Cost Accounting 12/13/2015rd1

12/13/20152 Assets Resources ~ owned by or owned to the company such as property with monetary value, cash, inventory, buildings, and equipment. Long term or fixed assets ~ investments in operating properties with costs consumed over extended period of time (land, equipment, buildings, etc.) Intangible assets ~ long term assets having value but no physical existence

12/13/2015rd3 Liabilities All financial obligations ~ Owed to outsiders like notes payable, accounts payable, bonds payable. Long term liabilities – payable in more than a year

12/13/2015rd4 Owner Equity or Net Worth Equity capital- Charter specifies the number of authorized shares of stock can be issued. Un-issued stock can also be sold. Own part of company. Corporate bonds – funds from investors (not owners) General revenue bonds – Finance public works (toll bridges, sewerage treatment). Usually tax exempt. Owner’s interest (assets minus liabilities) in an enterprise. Assets = liabilities + equity

12/13/2015rd5 Financial Functions Maximize value of business to its owners Value often based on market price of common stock, which is based on investment policies, methods of financing, and dividend decisions

Delta Corporation Balance Sheet December 31, 2008 AssetsLiabilities Current Cash$10,500 Accounts payable $19,700 Accounts receivable 18,700 Dividends payable 7,000 Interest accrued receivable 500 Long-term notes payable 16,000 Inventories 52,000 Bonds payable 20,000 Total current assets $81,700 Total liabilities $62,700 FixedNet Worth Land$25,000 Common Stock$275,000 Buildings and equipment438,000 Preferred stock 100,000 Less: Depreciation Retained earnings 25,000 allowance $82,000356,000 Total fixed assets381,000 Total net worth 400,000 Total assets$462,700 Total liabilities and net worth $462,700 12/13/2015rd6

Delta Corporation Income Statement Year ending December 31, 2008 Revenues Sales$505,000 Interest revenue 3,500 Total revenues $508,500 Expenses Cost of goods sold $290,000 Selling 28,000 Administrative 35,000 Other 12,000 Total expenses365,000 Income before taxes143,500 Taxes for year 64,575 Net profit for year$78,925 12/13/2015rd7

Statement of Cost of Goods Sold Year Ended December 31, 2008 Materials Inventory, January 1, 2008$ 54,000 Purchases during year 174,500 Total 228,500 Less: Inventory December 31, ,000 Cost of materials$178,500 Direct labor 110,000 Prime cost 285,500 Indirect cost 7,000 Factory cost 295,500 Less: Increase in finished goods inventory during year 5,500 Cost of goods sold $290,000 12/13/2015rd8

Business Ratios Used to evaluate the financial health of a company over time and in relation to industry norms. Median ratios are published by firms such as Dunn and Bradstreet in Industry Norms and Key Business Ratios. Solvency ratios ~ assess ability to meet short/long debts Efficiency ratios ~ measure managers ability to use assets Profitability ratios ~ rate ability to earn a return for owners 12/13/2015rd9

12/13/2015rd10 Current Ratio Current Ratio = Current Assets Current Liabilities = 81,700 26,700 = to 3 is considered the norm Assumes that inventory can be converted to cash quickly.

12/13/2015rd11 Quick Ratio Quick Ratio = Current Assets - Inventories Current Liabilities = 81, ,000 26,700 = 1.11 Indicates how well a company can meet its obligations without having to liquidate inventory. Ratio of 1 is considered strong.

12/13/2015rd12 Debt Ratio Debt ratio = Total liabilities / Total assets = 62,700/462,700 = 13.6% Creditors have supplied 13.6% of Engineered Industries financing. Thus company is 86.4% stockholder-owned. 20% or less is considered sound financially.

Return of Sales Ratio Return on sales = net profit / net sales = 78,925 / 505,000 = 15.6% Income ratio of 3% is quite healthy for relatively large- volume, high turnover businesses. 12/13/2015rd13

12/13/2015rd14 Return on Assets Return on assets = net profit / total assets = 79,925/462,700 = 17.1% Net income + interest expense x (1 – tax rate) Divided by Average total assets

Inventory Turnover Ratio Net sales to inventory = net sales / average inventory = 505,000 / 52,000 = 9.71 Ratio indicates the number of times the average inventory value passes through the operations of the company. The average value of the inventory has been sold 9.71 times during the year. 12/13/2015rd15

12/13/2015rd16 Methods of Financing Short Term—loans that mature in a year raise funds for seasonal variations or special funding from trade credits, bank loans, commercial notes. Long Term– 5 years or more for fixed assets.

12/13/2015rd17 Financial Management Current Ratio ~ assets / liabilities Earnings per share – earnings / # shares net earnings = profit – preferred dividends Debt-to-equity ratio – long term debt + current liabilities total stockholders equity Profitability ratio (sales) = net profit after taxes total sales (investment) = net profit after taxes total tangible assets

12/13/2015rd18 General Accounting General – Balance sheet (snapshot of finances) profit and loss statement (yearly) Five classifications of accounting are: Assets, liabilities, net accounts (balance sheet) assets = liabilities + equity revenue, expenses (income statement)

12/13/2015rd19 Cost Accounting Cost of goods and sold Direct Material –directly charged to project Direct labor – hours * wage rate Indirect or factory overhead – all costs not charged to direct Factory cost – sum of direct material, direct labor and factory overhead. Administrative costs – executive salaries, clerical, supplies. Selling costs – incurred in disposing of the products and services produced (commissions, office space and supplies, rentals market surveys, entertainment of customers)

12/13/2015rd20 Problem Cash$ 90K Net Accounts and notes receivable 175K Retailer's inventories 210K Prepaid expenses 6K Accounts and notes payable (short term) 322K Accumulated liabilities 87K From the balance sheet above, determine a) working capital, b) current ratio, and c) acid-test ratio. a) ( )K - ( )K = 475K - 409K = $66K b) current ratio = 475/409 = c) acid-test ratio = ( )/409 = 0.648

12/13/2015rd21 Depreciation Accounting Book Value of an asset MACRS

12/13/2015rd22 Business Papers Original documents from transactions such as sales invoices, cash register tapes, purchase invoices, debit or credit memorandum, check stubs, etc.

12/13/2015rd23 Journals Books of original, chronological entry used for classifying and recording transactions

12/13/2015rd24 Ledgers Complete set of accounts for the business that is used to classify and summarize data according to function. Entry items are know as posting. Summarize increases and decreases in the firm’s assets, liabilities and capital.

12/13/2015rd25 Operating Expenses Selling Expenses General and Administrative Expenses Other incomes and expenses (miscellaneous)

12/13/2015rd26 Income Statement Summary of the revenues, expenses and net income of a business entity for a specified period of time. Also called profit and loss statement, operating statement, or a statement of operations. Revenues from sales, cost of goods sold, gross profit on sales, operating expenses. Net income = Gross Profit – Operating expenses

12/13/2015rd27 Income Statement Revenue$300,000 Operating Expenses 250,000 Gross Profit 50,000 Administrative Costs 10,000 Other Income 5,000 Net Income Before Tax 45,000 Tax 20,000 Net Income of Net Profit After tax 25,000 Dividends 10,000 Retained Earnings 15,000

12/13/2015rd28 Balance Sheet Statement of financial position Presents the assets, liabilities and capital of a business at a specified date Assets in order of liquidity Liabilities in order of expected payments Capital or Stockholders’ Equity – emphasizing current solvency.

12/13/2015rd29 Balance Sheet AssetsLiabilities and Owners Equity Cash $50,000Accounts Payable$30,000 Securities 5,000Note Payable 20,000 Accounts Receivable 5,000Taxes Payable 10,000 Inventory 90,000Common Stock 300,000 Equipment 200,000Retained Earnings 90,000 Buildings 100,000 ______ Total Assets $450,000Total Liability and Owners Equity $450,000 Current Assets Long-term Assets = Current Liabilities Long-term Liabilities Equity 1. Owner's Contributions 2. Retained Earnings

12/13/2015rd30 Balance Sheet Engineered Industries K AssetsLiabilities Current assetsCurrent liabilities Cash1940 Accounts Payable 1150 Accounts Receivable 950 Notes Payable 80 Securities4100 Inventories1860Accrued expense 950 (-) Bad debt provision -80 Total current liabilities 2180 Fixed assets Long-term liabilities 1200 Land 335 Plant & Equipment6500 (-) Accumulated depr-2350Equity Preferred stock 110 Other assetsCommon stock 650 Prepays/deferred charges 140Capital Surplus 930 Intangibles 420Retained earnings 8745 Total other assets 560 Total equity 10,435 Total assets13,815 Total liabilities and equity13,815

12/13/2015rd31 Analysis by Ratios Ratios that determine solvency by looking at current assets and current liabilities.

12/13/2015rd32 Working Capital Dollar excess of current assets over current liabilities ~ measures short-run solvency

12/13/2015rd33 Current Ratio Current Assets Current Liabilities Accepted minimum is at least 2 to 1. Better indicator than working capital

12/13/2015rd34 Quick or Acid Test Ratio Exclude from current assets inventories and prepaid expenses divided by current liabilities Measure of a company’s ability to pay its debt quickly. Inventories are subject to decline in market value and it takes time to convert inventory to cash.

12/13/2015rd35 Balance Sheet Given partial data from a balance sheet, compute working capital, current ratio and acid test ratio. Cash$200,000 Marketable securities 90,000 Accounts receivable 300,000 Retailers inventories 400,000 Prepaid expenses 16,000 Accounts payable 630,000 Other liabilities to date 180,000 Total assets = 200, , , , ,000 = $1,006,000 Total liabilities = 630, ,000 = $810,000 Working capital = (1,006,000 – 16,000) – 810,000 = $180,000 Current ratio = 990,000/810,000 = 1.22 Acid test ratio = (200, , ,000)/810,000 = 0.73.

12/13/2015rd36 Financial Ratios Debt Ratio Times-Interest-Earned Ratio Current Ratio Quick Ratio Inventory Turnover = sales/average inventory Day's Sales Outstanding = receivables/avg sales Total Assets Turnover = sales/total assets

12/13/2015rd37 Balance Sheet Engineered Industries ($K) AssetsLiabilities Current assetsCurrent liabilities Cash1940 Accounts Payable 150 Accounts Receivable 950 Notes Payable 80 Securities4100 Inventories1860Accrued expense 950 (-) Bad debt provision -80 Total current liabilities 2180 Fixed assets Land 335 Plant & Equipment6500 (-) Accumulated depr-2350Equity Preferred stock 110 Other assetsCommon stock 650 Prepays/deferred charges 140Capital Surplus 930 Intangibles 420Retained earnings 8745 Total other assets 560 Total equity 10,435 Total assets13,815 Total liabilities and equity13,815

12/13/2015rd38 Income Statement Revenue$300,000 Operating Expenses 250,000 Gross Profit 50,000 Administrative Costs 10,000 Other Income 5,000 Net Income Before Tax 45,000 Tax 20,000 Net Income of Net Profit After tax 25,000 Dividends 10,000 Retained Earnings 15,000

12/13/2015rd39 Inventory turnover ratio Inventory turnover ratio = sales average inventory balance = 300,000/1860 = times Measures how many times the company sold and replaced its inventory over a specific period. The average is usually calculated over 2 years.

12/13/2015rd40 Times-Interest-Earned Ratio Times-interest– earned ratio = net income + interest Interest is earnings before interest and incomes taxes Times-interest– earned ratio = 45,000 + interest interest paid The ratio indicates the extent to which operating income can decline before firm is unable to meet annual interest costs. A lower times interest earned ratio means less earnings are available to meet interest payments and that the business is more vulnerable to increases in interest rates.

12/13/2015rd41 Day's Sales Outstanding (DSO) DSO = Receivables/average sales per day = 950,000/45,000 = days On average it takes days to collect on a credit sale. If 30 days credit it extended, company is doing good but customers are not enjoying the float as long as offered.

12/13/2015rd42 Total Assets Turnover Total Assets Turnover = Sales / Total assets Indicates how company is using its total assets compared with other companies.

12/13/2015rd43 Profit Margin on Sales Profit margin on sales = net income available to stockholders / Sales e.g., a 5.76 ratio indicates that the profit margin of 5.76 cents is made for each sales dollar generated.

12/13/2015rd44 Return on common equity (ROCE) ROCE = net income / average common equity

12/13/2015rd45 Price-to-Earnings Ratio P/E ratio = Price per share / Earnings per share 30 => stock was selling for about 30 times its current earnings per share => high growth rate expected.

12/13/2015rd46 Book Value per Share Book value per share = total stockholder's equity – preferred stock Shares outstanding More historical than future expections.