Financial Accounting: Section 3

Financial accounting
Section 3
1
Financial accounting
 What is accounting?
 Accounting is the collection and aggregation of information for decision makers
– including managers, investors, regulators, lenders, and the public
 Information contained within an accounting system has the power to influence
actions
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Financial accounting cont..
 Relevance of accounting and capital budgeting to environmental
management and engineering design issues
 Accounting systems inform and motivate behavior, thus any information
included therein has the potential to influence behavior.
 Including environmental information in accounting systems is a prerequisite to
linking sound environmental management and the principles of sustainable
development with everyday business and personal decisions.
 Most environmental effects are the result of design and engineering decisions.
 For example, a product which contains toxic materials has the potential to have
a high environmental cost.
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 Manufacturing processes which generate large amounts of waste will result in
high disposal costs, in addition to the costs of inefficient resource utilization and
the costs associated with handling and managing materials which do not
ultimately become marketable product.
 The process engineer may be aware of the waste handling costs, but is unlike to
fully realize additional costs associated with waste.
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 Types of accounting systems
 National Accounting Systems
 Financial Accounting Systems
 Management or Cost Accounting Systems and Capital Budgeting
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 Cost Accounting Systems
 Management or cost accounting systems are part of an enterprise’s information
system and refer to the internal cost tracking and allocation systems to track
costs and expenditures. These are internal rather than external accounting
systems.
 The broad definition of cost accounting is the process of identifying
summarizing and interpreting information needed for (1) Planning and control,
(2) managerial decisions and (3) product costing
 Capital budgeting is basically a form of predictive cost accounting over a set
time frame which is used to analyze the costs of alternative projects or
expenditures over the specified period of time.
 Good cost accounting is vital to understanding the profitability of current
activities and to predicting the profitability of future activities.
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❑ The main objectives of managerial/cost accounting include:
 Providing managers with information for decision making and planning.
 Assisting managers in directing and controlling operations.
 Motivating managers towards the organization’s goals.
 Measuring the performance of managers and sub-units within the organization.
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❑ Cost and their classification
• The principal methods of accumulating costs are:
▪ Function:
• Manufacturing: cost applied to producing a product
• Marketing: costs incurred in selling of a product and service
• Administrative: costs incurred in policy marketing activities
• Financial: costs related to financial activities
▪ Elements:
• Direct material: material which is a n integral part of the finished product
• Direct labour: Labour applied directly to component of the finished product
• Factory overhead: indirect materials, indirect labour and manufacturing expenses
that cannot easily be allocated directly to specific units, jobs or products
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▪ Product
• Direct: cost which are charged directly to the product
• Indirect: cost which must be allocated
▪ Department:
• Production: a unit in which operations are performed on the part or product
• Service: A unit not directly engaged in production and in cost of sales when the
product is sold
▪ When charged to income
• Product: cost included when product cost are computed
• Period: cost associated with the passage of time rather than with the product.
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▪ Relation to volume:
• Variable: cost which change in total in direct proportion to change in related
activity
• Fixed: cost which do not change in total wider range volume
▪ Period covered:
• Capital: costs which are expected to befit future period and classified as assets
• Revenue: costs which benefit only the current period and are thus expenses as
incurred
▪ Degree of averaging
• Total: the cumulative cost for the established category
• Unit: the total cost divided by the number of units of activity or volume
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❑ More on basic cost concepts
 Variable Costs (sometimes called direct costs): change in total in proportion to the level
of activity. For example if a carmakers production increases by 5%, its tire costs will
increase by about 5%. A direct cost is the cost of direct labor and material used in
making the product or delivering the service.
 Fixed Costs (sometimes called Indirect Costs/Overhead Costs): remains unchanged in
total as the level of activity varies. For example, the property tax on a rental
apartment is the same regardless of the number of building occupants. Indirect costs
are costs of an activity which are not easily associated with the production of specific
goods or services.
 Opportunity Costs: The benefit that is sacrificed when the choice of one action
precludes an alternative course of action.
 Sunk Costs: Costs that have been incurred in the past and cannot be changed by
current actions.
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 Profit volume relationships
 Cost-volume-profit (CVP) analysis helps managers understand the interrelationships
among cost, volume, and profit it is a vital tool in many business decisions.
 These decisions include, for example, what products to manufacture or sell, what
pricing policy to follow, what marketing strategy to employ, and what type of
productive facilities to acquire.
 Cost-Volume-profit(CVP), in managerial economics is a form of cost accounting. It
is a simplified model, useful for elementary instruction and for short-run decisions.
 Cost-volume-profit (CVP) analysis expands the use of information provided by
breakeven analysis.
 A critical part of CVP analysis is the point where total revenues equal total costs
(both fixed and variable costs). At this breakeven point (BEP), a company will
experience no income or loss.
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 The components of Cost-Volume-Profit Analysis are:
▪ Level or volume of activity
▪ Unit Selling Prices
▪ Variable cost per unit
▪ Total fixed costs
▪ Sales mix
 Breakeven Point = Fixed Costs/(Unit Selling Price -Variable Costs)
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 Full cost accounting describes how goods and services should be priced to
reflect their true costs (including environmental and other social costs)
 Product cost calculations

 All revenues and costs have been organized into accounts
 Accounts are normally consolidated first into head accounts and later into variable
(i.e. direct) and fixed (i.e. indirect or overhead) costs.
 The pricing of products depends notably on the competition in the market
 Sales price = cost + profit
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15
 A fertilizer manufacturer’s NPK production facility carries fixed costs of
N$500000. Assume that the variable cost of production, per bag of NPK is
N$10 and that the company is considering selling to wholesalers at N$20.
 How many bags of NPK need the company to sell to breakeven?
 Determine the company profit if it sells 75 000 bags?
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 Financial statements
 Income Statement
 Cash Flows Statement or statement of cash flows
 Balance Sheet
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 Income statement (Profit and Loss Statement)
- based financial information in the forgoing farming records (Summary of
income and expenditure of the farm business for a specific period, production
year, financial year or tax year)
- A link can be drawn btn the income statement and balance sheet known as
reconciliation of net worth according to the opening and closing balance sheets.
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• Balance sheet
- reflects the financial position of a farm business at a specific
date usually the 1st and or last day of the financial year.
- Three aspects, assets, liabilities and net worth determine the finance of the farm
business.
- Assets: represents all the possessions of the business e.g. land, buildings etc.
• Liabilities: represents all the debts or liabilities
• Net worth (own capital): represent the amount the farmer retain if all assets
were sold all debts paid.
• Accounting Formula: Assets = Liabilities + net worth
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• Cash flow statement
- shows a company's flow of cash. The money coming into the business is called
cash inflow, and money going out from the business is called cash outflow.
- NB an important shortcoming of balance sheets and income

statements is that thy do not take account of the cash flow or flow
of funds in the farm business for the period under review.
- The most important feature of the cash flow statement is that only cash
expenses and cash income are indicated at the time of payment or receipt
- It reflects the sources from which funds were generated during the accounting
period as well as the purpose for which these funds were used.
- Consist of three components (income, expenditure and the bank balance:
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 Financial Ratios (See Hand out)
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 What is a budget?
- A budget is a written plan for future action, expressed in physical and financial
quantities.
- It is a logically consistent device/tool for examining alternatives plans for the farm
business and estimating the profitability of each enterprise
- It is about the future, this advance planning is based on forecasts, historical data,
assumptions and experience.
- Overestimate and underestimate of budget value should be prevented
- What are the main objectives of budgets?
- Useful of budget depends on correctness and realism with which the quantity and
nature of the expected inputs, cost price of inputs, expected yield (outputs) and
prices of yield.
- The best most practical way is estimate based on Pessimistic, Normal and Optimistic
estimate.
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 Different types of budgets
- Enterprise budget
- Partial budget
- Break even budget
- Total farm budget
- Capital budgeting
- Cash flow budget
a) Enterprise budget
- Enterprise budgets are often perquisite to the development and compilation of their budgets
(partial , total , capital and cash flow budgets.
- The format and details of enterprise budget depends on circumstances and preferences and
reasons of compiling it. Complete enterprise budget include
- Gross margin analysis
- Monthly transaction flow
- A parametric or sensitivity analysis of the Gross margin
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 Gross margin analysis
- Involves the estimated income and directly allocable VC of an enterprise on a per
unit basis (ha etc)
- Gross margin = Gross income – variable costs [GM = (PxY) – VC]
- It includes sales and value of produce consumed at home (farm) and retention for
livestock feed. It equal to GI=PxY where P is the price of product,Y is the yield.
 Monthly transaction flow
- Reflects the monthly income and expenditure of the enterprise on per unit basis.
This is a summary which is important for coordinating farming activities and
compiling a total budget.
 The Sensitivity analysis; takes into account the effect of fluctuating product
prices and production quantities. It reflects various options at high (optimistic) and
low (pessimistic) prices and yields.
 Student Activity: Gross Margin Analysis (Details enterprise budgets)
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 b) Partial budgets
- It serves as an aid for evaluating or testing the profitability of decision alternatives for
examples a specific farm practice or enterprise, which only affects a part or certain parts of
the farm business.
- When compiling a partial budget, only relevant fixed and variable costs are taken in account.
The net influence on profitability should be determine by the following four steps
- Determine the additional cost, which will result from the change.
- Determine what income will be lost as a result of the change.
- Determine the cost, which will be saved as a result of change.
- Determine additional income that will be obtained as a result of the change
Existing Practice Alternative Practice

Forfeited income a Additional income c
Saved costs b Additional costs d
Difference a-b Difference c-d

(sacrifice) (benefit)
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 Partial budgets conclusion:
- Expected change in net income
- = (c-d) – (a-b)
 NB if the change (c-d) – (a-b)] is positive, the change is desirable, if the change is
negative the change is detrimental and undesirable.
 Student activity: Partial Budget
 c) Break even budgets

 Determine the points of production and the volume of sales where the total cost is
equal to total income (TI=TC).
 BEP = TFC ÷ (P –VC)
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 Graphic representation of BEP
N$
TI
TC
TFC
BEP Size
 Student activity: BEP

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 d)Total budgets
- It includes all the expenses and revenue of the farm business, it is used in a decision-making
situation where the alternatives affect the use of all or most of the farm resources. It therefore
based on enterprise budget, partial budget and break-even budget
- The following will influence the decision to implement or not implement total budget
- Risk involve in making a change
- Existing medium-long term assets of the business
- Sources of capital available to the business
- effect of the change on mgt
- How the costs of change will influenced the availability of cash for debt redemption, living
expenses, replacement and expansion.
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 e) Capital budget
- Also called investment budgeting usually concerns envisaged capital investment in
long and medium term assets such as land, vehicles implements, breeding stock and
envisaged long and short term capital projects i.e building dams, planting orchards
- The objective of capital budgeting:

- To determine the desirability of an envisaged capital projects
- To determine the relative profitability of alternative capital projects
- NB issues around capital investments are based on the time value of money. The time
value of money arises from the fact that money in possession to (presently) is more
valuable than the same amount in the future, regardless of effect of inflation.
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 Capital budgets cont.
- Time value of money
- Is simply a reflection of the combined influence of interest and time, and is fundamental to
financial decisions.
- Time value of money can be approached from two angles:
- The Future value of a sum of money that is invested today
- The present value of a sum of money that will become available in the future.
 The future value
- Refers to the value of money that one will receive at some future time
- Compound interest: indicate that the amount earned on a given deposit has become part of
the principal at the end of a specified period
- Principal: refers to amount of money on which the interest is paid
- Simple interest is only calculated on the initial investment.
- FV = PV(1+i)n
- FV (compound amount sought, future value), PV (principal, present value), i
(annual rate of interest) n (number of years)
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 Compounding more frequently than annually (Compounding is done
more that once annually
 FV = PV(1+i/m)nxm
 Where m = the number of times per year interest is comounded
 Student activity: FV
 Present value
- The present or discounting process is the inverse or reciprocal function of the
approach for compounded interest or future value
- PV = FV/(1+i)n
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 Annuities
- Is a sequence of equal payments made at equal intervals. Examples of annuities are
premiums paid for insurance policies, benefits paid in respect of a pension scheme,
and loan or bond repayments or amortization.
- Future value of annuity

- If the equal payments or receipts of an annuity take place at the end of each period
this is referred to as regular annuity or a deferred payment annuity. NB if payment or
receipt take place at the beginning of each period is referred to as annuity.
- Formula
- A = the periodic payment
- i = rate of interest per annum
- m= number of times interest is compounded per annum
- n= number of payments intervals
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 Present value of an annuity
- In financial decision-making and particularly investment decisions, the present value
of an amount consisting of series of equal amounts of cash at specific periods, for
specific term, is often required.
- Formula
- Student activity: annuity
 Capital Budgeting techniques (financial selection criteria)

- Net present value (NPV)
- Internal rate of return (IRR)
- Payback period
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 Depreciation
- One of the most important costs involved in the utilization of machinery and caused
by two factors namely obsolescence and wear and tear.
- Depreciation is calculated to make provision for the replacement of machinery and
equipment.
 Methods of calculation depreciation

- In principal there are three methods of determining depreciation
- The straight line methods
- The declining/ diminishing balance method
- The sum of digits methods
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 The straight line method
- This is the simplest method of calculating depreciation. Calculated as purchase price
minus expected scrap value divided by expected years of service.
- Formula: D = P-R/n
- If P = is the initial value, n = the number of years useful life, R = is the scrap value,
D = annual depreciation. This figure is then deducted annually from the initial value.
 Declining (diminishing) Balance method

- A fixed percentage is written off the falling book value each year and not off the
original cost. Annual depreciation therefore decreases with time.
- Formula = (P-S) x R/100 = Book value at beginning of Year * depreciation rate
- If P = is the initial value, n = the number of years useful life, S=is the scrap value, D
= annual depreciation, R = is percentage rate of depreciation
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 The sum of digits methods
- This method is based on the sum of the individual years of useful life of the asset e.g.
if the assets expected useful life on the farm.
- When n= 5years : then the sum of digits (SDN) = 5+4+3+2+1+0=15
 Depreciation at end of year one = (P-S) x n

SDN
 Depreciation at the end of one year = (P-S) x n-1

SDN
 Depreciation at the end of one year = (P-S) x n-2

SDN
 Student activity: Depreciation Methods
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 Definition of marketing
 Marketing has a variety of meanings to different people:
 Generally defined as a social and managerial process by which individuals and
groups obtain what they need and want through creating and exchanging
products and value with others (Kotler and Amstrong, 1999).
 From business perspective marketing is a process by which individuals obtain

what they need and want through producing the goods and exchanging products
and money with others. Marketing is also defined as the performance of
business activities that direct the consumer flow
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❑ Important decision by producers:

 These decisions include:
 What to produce and what production methods should be used?
 When and where to buy or sell?
❑ Factors affecting the marketing system:
 The number of marketing functions required for a product and to what extent it can
be specialized, or combined with others and performed at a lower cost by a separate
business.
 The degree of concentration of raw materials, and their location.
 The degree of dispersion of buyers, and their location.
 Historical development within an industry.
 Whether or not one or few companies under control the product patented process.
 The stage of economic development of a country or society.
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❑ Approaches to the study of marketing
 The study of marketing involves various approaches. The common are the
commodity, functional, institutional approaches.
▪ Functional approach: It studies marketing in terms of many activities that are

performed in getting farm products from the producer to the consumer.
 Classification of functions
 Exchange – buying and selling
 Physical – processing, storage and transportation
 Facilitating - standardisation, financing, risk bearing and market information
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 Exchange functions: Buying functions: this is the one that seeks the sources of
supply, assembling the products and performing activities related to purchasing.
Selling functions: this involves packaging, labelling, advertising, promotion and
all other merchandising activities.
 Physical functions: These are activities that involve handling, movement and
physical change of the commodity, thus add form, time, and place utility
(value).
✓ Processing, add form utility to a product
✓ Storage adds time utility to a product
✓ Transportation adds place utility to a product
40
 Facilitating functions: Are those functions that improve performance of the
marketing system by increasing operational and pricing efficiency?
 Standardisation is the establishment and maintenance of grades and quality criteria for
a commodity uniformly.
 Financing, involves the use of money to carry on the various aspects of marketing e.g.
risk bearing, is the accepting of possible loss in the marketing of product. Risk
bearing is either physical risk or market risk. Physical risks are those are that result
because of deterioration or destruction by fire, moisture wind, heat or other means.
Market risks are those that result because of changes of product as it is marketed. For
instance farmers and merchandiser’s losses due to price movements, that results in
high inventory losses.
 Marketing information involves collecting analysing and disseminating information
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❑ Institutional Approach: The institutional approach considers and examines the
nature and characters of various middlemen and business organisations.
 Middlemen are those individuals or business concerns that perform operations
significant to transfer goods from the producer to the consumer.
▪ Classification of middlemen
 Merchant middlemen (retailers and wholesalers)
 Agent middlemen (brokers and commission men)
 Speculative middlemen
 Facilitative organisations
 Food processors
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 Merchant middlemen: Retailers purchase from the wholesalers taking title to the
product they handle. Wholesalers buy commodities from processors and sell to
industrial users or to retailers. The later also provide credit to retailers, offer
merchandising assistance, and assume some risk retailers would have to take if the
retailers purchase directly from the manufacturer.
 Agent middlemen: They only act as representatives of their clients. The agents are
engage in negotiations that transfer the title of products from seller to buyer. They
are divided into two groups.
 Broker, usually represent the seller, but aimed at bring the buyer and seller together.
 Commission men, arrange for the term of sale, collect, deduct their expenses and remit
give the balance to the seller.
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 Speculative middlemen: They are those who buy and sell products with the main
aim of profiting from price fluctuations (movements).
 Facilitating organisations: They are those organisation that provide physical
facilities for marketing such as auction yards e.g. trade associations
 Processors: They transform raw products into different final products.
 Commodity approach: These approach focuses on a single commodity from the

time it leaves the farm to unit whereby it is loses its identity
 Market structure approach: This is a market structure analysis emphasizes the

nature of market competition and relate variable of market performance to types of
market structure and conduct.
44
❑ Marketing planning, strategies & analysis
 Marketing management: the analysis, planning, implementation and control of

programs designed to create, build and maintain beneficial exchanges with
target buyers for the purpose of achieving organizational objectives.
 A marketing plan is a statement of who the product or service is going to be sold

to and the strategy of how it is intended to make the customer aware of and
willing to buy the products or service. Thus marketing is the act of defining
your potential customer and away to attract the customer as oppose to sale
which is the act of convincing the attracted customers to buy.
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❑ The marketing plan should include the following elements
 Marketing scope and distribution
 Market segmentation
 Market demand changes and trends
 Major customers and concentration
 Sales tactics
 Market share and sales
 Objectives
 Strategies
 Media mix
 Budget
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▪ Marketing scope and distribution
 Market scope may be local, regional, national or international. While distribution
may be direct to customers or indirect to middlemen (to retailers or it may require a
wholesaler or broker)
▪ Market segmentation
 A market segment is a group of customers who shares common characteristics that
distinguish them from other customers according to:
 Geographic – region, city, climate etc.
 Demographic – age, sex, income, occupation, education, religion, culture etc.
 Psychographic – lifestyle, personality, degree of locality
 Behaviouristic – Product usage, loyalty status, sensitivity and benefit sought
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▪ Market demand changes and trends
 Has market demand increased, deceased or remained steady? Has the market shifted
its geographic location or are new market segments emerging? What are the trends
that point to future changes?
▪ Major customers and concentration

 Who are your principal customers? What are their characteristics? What do they
want and need from your product or services? Note that it is important to list some
potential customers for your product or services.
▪ Sale tactics
 Will you use your sale forces, sales representatives, distribution, or retailers? Identify
the role of advertising, promotion and public relations. What the policy regarding
discounts? And what percentage is made of cash or credit?
48
▪ Market and sales
 What share of the total industry does your company holds? Market share should
be translated in order to forecast market sales.
▪ Objectives
 Is your objective(s) to?
 Increase profits
 Stop sales declines
 Respond to competition
 Maintain business as usual
 Successfully introduce a new product or service
 Increase customer satisfaction
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▪ Strategy
 Your strategy should include the eight P’s of the modern market mix
(packaging, product, price, premium, promotion, physical distribution,
personal selling and publicity)
▪ Media mix
 These include newspapers, trade journals, magazines, radio and TV stations,
direct mail outdoor displays, special events, community relations and personal
selling.
▪ Budget
 Budget for marketing activities as an investment into a company.
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 Controlled factors that influence customers decision to buy a
product (The four P’s of marketing)
 Product: It is essential to provide a product that clearly meets the needs of
consumers. Product(s) with good quality, well design, have brand name,
packaging; appropriate size, service guarantees.
 Place: Consider the following the channels of distribution location of business
and transport.
 Price: Include the following; selling price, discounts, credit terms, payments
period
 Promotion: Based on advertising, personnel selling, publicity, special offers, point
of sale, trade fairs etc.
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❑ Marketing strategy
▪ Pricing strategies
 Pricing strategy deals with what prices will be charged for various products and
services. Consider the prices of competitors and how price competition should
be handled. Therefore in setting the pricing objective the following objectives
should be realised.
 The price should be considerable high to ensure that business (firm) makes
profit.
 The price should be considerable low to ensure that the products are widely
accepted and affordable by your customers.
52
▪ Product strategies
 The product strategies for different product and brands may emphasise quality,
convenience, packaging and even price.
 Branding: A brand is a name, term, symbol or design that identifies the seller and
differentiated it from those of the competitors.
 Innovation and new product development: An innovation is the discovery and application
of a new idea.
 The product life cycle: The product life can be divided into four stage lifecycles:
introduction, growth, maturity and decline.
▪ Distribution Strategies
 Distribution or place strategies include selling foods through conventional food
stores, non-food stores, food service market, mail or catalogue selling, home
delivery, even selling to open market and door to door selling. Processors may
choose to market their products in alternative ways that may involve local, regional,
and international sales.
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▪ Promotional strategies
 The manufacturers have many choices of selecting the goal of the promotion (to
remind, inform, or persuade); the theme or appeal (price quality etc.) the
[promotion (advertisement, sale promotion, etc.) which media (print,
broadcast, direct mail, point of purchase etc.) will carry the promotion and
who the promotion will be targeted to (the user, the buyer or the influence.
❑ Marketing research (gathering of information)
 The function that links the consumer, customer and public to marketer through
information which is used to identify and define marketing opportunities and
problems, generate, refine, and evaluate marketing actions, monitor marketing
performance, and improve understanding of marketing as a process.
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Financial Accounting: Section 3

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Financial Accounting: Section 3

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Financial accounting

 Product cost calculations

• Accounting Formula: Assets = Liabilities + net worth

- NB an important shortcoming of balance sheets and income

- Consist of three components (income, expenditure and the bank balance:

- What are the main objectives of budgets?

Existing Practice Alternative Practice

Difference a-b Difference c-d

 Student activity: Partial Budget

 c) Break even budgets

 Student activity: BEP

- The objective of capital budgeting:

- Future value of annuity

- Student activity: annuity

 Capital Budgeting techniques (financial selection criteria)

 Methods of calculation depreciation

 Declining (diminishing) Balance method

 Depreciation at end of year one = (P-S) x n

 Depreciation at the end of one year = (P-S) x n-1

 Depreciation at the end of one year = (P-S) x n-2

 From business perspective marketing is a process by which individuals obtain

❑ Important decision by producers:

▪ Functional approach: It studies marketing in terms of many activities that are

 Commodity approach: These approach focuses on a single commodity from the

 Market structure approach: This is a market structure analysis emphasizes the

 Marketing management: the analysis, planning, implementation and control of

 A marketing plan is a statement of who the product or service is going to be sold

▪ Major customers and concentration

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