BAO6504

Accounting for Management

Lecture 3

Assets, Liabilities and Equity

Reference: Chapters 4,8, 9 and 10

Current Assets

Inventory
Cash
Accounts Receivables
Notes Receivables

CLASSIFYING INVENTORY

In a manufacturing business, inventories are

usually classified into three categories:

Raw materials: materials that will be used but

have not yet been placed in the production
process

Work in process: manufactured inventory that has

been started but not yet completed in the
production process

Finished goods: completed manufactured items

that are ready for sale
3

Cash

Cash is the most desirable asset

because it is readily convertible
into any other asset
Cash consists of

Cash on hand (notes and coins)

Cash at bank
Cheque accounts

Managing and monitoring

cash
Operating cycle of a retail business

Accounts Receivable

Accounts receivable are amounts

owed by customers on account
3 accounting problems associated
with accounts receivable are:

Recognising accounts receivable

Valuing accounts receivable
Accelerating cash receipts from
receivables
6

Accounting for receivables

continued
Ageing of Accounts Receivable

Managing receivables
1.

2.
3.
4.
5.

Determine to whom to extend

credit
Establish a payment period
Monitor collections
Evaluate the receivables balance
Accelerate cash receipts from
receivables when necessary
8

RECEIVABLES

Notes receivable are claims for

which formal instruments of credit
are issued evidencing the debt
Other receivables include nontrade receivables such as interest
receivable, loans, advances and
GST receivable
9

Accounting for receivables

continued

Notes receivable
A note receivable is a formal credit
instrument
It does not always arise from
transactions with customers
It is included as an asset in the
financial statements
10

Non-current Assets

Property, Plant and Equipment

Intangible assets

11

PROPERTY, PLANT AND

EQUIPMENT

Property, plant and equipment (PPE) are

physical assets used in the business to
provide future economic benefits for a
number of years

According to AASB 116, economic benefits

derived from the use of an asset must be
recognised on a systematic basis over the
assets useful life

This decline is recognised as depreciation

expense in the income statement

12

PROPERTY, PLANT AND

EQUIPMENT continued
Two classes of PPE assets:
Property

Includes land and buildings

Plant and equipment

Includes cash registers, computers,

office furniture, factory machinery,
motor vehicles
13

Determining the cost of

PPE continued

The cost of an asset

Consists of the fair value of all
expenditure necessary to acquire
the asset and make it ready for
use
e.g. For property, Cost of land includes
purchase price, settlement costs (e.g.
solicitors fees), stamp duty, property taxes
assumed by purchaser
e.g. For equipment, cost includes purchase
price, freight costs paid, installation costs

14

Depreciation

Depreciation is the process of allocating to

expense the cost of a PPE asset over its useful
(service) life in a rational and systematic
manner

Carrying amount equals cost less accumulated

depreciation

15

Depreciation

continued

Factors in calculating depreciation

Cost

Useful life

All expenditures necessary to acquire the asset and

make it ready for intended use
Estimate of the expected life based on intended use,
need for repair, vulnerability to obsolescence and legal
life

Residual value

Estimate of the assets value at the end of its useful life

16

Depreciation

continued

Depreciation methods
Straight line
Reducing balance
Units of production
Example
Delivery truck purchased by Bills Pizzas

Cost
$13 000
Expected residual value
$ 1 000
Estimated useful life (in years)
5
Estimated useful life (in kms)
100 000
17

Depreciation

continued

1. Straight-line method
Depreciation expense same each year as benefits are
consumed at same rate each year
Calculation for annual charge:
cost of asset residual value
useful life of the asset
Bills Pizzas example:

Annual depreciation
($13 000 - $1 000) / 5 = $2 400

18

Depreciation

continued

Straight-line depreciation schedule

BILLS PIZZAS
Calculation
End of year
Depreciable Depreciation Depreciation Accumulated Carrying
Year
amount
x
rate
= expense p.a. depreciation
amount
2010
$12 000
20%
$ 2 400
$ 2 400
$10 600 *
2011
12 000
20
2 400
4 800
8 200
2012
12 000
20
2 400
7 200
5 800
2013
12 000
20
2 400
9 600
3 400
2014
12 000
20
2 400
12 000
1 000
Total $12 000
19
* Cost $13 000 Year 1 depreciation $2400 = Carrying amount $10 600

INTANGIBLE ASSETS

Intangible assets: non-monetary

assets that have no physical
substance
1.
2.
3.
4.
5.
6.

Patents
Research and development costs
Copyright
Trademarks and brand names
Franchises and licences
Goodwill

20

Accounting for intangible

assets continued
Amortisation
This is the term used to describe
the allocation of the cost of an
intangible asset to expense
Intangible assets are assumed to
have a limited life and are
amortised
Patents are amortised over legal or
useful life, whichever is shorter 21

Accounting for intangible

assets continued

Example

Patent costs $60 000 and has an estimated

useful life of 8 years

Annual amortisation expense

$60 000 8 = $7500

22

Current and Non-current

Liabilities
CURRENT LIABILITIES

A current liability is an obligation that can

reasonably be expected to be paid within one
year or within the operating cycle, whichever is
the longer.

Examples of current liabilities include:

notes payable

accounts payable

revenue received in advance

23

Notes Payable

Notes payable record obligations in

the form of written notes
Usually require borrower to pay
interest or borrowing costs
Frequently issued to meet shortterm financing needs
Issued for varying periods of time
24

Payroll and payroll

deductions payable

Employers deduct amounts from employees wages

and salaries if they are required to be paid to other
parties

These include deductions for:

Tax (pay-as-you-go or PAYG)

Superannuation

Trade union fees

Health insurance

Employers are responsible to remit these withheld

funds to the appropriate parties

25

Revenues received in
advance

Occurs when customers pay ahead

of time for goods or services
e.g. Purchase of plane tickets
Magazine subscriptions
Season passes to sporting events

26

Accrued Liabilities

Occurs when the firm has incurred

expenses that have not been paid
for, and for which no specific
invoice / claim has been made by
the relevant party.
27

NON-CURRENT LIABILITIES

Obligations expected to be paid after

1 year or outside normal operating cycle

Common forms of these obligations are:

Bank loans

Long-term notes

Debentures are notes that are subject to a secured

charge on the issuers assets

Unsecured notes are not subject to a security over

assets
28

LOANS PAYABLE BY INSTALMENT

Entities may borrow money from a single

borrower in the form of loan

It is common for such loans to be repayable by

instalment, e.g. mortgages

A mortgage is a loan secured by a charge over

property

If the borrower is unable to repay the loan, the

lender may sell the property and use the
proceeds to repay the loan
29

Current and non-current

components of long-term
debt

Entities often have a portion of

long-term debt that falls due within
the coming year

This portion of the long-term debt

should be classified as a current
liability
30

Why issue long-term

notes?
Advantages of Debt Financing

Shareholder control is not affected

Tax savings result

Current owners retain full control of company

Interest is deductible for tax purposes; dividends on

shares are not

Earnings per share may be higher

Although interest expense reduces net profit, earnings

per share may be higher because no additional shares
are issued

31

Why issue long-term

notes? continued
Disadvantage of Debt Financing

Company is locked into fixed payments.

These must be made in good and bad times

Interest must be paid on periodic basis

Principal must be paid at maturity

Company with fluctuating earnings and relatively weak

cash flow may experience difficulty in meeting interest
payments in periods of low earnings

32

Equity

A company is owned by its

shareholders
Different classes of shares carry
different ownership rights

Ordinary shares
Preference shares

33

Shareholder rights

Ordinary shares have 3 major

ownership rights:

continued

Right to vote
Right to share in companys profit
Right to a residual claim if company is
liquidated

Preference shares

have priority over ordinary

shares with respect to dividends and claims at
liquidation
34

DIVIDENDS

A dividend is a distribution of profit by a

company to its shareholders on a pro rata
basis
Forms of dividends:

Cash
Property
Shares

Public companies often pay 2 dividends:

Final dividend determined at end of year

Interim dividend paid during the year
35

Cash dividends

A cash dividend is a pro rata

distribution of profit paid in cash to
shareholders
To pay a cash dividend, a company
needs:

Adequate retained earnings

Adequate cash available to avoid
insolvency
Dividends declared by directors

36

Share dividends

A share dividend is a pro rata distribution of

the companys shares to shareholders
Total shareholders equity does not change
because:

Retained earnings decreases and

Share capital increases

A share dividend signals that this amount of

retained profits is not available to
shareholders as cash dividends
37

REPORTING ON
SHAREHOLDERS EQUITY

Equity section of balance sheet of a

corporation includes:

Share capital: contributed equity (paid

and any outstanding amounts)
Retained earnings: prior profits kept
within company and not distributed as
dividends
Reserves: changes in equity not created
through transactions with owners
38

Reserves

Most reserves of Australian companies

are classified as revenue reserves and
can be distributed as dividends

Companies must:

Show the aggregate amount of reserves

on the face of the balance sheet

Disclose the nature and purposes of

reserves

Provide a reconciliation that explains

39

Retained earnings

Retained earnings represent accumulated

profits that have not been distributed to
shareholders as dividends

On the balance sheet, companies must

report:

The opening amount of retained earnings

Changes to retained earnings during the year

The amount of retained earnings at balance date

40