Lecture 5 Flashcards
What is the capital working cycle?
The sequence of transactions and events, involving current assets and current liabilities through which the business makes profit
What is the working cycle if you were to draw it?
Inventories (stocks) -> Receivables (debtors) -> Cash -> Payables (creditors) in a circle
What is the definition of working cycle?
The amount of finance which a business might provide to finance the current assets of a business to the extent that these are not covered by current liabilities
How do you calculate the working capital?
Current assets - current liabilities
What does it mean if the working capital of a business is low?
The business has a close match between current assets and current liabilities
May risk not being able to pay its liabilities as they fall due
Not enough inventory to meet demand
What does it mean if the working capital of a business is high?
Current assets are greater than current liabilities
Too much money being put into current assets
If assets are MUCH GREATER than liabilities, business has a lot of finance tied up in the current assets when the finance would maybe be put to better use by getting more fixed assets to expand the profit-making capacity of operations
What is the future economic benefit of finished goods, WIP, raw materials?
The selling price which exceeds the cost of purchase or manufacture that makes a profit and increases OI but prudence dictates that profit should not be anticipated
How are finished goods, WIP and raw materials measured?
The cost of purchase or manufacture
If the cost of manufacture is less than the market value, which figure should be used?
The lower one - so in this case, cost of manufacture
What are receivables (debtors)?
People who owe money to a business
What are trade receivables?
Amount outstanding from customers buying goods on credit
What are some examples of other receivables?
Loans made to another enterprise to help that enterprise in its activities
Loans made to employees to cover removal and relocation expenses or advance in salaries
Refund due to overpaid tax
Why do trade receivables meet the recognition conditions?
There is an expectation of benefit when the customer pays
How are trade receivables measured?
At the selling price of the goods
In terms of trade receivables, when is profit recognised?
When the goods or services have been supplied to the customer
What are doubtful debts?
When there is a risk that a customer will not pay
How are doubtful debts/risk of non-payment dealt with?
By reducing the reported value of the reported value of the asset by and estimate for doubtful debts
What are prepayments and what are some examples?
Amounts of expenses paid in advance
E.g. rent, insurance premiums
Tell me about investments as current assets
Usually highly marketable and readily convertible int cash
Expectation of future economic benefit is therefore usually clear
How are investments as current assets measured?
At fair value
What is fair value equal to?
Selling price
Is change in fair value reported in the income stamens?
Yes x
What is the meaning of cost?
The cost of any item of inventory or WIP is specified as the expenditure
Has to be incurred in the normal course of business in bringing the product or service to its present location and condition
How is expenditure calculated?
Purchase price + transport and handling + import duties - discounts - subsides
Treatment of item of inventory whose market value has decrease due to obsolesce, damage or other changes in market conditions
Items have become “slow moving”
How do we treat these items?
Application of the prudence concept
Inventories are valued at the lower between the cost and the market value (net realisable value)
How would you calculate the Net Realisable Value?
Estimated selling price - any further costs of completion and all costs to be incurred in marketing, selling and distributing the sale
EXAMPLE:
Coffee beans purchased by coffee manufacturer for $1,000. Beans hold for 3 months up to the date of the financial statements.
During that time, there is a fall in the word price of coffee beans and the coffee beans would now only sell for $800 in the market.
What effect will this have on the accounting equation?
When asset is acquired:
Assets (inventory) will increase by $1000 and assets (cash) will decrease by $1000
After asset found to be worth $800:
Assets (inventory) decrease by $200 and OI (expense) decrease by $200
What should be done if there is doubt about the value of an asset?
Directors should be invited to consider making provision (estimation of the amount of doubtful debt that will need to be written off) against the loss of the asset
What should be done when it is KNOWN that the debt is bad (customer has declared themselves bankrupt)?
Debtor should be removed from the record s a bed debt (trade receivable value as €0)
Where/how would you record doubtful debts in a spreadsheet?
Under assets (provisions) and OI (profit of the period)
EXAMPLE:
During year 2, customer who was showing signs of financial distress could improve their financial position and there is no longer any doubt that they will not be able to make their payment.
At the end of year 2, provision for doubtful debts is no longer needed
At the end of year 2, the receivables amount to €2,500. A review of th list of debtor causes considerable doubt regarding an amount of €350/
A new provision of €350 is created
How would you record in the spreadsheet if the provision is no longer needed (customer was able to improve financial situation and so can pay the complete amount)?
Remove it from the record under the provisions
For example if doubtful debt was already recorded as -€200, add €200 back to assets (provisions) and OI (profit of the period)
How is tax recorded on the balance sheet?
Liability increase, OI decrease
When tax paid in following year:
Assets (cash) decrease, liability decrease
What will an understatement of liabilities result in?
An overstatement of the OI
What is the matching concept?
Match all expenses of the period against revenue, whether paid in cash or not
What is the matching concept?
Match all expenses of the period against revenue, whether paid in cash or not
What is the accruals concept?
Record all known liabilities at the date of the financial statements
What does the accrual of a liability allow the reporting entity to do?
To match costs incurred with the revenue that have been generated in the accounting period
What is this an example of?
When a company purchases supplies from a vendor but has not yet received an invoice for the purchase
Accrual
What if payment is made in advance for the year ahead and the benefit is gradually used up as the year goes along e.g. insurance premium?
(on the balance sheet and income sheet)
Need to allow the balance sheet to recognise the unexpired portion of the insurance premium as an asset
The income statement will report the amount consumed during the period
EXAMPLE:
On 1 Oct Year , a company paid $1,200 for one year’s vehicle insurance. At the balance sheet date of 31 Dec there have been three months benefit used up and there is a nine month benefit yet to come.
How would this be recorded on the spreadsheet?
Payment of premium:
Cash -1200
Expense -1200
Identification of asset remaining as prepayment:
Prepayment +$900
Expense +$900
Cash total: -1200
Prepayment total: +900
Expense total: -300
