Engineering Management Accounting Lecture 8 Revision

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Engineering ManagementAccounting Lecture
8Revision
ELE 2EMT
George Alexander G.Alexander_at_latrobe.edu.au http/
/www.latrobe.edu.au/eemanage/
4 October, 2007
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About the exam

• 2 pm 15/11, Language Centre but check venue
• Structure has changed from last year
• 20 multiple choice questions on management topics
  - worth 40 of exam
• Two Accounting questions - each worth 15 of exam
• Two Economics questions - each worth 15 of exam
• The exam is worth 70 of the total unit
  assessment
• Previous exam questions/solutions available at
  http//www.latrobe.edu.au/eemanage/ will be
  useful preparation, as well as these revision
  slides.

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Accounting for Engineers - because

• Engineers invariably operate in a managed
  business environment.
• Accounting provides a means of measuring the
  viability and performance of organisations.
• Accounting is closely linked to Engineering
  Economics in that it provides many of the
  analytical tools and data required for analysis.

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So what is accounting?

• The process of identifying, measuring and
  communicating economic information to permit
  informed judgement and decisions by users of the
  information.
• Bazley et al

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Financial Accounting

• That part of an accounting system that tries to
  meet the needs of various external users.
• Bazley et al

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Management Accounting

• That part of an accounting system that tries to
  meet the needs of management and internal users.
• Bazley et al

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Topics

• Financial Accounting
• Profit and Loss Statement
• Balance Sheet
• Cash Flows
• Capital assets/depreciation
• Business Analysis/Ratios
• Management Accounting
• Budget Process
• Organisation Structure
• Product Cost Calculation

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Balance Sheet(Statement of Financial Position)

• Records the financial position of the
  organisation at a given point in time.

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• Balance Sheet (Statement of Financial Position)
  as at
• Current Assets
• Cash at Bank 8 000
• Inventory 1 500
• Total Current Assets 9 500
• Non-Current Assets
• Equipment 5 000
• Total Non-Current Assets 5 000
• Total Assets 14 500
• Current Liabilities
• Accounts Payable 4 000
• Total Current Liabilities 4 000
• Net Assets 10 500
• Owners Equity
• Owner - Capital 10 500

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Profit and Loss Statement(Statement of Financial
Performance)

• Reports receipts and expenditure over the period
  in question the accounting period.

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Example Profit Loss Statement
Net Sales 707,500 Less cost of goods
sold 340,000 Gross Margin (gross profit)
367,500 Less operating expenses 325,500 Net
Profit 42,000
Note Tax is calculated on the Net Profit
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(No Transcript)
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Cash Flow Statement

• Reports cash flows in and out over the accounting
  period.
• It is an indicator of the organisations ability
  to survive in the short term

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The money flows

• IN
• Equity capital (Owners)
• Debt capital (Lenders)
• Revenue from sales (Customers)
• Interest on reserves (Financial Institutions)
• OUT
• Dividends (Owners)
• Repayments/Interest (Lenders)
• Purchases of assets (Suppliers)
• General expenditure (Suppliers/employees)
• Taxes/charges (Government)

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Definition of Assets (Bazley)

• Assets Future economic benefits controlled by
  the entity as a result of past transactions or
  other past events
• Fixed assets held for the purpose of
  generating income over a number of years.
• Current assets cash or cash-equivalent,
  expected to be realised within 12 months of the
  reporting date.

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Types of Assets

• Fixed Assets
• Buildings
• Plant
• Equipment
• Current Assets
• Stock (inventory)
• Cash on hand
• Accounts receivable
• Short-term investments
• Intangible assets e.g. patents, goodwill

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Other Expenditure

• Salaries and wages
• Rent and other building-related expenses
• Insurance
• Taxes and charges
• Marketing and advertising
• Communications
• Motor vehicles and travelling
• Entertainment

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Liabilities

• What the firm owes as a result of past
  borrowings or expenditure
• Current
• Short-term borrowings e.g. overdraft
• Accounts payable
• Taxes
• Non-current
• Long term borrowings
• Other future commitments

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Owners Equity or Net Worth Assets - Liabilities
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Why capitalise/depreciate?

• Capital assets have an estimated useful lifetime.
• Consequently, it would be misleading to account
  for the associated expenditure in just one
  accounting period.
• As a result, the expenditure is accounted for
  over the assets lifetime through depreciation.
• This also provides a basis for valuing the asset.
• ATO requires that the asset expense deduction is
  claimed over the assets lifetime.

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Depreciation

• Capital investment in tangible assets -
  equipment, computers, vehicles, buildings, and
  machinery - are commonly recovered through
  depreciation.
• The process of depreciating an asset accounts for
  the decrease in an assets value because of age,
  wear, and obsolescence.
• Depreciation is a tax-allowed deduction included
  in tax calculations.
• Taxes (income - deductions)(tax rate)

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Book Depreciation

• Used for internal managerial decision making.
• Management is free to use any method they so
  choose to compute book depreciation amounts.
• Any method can be used
• Straight Line,
• Declining Balance
• Other.
• Defines the reduced investment in an asset based
  upon usage pattern and an assumed life.

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Tax Depreciation

• Must follow the current state and federal law
  pertaining to acceptable methods for computing
  depreciation for income tax purposes.
• It may have nothing to do with the actual life
  of the asset or the usage pattern.

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Example - Straight Line Depreciation
B 50,000 n 5 years S 10,000 at t
5 Dt for each year is (50,000 - 10,000)/5
8,000/year
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Plot of SL Book Value
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Accelerated Depreciation

• SL book values decline in a linear fashion down
  to a specified salvage value.
• Declining Balance (DB) method allows the book
  value to accelerate faster.
• The SL method writes off the asset in equal
  amounts over the recovery period.
• The DB method permits greater depreciation
  amounts in the early years, and hence reduces the
  book value faster than the SL method.

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Accelerated Depreciation - cont.

• More depreciation in the early years means more
  tax savings sooner.
• Assumes a profitable firm.
• Tax savings early in the life of an asset has a
  greater present value than tax savings out in
  time.
• Larger depreciation amounts early on result in
  increased present worth of future tax savings to
  the firm.

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Need for Business Analysis

• Stakeholders and potential stakeholders need to
  know how to evaluate an organisations financial
  success.
• The evaluation process requires a good
  understanding of financial statements and
  performance ratios.

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Balance Sheet Relationship
Assets Liabilities Net Worth Net Worth
Assets - Liabilities
Net Worth also called Owners Equity or
Proprietorship
A L P P A - L
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Profit Loss StatementStatement of Financial
Performance

• The basic equation for profit is
• Profit Sales - Costs
• P L Statement shows an organisations sales
  revenues and costs over a given period, typically
  a year, quarter or month.
• A well-written statement can help in identifying
  the areas of the business associated with profit
  or loss.
• Assessment can be based on a division,
  department, business unit, product line, etc.

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Performance Ratios

• The gross margin percentage
• The net profit percentage of
  sales
• The operating expenses ratio
• Market ratios (based on share data)
• Other financial ratios ROA, ROI
• Employee ratios sales or earnings/employee
• The stock turnover ratio sales/average stock

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Financial Ratio Analysis

• Financial ratios are somewhat limited in meaning
  when viewed in isolation.
• They are more useful when used to compare similar
  companies (benchmarking), or when examining
  trends.
• Some ratios are available on financial websites
  such as Commsec and InvestorWeb.
• More detailed data is available on individual
  company websites.

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Example ROA Calculation
ROA Net Profit / Total Assets
Suppose that the total assets for the
organisation is 425,000 and the net profit is
42,000
ROA 42,000 / 425,000 0.0988
or 9.88
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ROI Return on investment
ROI Net Profit / Net Worth
This shows the profitability of shareholders
equity. Suppose that the total assets for the
organisation is 425,000, the net profit is
42,000 and the total liabilities are 200,000.
ROI 42,000 /( 425,000 200,000) 0.187
or 18.7
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Budget

• This is a key aspect of management accounting
  within the organisation.
• Bazley et al define the budget as
• A short and long-term plan of action for the
  future operating activities of a business,
  expressed in monetary terms.
• It covers a period of time called the budget
  period which is normally one year.

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Overall Purpose of the Budget

• Budgetary Control actual performance can be
  compared with the budget to identify any
  deviations so that management can take corrective
  actions. (Bazley et al).
• Budgetary control provides a useful mechanism for
  predicting likely financial outcomes to the
  stakeholders.

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PL/Balance Sheet/Budget

• PL reports receipts and expenditure over the
  period in question the accounting period.
• The Balance Sheet records the financial position
  of the organisation at a given point in time.
• The budget is attempting to predict in advance
  what the PL will look like in the same timeframe
  the budget period, and what the balance sheet
  will look like at the end of the same period.

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Significance of the manufacturing budget

• It is a major factor in determining the cost of
  the goods sold (refer PL).
• It needs to be accurate or
• Overstated cost could result in uncompetitive
  pricing.
• Understated cost could result in low pricing and
  reduced profit
• Refer example manufacturing cost calculation

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Manufacturing budgets required

• Budget Type
• Capital
• Personnel
• Expenses
• Inventory
• Purchases

• Impacts
• Cash flow, depreciation expenses
• People-related expenses
• Hourly rate calculations
• Borrowings, warehouse planning
• Cash flow

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Manufacturing Resource PlanningMRP II

• Computer based information system integrating
  production planning and control activities of
  basic MRP systems with related financial,
  accounting, personnel, engineering and marketing
  information.
• MRP Materials Requirements Planning
• Bartol, K.M., Martin, D.C., Tein, M.,
  Matthews, G., Management A Pacific Rim Focus,
  McGraw-Hill, 2002 (Supplement 2 to Chapter16)

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Budget Inputs Required

• Forecast of specific product volumes
• The latest comparison of budget and actuals
• Forecasts of inflation rates and salary
  increases.
• Specific cost reduction/efficiency initiatives.
• Charges from other departments (facilities,
  support etc.)

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Impact of volume variations

• This occurs when actual sales vary from budget.
• The most serious consequence is when sales fail
  to meet budget.
• As a rule, direct costs are variable and can be
  adjusted to changed volumes.
• This rule may not apply if the volume variation
  is significant but temporary.
• The major problem arises with overhead costs
  which are relatively fixed.

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Impact on Profit Loss Statement
Budget Actual Net Sales
69,160,000 62,244,000 Less cost of goods
sold 33,250,000 30,613,000 Gross Margin
(gross profit) 35,910,000 31,631,000
Less operating expenses 31,813,600
31,813,600 Net Profit 4,096,400
(182,600)
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How to react?

• Scrutinise all budget elements for cost-cutting
  possibilities.
• Actions will depend on the size of the volume
  variation, and how sustained it is expected to
  be.
• Increase the price to restore the margin???
• Refer price elasticity

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Improving Net Profit

• Increasing prices
• Pricing objectives
• Supply v demand, etc.
• Competition
• Reducing cost of goods sold
• Alternative sources
• Make or buy, etc.
• Reducing operating expenses
• Efficient use of resources
• Management policies, etc.

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Setting Prices

• 1. Determine your pricing objectives.
• 2. Know the importance of price to your target
  market.
• 3. Know your demand.
• 4. Understand your costs.
• 5. Determine your pricing strategy.
• 6. Competitor issues pricing etc.

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Know Your Demand

• Price Elasticity - A measure of the effect of a
  change in price on the quantity of the product
  demanded.
• Relative Price Inelasticity
• Relative Price Elasticity
• Total Price Inelasticity
• Total Price Elasticity

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Know Your Costs

• Cost provides the floor on which to build a
  pricing strategy.
• Pricing methods based only on costs fails to
  include the all-important buyer in the pricing
  effort.
• Products may occasionally be sold at a loss, but
  cost must be recouped sooner or later.

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Supply Demand Relationship
High
S
Price
P1
D
Low
Q1
High
Low
Quantity
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References

• Bazley, Hancock, Berry, Jarvis Contemporary
  Accounting, Thomson
• Australian Taxation Office website
• www.ato.gov.au

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• Good luck on Nov 15!