performance)
Reports receipts and expenditure over the period in question – the accounting period.
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Telstra Profit and Loss StatementTelstra Profit and Loss Statement
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Cash Flow StatementCash Flow Statement
Is an indicator of the organisation’s ability to survive in the short term
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Telstra Cash Flow StatementTelstra Cash Flow Statement
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Money Flows - INMoney Flows - IN
• Equity capital (Owners)
• Debt capital (Lenders)
• Revenue from sales (Customers)
• Interest on reserves (Financial Institutions)
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Money Flows - OUTMoney Flows - OUT
• Dividends (Owners)
• Repayments/Interest (Lenders)
• Purchases of assets (Suppliers)
• General expenditure (Suppliers/employees)
• Taxes/charges (Government)
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Definition of Assets Definition of Assets (Bazley)(Bazley)
• Assets – “Future economic benefits controlled by the entity as a result of past transactions or other past events”
• Fixed assets – “… held for the purpose of generating income over a number of years.”
• Current assets – “… cash or cash-equivalent, expected to be realised within 12 months of the reporting date”.
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Types of AssetsTypes of Assets• Fixed Assets
– Buildings
– Plant
– Equipment
• Current Assets– Stock (inventory)
– Cash on hand
– Accounts receivable
– Short-term investments
• Intangible assets e.g. patents, goodwill
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Other ExpenditureOther Expenditure• Salaries and wages• Rent and other building-related expenses• Insurance• Taxes and charges • Marketing and advertising• Communications• Motor vehicles and travelling• Entertainment
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LiabilitiesLiabilities
What the firm owes as a result of past borrowings or expenditure –
• Current– Short-term borrowings e.g. overdraft– Accounts payable– Taxes
• Non-current– Long term borrowings
• Other future commitments
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Owners Equity/Net WorthOwners Equity/Net Worth= =
Assets - LiabilitiesAssets - Liabilities
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Relationship – Balance Sheet/ P&L statementRelationship – Balance Sheet/ P&L statement
Balance Sheet (Beg)
+
Revenue/Expenditure/Depreciation
during accounting period
=
Balance Sheet (End)
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Why capitalise/depreciate?Why capitalise/depreciate?
• Capital assets have an estimated useful lifetime.• Consequently, it would be misleading to account
for the associated expenditure in just one accounting period.
• As a result, the expenditure is accounted for over the asset’s lifetime through depreciation.
• This also provides a basis for valuing the asset.• ATO requires that the asset expense deduction is
claimed over the asset’s lifetime.
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Depreciation - an introductionDepreciation - an introduction• Capital investment in tangible assets -
equipment, computers, vehicles, buildings, and machinery - are commonly recovered through depreciation.
• Depreciation also referred to as capital recovery (US) and capital allowance (ATO)
• Visit www.ato.gov.au - search for depreciation.
• The depreciation amount itself is not an actual cash flow.
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Introduction - cont.Introduction - cont.
• The process of depreciating an asset accounts for the decrease in an asset’s value because of age, wear, and obsolescence.
• Depreciation is a tax-allowed deduction included in tax calculations.
Taxes = (income - deductions)(tax rate)
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Book DepreciationBook Depreciation
• Used for internal managerial decision making.• Management is free to use any method they so
choose to compute book depreciation amounts.• Any method can be used:
– Straight Line,– Declining Balance;– Sum-of-the-years digits;– Other.
• Defines the reduced investment in an asset based upon usage pattern and an assumed life.
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Tax DepreciationTax Depreciation
• Must follow the current state and federal law pertaining to acceptable methods for computing depreciation for income tax purposes.
• It may have nothing to do with the actual life of the asset or the usage pattern.
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Different Depreciation MethodsDifferent Depreciation Methods
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Straight Line DepreciationStraight Line Depreciation
• The book value decreases linearly with time.
• The depreciation rate, d = 1/n, is the same each year of recovery period n.
• It is considered the standard against which any depreciation model is compared.
• The annual SL depreciation is determined by:
(first cost - salvage value) d
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ExampleExample
B = $50,000;B = $50,000;
““n” = 5 years;n” = 5 years;
S = $10,000 at t = 5;S = $10,000 at t = 5;
DDtt for each year is: for each year is:
($50,000 - $10,000)/5 = $8,000/year($50,000 - $10,000)/5 = $8,000/year
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10,0008,0005
18,0008,0004
26,0008,0003
34,0008,0002
$42,000$8,0001
BVtDtt
Table of ResultsTable of Results
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Plot of SL Book ValuePlot of SL Book Value
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Accelerated DepreciationAccelerated Depreciation
• SL book values decline in a linear fashion down to a specified salvage value.
• Declining Balance (DB) method allows the book value to accelerate faster.
• The SL method writes off the asset in equal amounts over the recovery period.
• The DB method permits greater depreciation amounts in the early years, and hence reduces the book value faster than the SL method.
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Accelerated Depreciation - cont.Accelerated Depreciation - cont.
• More depreciation in the early years means more tax savings sooner.
• Assumes a profitable firm.• Tax savings early in the life of an asset has a
greater present value than tax savings out in time.
• Larger depreciation amounts early on result in increased present worth of future tax savings to the firm.
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What it means for the firm ?What it means for the firm ?
• If the firm is profitable, then more depreciation amounts in the early years means:– Lower tax liability;– Pay less taxes – more $$ available for
reinvestment!– The firm can retain more after-tax funds if the
depreciation is accelerated in the early years of an assets’ life.
– Thus, more depreciation $$ early on are better!
36
Refer ATO web siteRefer ATO web site
• Refer description/examples on link below
• http://www.ato.gov.au/individuals/content.asp?doc=/content/42787.htm&page=8#H23
• Note ATO terminology –– DB =‘Diminishing Value’– SL = ‘Prime Cost Method’
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Thanks for your attention Thanks for your attention