BS and Depreciation 3.5 IB BUS MGT

Limitations of Balance Sheet Balance Sheets are static documents – financial position can change next day The value of assets on BS are only estimates, the true value is not known until the asset is sold Not all assets, especially intangible ones, are included in the balance sheet, e.g. Football Players

Uses of Balance Sheets We can see the Working Capital figure to show the amount of money available to the business for the day-to-day running of the bus Capital Employed figure can indicate the size of a firm for potential investors The asset structure can be analysed to see if there is too much OVERTRADING in stocks or whether they are trying to expand with more fixed assets

Evaluating the Importance of Final Accounts to Each Stakeholder Group Different stakeholders will view the accounts with different perceptions depending on the stakeholder’s objectives and motives. Stakeholders will also have to consider qualitative information as well as the external environment in which it operates Given the economic uncertainty at the moment, balance sheet values should be treated with caution. The lessons of the dot.com boom need to be learnt!...

Today’s Lesson Objectives By the end of this morning’s lesson you will: Be able to DEFINE the term depreciation means Understand where and how depreciation is recorded in the financial reports and be able to APPLY this to given examples Be able to CALCULATE Straight Line Depreciation and Reduced Balanced Be able to ANALYSE the use of both methods of depreciation

Taylor Autocratic Job enlargement Trust Employees Hierarchy Responsibility Safe Working Conditions Theory Y Strict Supervision Theory X Piece rate Motivators Self-Esteem Pay as a Motivator Two factor Theory Scientific Hygiene Factors Self actualisation Physiological FIXED ASSETS Vehicles Equipment Debentures Creditors Buildings Bank Loan Cash Debtors Property Premises Land Stock Machinery Fixed Assets Fixed Assets ASSETS & LIABILITIES ASSETS & LIABILITIES

Depreciation – the definition… The reduction in the value of a fixed asset over its useful life Depreciation is usually measured annually

Explanation of Depreciation When you buy a new car or computer it loses value the minute it leaves the shop. Why?

Why Assets Depreciate in Value Technology moves on – newer technology makes the asset’s current technology obsolete or less valuable Time – the more time goes on, the less valuable an asset may become because of many reasons such as fashion/tastes changing Wear and Tear – the more the asset is used, the more it breaks down and develops problems with it’s functions

Why is this Important for Financial Accounts? The Balance Sheet has to show an accurate value of the assets on the day it is prepared. Depreciation is a business expense (i.e. they are losing money) which must be deducted in order to show accurate levels of profit. Whereabouts on the Balance Sheet do you think depreciation is recorded?

Balance Sheets £££ Cost Depreciation to date Net Book Value Fixed Assets Land & Buildings 250, ,000 Machinery120,00060,00060,000 Motor Vehicles 50,00030,00020,000

Profit & Loss Accounts ££ SalesX Less Cost of Sales (X) Gross Profit X, Less Expenses DepreciationX Other expenses X Total Expenses (X) Net Profit X or (X)

Annual Depreciation Charge The Straight Line Method Cost of the Asset – Residual Value of the Asset Useful Life (years) What you paid for it What it’s going to be worth when you’ve finished with it How long you intend to keep it for

Straight Line Depreciation Example When Barabbas bought his car it cost him $1,500. He intends to keep it for 5 years, at which point he expects to sell it for $200. What is Barabbas’ annual depreciation charge?

Answer $1,500 - £200 5 years = $260 per year. We can put this straight into the expenses section of our P&L Account and in to the Fixed Assets section of the Balance Sheet

And for the Balance Sheet? Yr Annual Depreciation Charge ($) Cost ($) Depreciation to Date ($) Net Book Value ($)

Reducing Balance Method of Depreciation

Why do we use the Reducing Balance Method? Does a car depreciate in value equally over it’s lifetime? TIME VALUE

How the Reducing Balance Method Works A set PERCENTAGE is taken off the value of the asset every year it is owned.

Have A Go… Anjana bought a $25,000 Jaguar to impress clients of her new HR consultancy business. She decided to depreciate it at the rate of 40% every year. She intends to trade it in for a Porsche in 5 years time. Calculate Anjana’s depreciation using the Reducing Balance Method. Was this a good figure to use?

AnswerYear Value Brought forward Depreciation charge (40%) Value carried forward 1£25, £10,000£15,000 £1,296 £6,000£9,000 £3,600£5,400 £2,160£3,240 £15,000 £1,944

Balance Sheet/Depreciation Past Paper Question ZORA $$ FIXED ASSETS(30,000 – 19,200) Fixed Assets after Depreciation10,800 CURRENT ASSETS Stock8,000 Debtors14,000 Cash2,000 24,000 CURRENT LIABILITIES Creditors12,000 Short-Term Borrowing800 12,800 NET WORKING CAPITAL (Current Assets – Current Liabilities)11,200 NET ASSETS EMPLOYED (Fixed Assets + Working Capital)22,000 Finance By: Loan Capital11,600 Retained Profit8,500 Share Capital1,900 CAPITAL EMPLOYED22,000

a) 25,000 X 0.35 = 8,750 25,000 – 8,750 = 16,250 16,250 X 0.35 = 5, ,250 – 5,687.5 = $10,562.5

b)

C) Straight-Line Method = $25,000 – (4,420 X 3) = $11,740 Reducing Balance Method = $10,562.5 X 0.35 = 3, = $10,562.5 – 3, = $6,865 after 3 years Therefore the reduced balance method would depreciate the car most by end of the third year

D) $$ FIXED ASSETS Building38,260 Company Car11,740 50,000 CURRENT ASSETS Cash4,500 Debtors2,100 6,600 CURRENT LIABILITIES Creditors12,250 Overdraft8,550 20,800 NET WORKING CAPITAL (Current Assets – Current Liabilities)(14,200) NET ASSETS EMPLOYED (Fixed Assets + Working Capital)35,800 Finance By: Loan Capital12,800 Reserves800 Share Capital22,200 CAPITAL EMPLOYED35,800

e)

What we will learn now… By the end of this lesson you will: Be comfortable using the Straight Line Method of Depreciation Understand why we use the Reducing Balance Method of Depreciation Begin to be able to calculate depreciation using the Reducing Balance Method

What have we learned? Be comfortable using the Straight Line Method of Depreciation Understand why we use the Reducing Balance Method of Depreciation Begin to be able to calculate depreciation using the Reducing Balance Method

3.5 Intangible Assets: Higher Level These are non-physical assets that add value to the business, generate income and are not intended for sale within 12 months, therefore are FIXED ASSETS on B.S. Types of Intangible Fixed Assets: – Patents – Trademarks – Goodwill – Copyright They are difficult to measure and value and so are sometimes not shown on the balance sheet. They are also referred to as Intellectual Property Rights (IPR).

Vodafone’s Window Dressing

Patents If you have a new invention you can patent it. A new patent can protect many different aspects of a new product such as how it works, what it does, what it is made of and how it is made, for up to 20 years Firms must pay a fee to the patent holder if they wish to use or copy the ideas

Trademarks

A trademark protects any sign or symbol that distinguishes what you offer from your competitors. You can register a name, logo, slogan, domain name, a shape, a colour or a sound.

Trademarks A registered trade mark must be renewed every ten years to keep it in force Also provide legal protection against those that try to copy it Registered trademarks can be sold for appropriate fees (which should be reflected in the balance sheet). E.g. When Volkswagen bought the Bentley brand for $860 million in 1998

Copyright A copyright protects creative or artistic works such as: – Literature, including novels, instruction manuals, computer programs, song lyrics, newspaper articles and website content – Music compositions and recordings – Art, including paintings, engravings, photographs, sculptures, collages, - recordings of a work, including sound and film – Broadcasts of a work Others have to pay for the right to use your work. For example, when music is played on the radio, a copyright fee is paid to the artists who wrote it

Goodwill This is the value of an organisation’s image and reputation Goodwill is the sum of customer and staff loyalty to the business

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