Manufacturing Accounts Chapter 21 Manufacturing Accounts

notes reference - page 229

notes reference - page 229

Costs of production Direct costs Indirect costs Variable Fixed Vary with no. of goods produced & hours worked Not related to production of a unit e.g. raw materials & labour e.g. rates notes reference - page 230

Costs of production Total direct costs Total direct + indirect costs Factory cost of production +/- change in WIP Prime cost Factory cost of production Factory cost of finished goods produced notes reference - page 230

Lecture example 1 Manufacturing account for the year ended 31 December 20X1 Raw materials Opening inventory 7,630 Purchases 18,920 26,550 (7,890) Less closing inventory 18,660 Factory wages 20,860 39,520 Prime cost Indirect factory expenses Electricity (4,620 x ½) 2,310 Rent & rates (5,000 x ½) 2,500 Supervisor’s salary 8,200 Depreciation (plant & machinery) 4,700 17,710 57,230 Factory cost of production Opening work in progress 4,920 Closing work in progress (4,540) 380 57,610 Factory cost of finished goods produced notes reference - page 232

Lecture example 1 Income Statement for the year ended 31 December 20X1 Sales 181,820 Opening inventory of finished goods 6,780 Less cost of sales 64,390 Factory cost of finished goods produced 57,610 Less closing inventory of finished goods (5,430) 58,960 122,860 Gross profit Selling & distribution costs Electricity (4,620 x ¼) 1,155 Rent & rates (5,000 x ¼) 1,250 Depreciation (delivery vans) 1,600 Sales commissions 13,680 Salesmen’s salaries 20,000 (37,685) notes reference - page 233

Lecture example 1 Administration expenses Electricity (4,620 x ¼) 1,155 Rent & rates (5,000 x ¼) 1,250 Salaries (41,630 – 8,200) 33,430 Depreciation (fixtures & fittings) 1,420 (37,255) 47,920 Net Profit notes reference - page 234

Interpretation of accounts Chapter 22 Interpretation of accounts

Categories Profitability Liquidity Investors’ ratios Gearing notes reference - page 239

Profitability Profitability ROCE Profits earned in relation to capital employed NPM/GPM Relationship between costs and revenue Asset turnover Revenue generated by assets employed Profitability Return on equity Return to ordinary shareholders notes reference - page 241

Lecture example 1 Profitability Return on capital employed (ROCE) Profit from operations % TALCL 790 3655-965 462 1,801 = 29% = 25% Possible reason: New non-current assets may have improved efficiency notes reference - page 241

Lecture example 1 Profitability Return on equity (ROE) PAT – preference div OSC + reserves 478 2,190 266 1,401 = 21.8% = 19% Possible reason: Good use of extra capital raised notes reference - page 241

Lecture example 1 Profitability Asset turnover Revenue TALCL 7,180 2,690 5,435 1,801 = 2.7 = 3.02 Possible reason: New non-current assets bought in year have not had time to create the same rate of revenue notes reference - page 241

Lecture example 1 Profitability Net profit margin Profit from operations % Revenue 790 7,180 462 5,435 = 11% = 8.5% Possible reasons: Higher selling prices Better cost control notes reference - page 241

Lecture example 1 Profitability Gross profit margin Gross profit % Revenue 1,795 7,180 1,223 5,435 = 25% = 22.5% Possible reasons: Higher selling prices Better cost/production control notes reference - page 241

Average collection period Liquidity Current ratio Ability to meet short term commitments Quick ratio Stricter test of liquidity Average payment period Credit period taken by the business Inventory days Average period that Inventories are held Liquidity Average collection period Credit period taken by customers notes reference - page 241

Lecture example 1 Liquidity 1 Current ratio CA CL 2,314 965 1,679 704 = 2.4 = 2.4 Comment A healthy unchanged ratio. Depends on the industry so comparisons are necessary. notes reference - page 241

Lecture example 1 Liquidity 2 Quick ratio CA - inventories CL 1,308 965 808 704 = 1.4 = 1.1 Comment The company’s acid ratio has improved due to an increase in receivables and cash, not inventories notes reference - page 241

Lecture example 1 Liquidity 3 Inventory Days Inventories x 365 days Cost of sales 1,006 5,385 871 4,212 = 68 days = 75 days Comment The company holds inventories for less time. May be a reason for the improved margins. Note - Inventory turnover Cost of sales Inventories 5,385 1,006 4,212 871 = 5.35 = 4.84 notes reference - page 241

Lecture example 1 Liquidity 4 Receivables days Trade receivables x 365 days Credit turnover 948 7,180 708 5,435 = 48 days = 47 days Comment No significant change. notes reference - page 241

Lecture example 1 Liquidity 5 Payables days Trade payables x 365 days Credit purchases 653 5,385 516 4,212 = 44 days = 45 days Comment No significant change. However, payables days less than receivables days which could cause cash flow problems in the future. notes reference - page 241

Operating cycle Receivables Days Inventory Days Payables Days Cash out Cash in notes reference - page 241

Gearing Gearing Debt/Equity Shows how the company is financed Shows risk of shareholders not receiving dividend notes reference - page 242

Lecture example 1 Gearing 1 Gearing ratio Interest bearing debt Capital, reserves & debt 500 2,190+500 400 1,401+400 = 18.6% = 22.2% Comment Gearing has decreased due to the issue of shares. notes reference - page 242

Limitations of ratios Lack of comparability of accounting policies. Non trading income included in some ratios Useless in isolation Cannot compare across industries Can be manipulated notes reference - page 242

IAS 7: Cash Flow Statements Chapter 23 IAS 7: Cash Flow Statements

XYZ Co – Cash Flow statement (Indirect method) $000 $000 Cash flows from operating activities Net profit before taxation 3,570 Adjustment for: Depreciation 450 Investment income (500) Interest expense 400 Operating profit before working capital changes 3,920 Increase in trade and other receivables (500) Decrease in inventories 1,050 Decrease in trade payables (1,740) Cash generated from operations 2,730 Interest paid (270) Income taxes paid   (900) Net cash from operating activities 1,560 notes reference - page 248

XYZ Co – Cash Flow statement (Indirect method) Cash flows from investing activities Purchase of property, plant and equipment (900) Proceeds from sale of equipment 20 Interest received 200 Dividends received 200 Net cash used in investing activities (480) Cash flows from financing activities Proceeds from issuance of share capital 250 Proceeds from long-term borrowings 250 Dividends paid (1,290) Net cash used in financing activities (790) Net increase in cash and cash equivalents 290 Cash and cash equivalents at beginning of period (Note) 120 Cash and cash equivalents at end of period (Note) 410 notes reference - page 248

Cash flows from operating activities Cash flows derived from operating or trading activities Can use: Direct method Indirect method (more common in exams) notes reference - page 249

Lecture example 1 Income Tax payable Tax paid 116 bal b/d 168 bal c/d 156 IS 104 272 notes reference - page 249

Lecture example 2 Plant and equipment Accumulated depreciation b/d 200 c/d 280 Disposal 20 Disposal 9 b/d 80 c/d 111 Addition 100 Charge 40 300 300 120 120 notes reference - page 250

Lecture example 3 Dividends paid Dividends payable b/d 35 R Earnings 60 Cash 50 c/d 45 95 95 notes reference - page 252

Lecture example 4 $000 $000 Cash flows from operating activities $000 $000 Cash flows from operating activities Net profit before taxation 87 Adjustments for: Depreciation 42 Interest expense 8 Operating profit before working capital changes 137 Increase in trade receivables (168 – 147) (21) Increase in inventories (214 – 210) (4) Increase in trade payables (136 – 21) 15 Cash generated from operations 127 Interest paid (8) Income taxes paid (W1) notes reference - page 253

Lecture example 4 (cont’d) Working 1 Income tax payable b/d 28 Cash 20 I/S 31 c/d 39 59 59 notes reference - page 253

Lecture example 4 (cont’d) $000 $000 Cash flows from operating activities Net profit before taxation 87 Adjustments for: Depreciation 42 Interest expense 8 Operating profit before working capital changes 137 Increase in trade receivables (168 – 147) (21) Increase in inventories (214 – 210) (4) Increase in trade payables (136 – 21) 15 Cash generated from operations 127 Interest paid (8) Income taxes paid (W1) (20) Net cash from operating activities 99 notes reference - page 254

Lecture example 4 (cont’d) Working 2 Dividends payable b/d 16 Cash 22 R Earnings 24 c/d 18 40 40 notes reference - page 254

Property, plant and equipment (NBV) Lecture example 4 (cont’d) Working 3 Property, plant and equipment (NBV) b/d 514 Revaluation 10 Depreciation 42 Cash additions 146 c/d 628 670 670 notes reference - page 254

Lecture example 4 (cont’d) $000 $000 Cash flows from investing activities Purchase of property, plant and equipment (W3) (146) Net cash used in investing activities (146) Cash flows from financing activities Proceeds from issuance of share capital (320 – 260) 60 Proceeds from issuance of debentures (80 – 50) 30 Dividends paid (W2) (22) Net cash from financing activities 68 Net increase in cash and cash equivalents 21 Cash and cash equivalents at beginning of year (14) Cash and cash equivalents at end of year 7 notes reference - page 254

Note to the cash flow statement Cash and cash equivalents 31.12.X8 31.12.X7 $’000 $’000 Cash on hand 7 - Bank overdraft - (14) Cash and cash equivalents 7 (14) notes reference - page 254

Lecture example 5 Angus Ltd Cash flow statement for the year ended 31 December 20X0 $ $ Operating activities Cash received from customers (54,000 – 6,700) 47,300 Cash paid to suppliers (31,000 – 2,500) (28,500) Cash paid to & on behalf of employees (15,000) Interest paid (11/12 x 4,800) (4,400) (600) Net cash inflow from operating activities Cash flow from investing activities Payments to acquire tangible fixed assets (40,000) Cash flow from financing activities Proceeds from long-term loan 60,000 Issue of ordinary shares 50,000 Repayment of loan (6,000) 104,000 Increase in cash balances 63,400 notes reference - page 256

Lecture example 5 part (b) This cash flow statement has been prepared using the direct method notes reference - page 256

Income and Expenditure Accounts Chapter 24 Income and Expenditure Accounts

Sources of income Main source of income = subscriptions Subscriptions received and receivable must be recorded in the correct period Subscriptions income in I&E account = Number of members x membership fees notes reference - page 263

Lecture example 1 Subscriptions account Opening receivables (5 x $100) 500 Opening payables (2 x $200) 400 (subs in arrears b/d) (subs in advance b/d) I & E a/c (subs income) 4,700 Cash 6,000 Closing receivables (10 x $200) 2,000 Closing payables (4 x $200) 800 (subs in arrears c/d) (subs in advance c/d) 7,200 notes reference - page 263

notes reference - page 265

notes reference - page 265

Proforma notes reference - page 265

Life membership subscription On receipt of the money Dr Cash Cr Life membership fund Two methods of accounting for life membership sub T/f to Acc Fund on death of member Dr Life membership fund Cr Accumulated fund Release to I&E a/c over life of member Dr Life membership fund Cr I&E account notes reference - page 266

Bar profits & social events notes reference - page 267

Disposal of fixed assets Non current asset disposal Asset had been depreciated Asset had not been depreciated T/f profit/loss to I&E a/c T/f profit/loss to acc fund notes reference - page 267

Investments & special funds Investment income recorded in I&E a/c Profit/loss on sale of investment goes to acc fund Special fund e.g. to raise money for new boat house Dr Special fund cash Cr Special fund account notes reference - page 267

End of day 6 - what to do now… Reinforce today’s learning Develop question skills Course Companion 1.Course notes review 2. Question practice 3. Study text review