M.

Raashid, Chemical Engineering

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Economics
 LECTURE OUTLINE
❑ Introduction

❑Basics of Accounting

❑Balance Sheet and Income Statement

❑Financial Ratios

❑Materials Costs

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•Accounting is the art of recording business transactions

in a systematic manner.

•Cost Accounting is simply keeping account (record) of

the costs of items in production

•The purpose of accounting is to record and analyze any

financial transactions that have an influence on the utility

of capital.
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•Accounts of all expenses, income, assets, liabilities, and

similar items are maintained in a company.

•These records can be of considerable value to the

engineer, since they indicate where errors were made in

past estimates and give information that can be used in

future evaluations.

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•Financial statements are both the basis for and the result

of management decisions. Such statements can tell

managers or engineers a great deal about their company,

provided that they can interpret the information

correctly.

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•Engineers involved in feasibility studies and detailed

process evaluations are dependent for financial

information on the company accountants. It is vital that

engineers correctly interpret such information and that

they can, if necessary, make the accountants understand

the effect of the chosen method of cost/ overhead

allocation.
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•Balance sheets and income statements are summarizing

records showing the important relationships among

assets, liabilities, income, and costs at one particular time

or over a period of time.

•Some method must be used for recording the day-to-day

events. This is accomplished by the use of journals and

ledgers.
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•A journal can be a book, group of vouchers, or some

other convenient computer printout in which the original

record of a transaction is listed, while a ledger is a group

of accounts giving condensed and classified information

from the journal.

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•When recording business transactions, a debit entry

represents an addition to an account, while a credit entry

represents a deduction from an account.

•In more precise terms, a debit entry is one which

increases the assets or decreases the equities, and a

credit entry is one which decreases the assets or

increases the equities.

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Accounting Concepts

(1)Money Measurement
(2)Business Entity
(3)Going Concern
(4)Cost
(5)Matching

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Accounting Conventions

(1)Materiality
(2)Conservatism or Prudence
(3)Consistency

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Questions to be Asked:

•What accounts are involved? (Must be minimum of 2)

•What account group do they each belong? (They
must belong to one of the five)
•Has the financial transaction increased or decreased the $
amounts in this account?
•Apply the table logic.
•Make sure that the total amount $ of the debits = the total
$ amount of the credits.

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•Concept of Assets, Equities and Mutual Relations

•Fundamental Relationship of Accounting:

Assets= Equities

•Equities can be further divided as proprietorship and

liabilities So we can write that

Assets= Proprietorship + Liabilities

(Assets also include expenses)

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•Large companies have shareholders instead of single

owner, so the word Stockholders’ Equity is used.

•For income, profits and cost relationship , we can write:

Total income= Costs + Profit

•Any engineering accounting analysis can be reduced to

above two equations, or a third one i.e. Total Debits =

Total Credits
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Balance Sheets can be made anytime and show the current financial position of a company

Therefore also called the position statement

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•Assets are on left side and liabilities on right hand side.

In modern balance sheets, top-bottom design is used too.

•Assets shown in separate headings: Current Assets, and

Non Current Assets (Non current assets are further

classified as Tangible or Fixed Assets, Intangible Assets

and Goodwill).

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•Stockholders’ equity and Liabilities are written on Right

hand side.

•The value of property items is usually reported as the

value of the asset at the time of purchase.

•Depreciation reserves are also indicated( Depreciation is

not actually a separate fund but is merely a bookkeeping

method for recording the decline in property value.)

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•Assets that are to be converted into cash within a period

of one year are current assets; others are noncurrent

assets.

•Liabilities that are to be paid within one year are current

liabilities; others are noncurrent or long-term liabilities.

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•Liquidity Ratios [Current Ratio, Cash Ratio, Liquid/ Quick

Ratio] can be easily calculated

•Concept of Liquid Asset, Liquid Liability

•Working capital can also be easily calculated

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Prepared on yearly/ biannually/ quarterly /monthly base

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•A balance sheet applies only at one specific time, and

any additional transactions cause it to become obsolete.

•Most of the changes that occur in the balance sheet are

due to revenue received from the sale of goods or

services and costs incurred in the production and sale of

the goods or services.

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•Income-sheet accounts of all income and expense items,

such as sales, purchases, depreciation, wages, salaries,

taxes, and insurance, are maintained, and these accounts

are summarized periodically in income statements.

•A consolidated income statement is based on a given

time period. It indicates surplus capital and shows the

relationship among total income, costs, and profits over

the time interval. 31

•The transactions presented in income-sheet accounts

and income statements are of particular interest to the

engineer, since they represent the facts which were

originally predicted through cost and profit analyses.

•Gross income or gross revenue, Net Profit before taxes,

Net Profit after taxes, Net income or net revenue

•Interest is a cost ( To be considered in financing by debt)

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•Most Commonly used financial

ratios

•May or may not include taxes

•May also include interest and

depreciation

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•FATR is of less value than ATR when applied to companies that use relatively large

amounts of working capital.

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•Accumulation, Inventory, and Cost-of-Sales Accounts

•Materials Costs

(In transferring the cost of chemical A to the

inventory and cost-of-sales accounts, there is a
question as to what price applies for chemical A.
There are three basic methods for handling problems
of this type. ( Current Average, fifo, lifo)

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1- The current-average method. The average price of all

the inventory on hand at the time of delivery or use is

employed in this method. In the preceding example, the

current-average price for chemical A would be $0.0380

per Pound.

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2- The first-in-first-out (or fifo) method. This method

assumes the oldest material is always used first. The price

for the 6000 lb of chemical A would be $0.0360 per

pound for the first 5000 lb and $0.0390 for the remaining

1000 lb.

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3- The last-in first-out (or lifo) method. With this method,

the most recent prices are always used. The price for the

6000 lb of chemical A would be transferred as $0.0390 per

pound.

(Any of these methods can be used. The current-

average method presents the best picture of the true
cost during the given time interval, but it may be
misleading if used for predicting future costs. For
predicting future costs, lifo is the best) 44
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