Accounting and Finance Midterm PDF

Money for Engineers Financial Accounting I Sameh Al-Shihabi The University of Sharjah Learning Objectives 1. Financial statement 2. Accounting equation 3. Users Sameh A...

Money for Engineers Financial Accounting I Sameh Al-Shihabi The University of Sharjah Learning Objectives 1. Financial statement 2. Accounting equation 3. Users Sameh Al-Shihabi Reflections What is the CV of a company? Person: Education, experiences, training, etc. Country: GDP, GDP per Capita, inflation, growth, unemployment, etc. Company: ? Sameh Al-Shihabi 3 Reflections Check the financial statement of Emaar for the year 2022. From the first page, try to answer the following: 1. What is the principal activity of the company? 2. How much profit was made in 2022? 3. Will the shareholders get any money? 4. Who is the auditing company? Sameh Al-Shihabi 4 Reflections Check the financial statement of Emaar for the year 2022. From the second page, opinion, try to answer: 1. What does the auditor say about the financial statement? 2. What accounting standards were used? Sameh Al-Shihabi 5 Reflections Check the financial statement of Emaar for the year 2022. How many statements does the report has? What is the purpose of each statement? What is the most important number in all these statement? Sameh Al-Shihabi 6 Reflections- Can you guess the equations for Income statement Balance sheet Sameh Al-Shihabi 7  Financial Account I LO 1 Financial Statement Business Activities All businesses are involved in three types of activity — ◆financing, ◆investing, ◆and operating. Sameh Al-Shihabi 9 Business Activities Financing Activities Two primary sources of outside funds are: 1. Borrowing money ◆ Amounts owed are called liabilities. E.g. Bonds ◆ Party to whom amounts are owed are creditors. 2. Issuing shares of stock for cash. ◆ Payments to stockholders are called dividends. Sameh Al-Shihabi Business Activities Investing Activities Purchase of resources a company needs to operate. ◆ Computers, delivery trucks, furniture, buildings, etc. ◆ Resources owned by a business are called assets. Business Activities Operating Activities Once a business has the assets it needs, it can begin its operations. ◆ Revenues - Amounts earned from the sale of products (sales revenue, service revenue, and interest revenue). ◆ Inventory - Goods available for sale to customers. ◆ Accounts receivable - Right to receive money from a customer,in the future, as the result of a sale. Sameh Al-Shihabi Business Activities Operating Activities ◆ Expenses - cost of assets consumed or services used. (cost of goods sold, selling, marketing, administrative, interest, and income taxes expense). ◆ Liabilities arising from expenses include accounts payable, interest payable, wages payable, sales taxes payable, and income taxes payable. ◆ Net income – when revenues exceed expenses. ◆ Net loss – when expenses exceed revenues. Sameh Al-Shihabi Company Resume Companies prepare four financial statements from the summarized accounting data: Retained Statement Balance Income Earnings of Cash Sheet Statement Statement Flows Sameh Al-Shihabi Financial Statement Income Statement ◆ Reports revenues and expenses for a specific period of time. ◆ Net income – revenues exceed expenses. ◆ Net loss – expenses exceed revenues. What would you do with the net income? Sameh Al-Shihabi Reflections Check the financial statement of Emaar for the year 2022. 1. Fill the numbers Revenue= ……………. -Cost= …………….. Gross profit 2. Why the gross profit is not the same as the total comprehensive income of the year Sameh Al-Shihabi 16 Financial Statement Income Statement Retained Earnings Statement Net income is needed to determine the ending balance in retained earnings. Sameh Al-Shihabi  Financial Statement ◆ Statement shows amounts and causes of Retained Earnings changes in retained earnings during the Statement period. ◆ Time period is the same as that covered by the income statement. Sameh Al-Shihabi  Financial Statement Balance Sheet Retained Earnings Statement Ending balance in retained earnings is needed in preparing the balance sheet. Reflections Check the financial statement of Emaar for the year 2022. What will happen to the made earnings? Check the balance sheet for the retained earnings number? Sameh Al-Shihabi 20 Financial Statement Balance Sheet ◆ Reports assets and claims to assets at a specific point in time. ◆ Assets = Liabilities + Stockholders’ Equity. ◆ Lists assets first, followed by liabilities and stockholders’ equity. Sameh Al-Shihabi Reflections Check the balance sheet of Emaar. -Total assets= total liabilities+ total equities …. Is this statement true for Emaar -Classify the assets -Classify the liabilities Sameh Al-Shihabi 22  Financial Statement Balance Sheet Statement of Cash Flows Sameh Al-Shihabi Financial Statement Statement of Cash Flows Answers: ◆ Where did cash come from during the period? ◆ How was cash used during the period? ◆ What was the change in the cash balance during the period? Sameh Al-Shihabi  Financial Account I LO 2 The Accounting Equation Equation Assets =Liabilities + Equities Sameh Al-Shihabi 26 Double-Entry Principle Any transaction needs to be recorded twice Sameh Al-Shihabi 27 Basic Accounts 1. Asset accounts: 1. Cash 2. accounts receivable: 3. Assets: 2. Liability accounts: 1. accounts payable: 2. Debt/ Loans: 3. Equities: 1. Revenue: 2. Expense: 3. Capital Sameh Al-Shihabi 28 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 1. Asset accounts: 1. Cash 2. accounts receivable Assets =Liabilities + Equities 3. assets. 2. Liability accounts: ? = + 1. accounts payable 2. debt. 3. Equities: 1. Revenue accounts. 2. Expense accounts. 3. Capital Sameh Al-Shihabi 29 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café Assets =Liabilities + Equities 200,000 = 0 + 200,000 Sameh Al-Shihabi 30 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 1. Asset accounts: 1. Cash 2. accounts receivable Assets =Liabilities + Equities 3. assets. 2. Liability accounts: = + 1. accounts payable 2. debt. 3. Equities: 1. Revenue accounts. 2. Expense accounts. 3. Capital Sameh Al-Shihabi 31 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED paid in cash Assets =Liabilities + Equities = 0 + Sameh Al-Shihabi 32 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED paid in cash 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) Assets =Liabilities + Equities Sameh Al-Shihabi 33 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) 4. He employed 2 workers and paid each 10,000 AED (Note this is expenses to be taken ) Assets =Liabilities + Equities ? = + Sameh Al-Shihabi 34 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) 4. He employed 2 workers and paid each 10,000 AED (Note this is expenses to be taken ) Assets =Liabilities + Equities Sameh Al-Shihabi 35 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) 4. He employed 2 workers and paid each 10,000 AED (Note this is expenses to be taken ) 5. Ahmad starting selling and made a revenue of 90,000 in the first year. Assets =Liabilities + Equities ? = + Sameh Al-Shihabi 36 Example Ahmad, would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) 4. He employed 2 workers and paid each 10,000 AED (Note this is expenses to be taken ) 5. Ahmad starting selling and made a revenue of 90,000 in the first year. Sameh Al-Shihabi 37 Example Balance Sheet Income Statement Sameh Al-Shihabi 38 Example Develop a statement of retained earnings if Ahmed would like to keep 50% of the profit in the company while spending the other 50% in a trip 39  Financial Account I LO 3 Users Users and Uses of Financial Information Who Uses Accounting Data External Internal Users Human Taxing Users Resources Authorities Labor Unions Finance Management Customers Creditors Marketing Regulatory Agencies Investors Sameh Al-Shihabi Users and Uses of Financial Information Questions Asked by Internal Users User 1. Can we afford to give our Human Resources employees a pay raise? 2. What price for our product Marketing will maximize net income? 3. Which product line is most Management profitable? 4. Is cash sufficient to pay Finance dividends to the stockholders? Sameh Al-Shihabi Users and Uses of Financial Information Questions Asked by External Users User 1. Is the company earning Investors satisfactory income? 2. How does Emirates Airlines Investors compare in size and profitability with Etihad? 3. Will Emirates be able to pay Creditors its debts as they come due? Sameh Al-Shihabi Money for Engineers Financial Accounting II Sameh Al-Shihabi The University of Sharjah Exercise Record the transactions given in the given exercise. 2 Reflections -Check Emirates financial report -Which company audited the report? -Check the main numbers of the income statement and balance sheet. -Check the operating, investing, and financing cash flow numbers? 3 Learning Objectives 1. External Auditing 2. Business Performance 3. Financial Ratios 4. Liquidity 5. Operational Measures  Financial Account II LO 1 External Auditing Financial Accounting Cash-based Accrual-based Cash-basis accounting Using the accrual method, documents earnings when you revenue is recorded when a sale receive them and expenses is made—whether or not cash is when you pay them. received at the time. Easy More complex Simple rules Follows GAAP or IFRS A must for Corporations 6 Accrual Accounting When recording revenues If a small delivery business provides $2,500 worth of services after two months, cash-based accounting will not record those sales until the customers actually pay. Accrual-based accounting would record the $2,500 as revenue right away. When recording expenses If a small delivery business got a fuel bill for $1,000 to be paid later, cash-based accounting would record the expense when the bill is paid, while accrual-based accounting would record the expense the moment the bill arrived. 7 Accrual Accounting Standards GAAP IFRS GAAP stands for Generally IFRS stands for International Accepted Accounting Principles, Financial Reporting Standards, which are the generally which are a set of internationally accepted standards for financial accepted accounting standards reporting in the United States used by most of the world's countries. 8 External Auditing An external audit looks at the accuracy of a company's financial statements and whether its accounting practices comply with all applicable rules and regulations. The auditor also verifies that the financial reports and records offer an accurate picture of the company's performance. 9 External Auditing - Responsibilities In an external audit, the external auditor expresses an opinion as to whether the financial statements are prepared in accordance with the used financial standards. The responsibility of the auditor is only to express an opinion about whether the financial statements are presented fairly and in conformity with the used financial standards. The auditor must plan and perform the audit so as to obtain reasonable assurance about whether the financial statements are free of material misstatement. The client’s (the company’s) management is responsible for the financial statements. Users and Uses of Financial Information Who Uses Accounting Data External Internal Users Human Taxing Users Resources Authorities Labor Unions Finance Management Customers Creditors Marketing Regulatory Agencies Investors Users and Uses of Financial Information Questions Asked by Internal Users User 1. Can we afford to give our Human Resources employees a pay raise? 2. What price for our product Marketing will maximize net income? 3. Which product line is most Management profitable? 4. Is cash sufficient to pay Finance dividends to the stockholders? Users and Uses of Financial Information Questions Asked by External Users User 1. Is the company earning Investors satisfactory income? 2. How does Emirates Airlines Investors compare in size and profitability with Etihad? 3. Will Emirates be able to pay Creditors its debts as they come due?  Financial Account II LO 2 Business Performance Business Performance Financial statements used in evaluating overall business performance include the balance sheet, the income statement, and the statement of cash flows. Financial performance indicators are quantifiable metrics used to measure how well a company is doing. No single measure should be used to define the business performance of a firm. 15 Basic Analytical Methods Users analyze a company’s financial statements using a variety of analytical methods. Three such methods are: Horizontal analysis Vertical analysis Common-sized statements Horizontal Analysis Each item on the most recent statement is compared with the same item on one or more earlier statements in terms of the following: Amount of increase or decrease Percent of increase or decrease Comparative Balance Sheet— Horizontal Analysis Comparative Income Statement— Horizontal Analysis Exercise Use Emirates financial statement to conduct a horizontal analysis for Cash Inventory Current assets Total assets Current liabilities Total Liabilities Revenue Profit Vertical Analysis The percentage analysis of the relationship of each component in a financial statement to a total within the statement is called vertical analysis. Each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity. In a vertical analysis of the income statement, each item is stated as a percent of sales. Comparative Balance Sheet— Vertical Analysis Comparative Income Statement— Vertical Analysis Exercise Use Emirates financial statement to conduct a vertical analysis for Assets (total assets 100%) Income statements (sales 100%) Main items only Common-Sized Statements In a common-sized statement, all items are expressed as percentages, with no dollar amounts shown. Common-sized statements are useful for comparing one company with another or comparing a company with industry averages. Common-Sized Income Statements  Financial Account II LO 3 Financial Ratios  Overview of Financial Statement Analysis Ratios are measures of a company’s state or performance. Ratios do not mean anything until they are put into a context This can be done by comparing the ratio to the same ratio for the same company for a prior period, or By comparing the ratio to a different company for the same period, or By comparing the ratios to management expectations for that period. Classifications of Ratios The different ratios are classified into the following categories Liquidity Operational measures Capital structure or solvency Return on invested capital Profitability analysis Earnings-based analysis, or earnings per share  Financial Account II LO 4 Liquidity Liquidity Liquidity is a financial concept about an asset’s “nearness to cash” or the ease of converting an asset to cash. Cash is the most liquid asset. Liquidity ratios help determine whether an organization can pay its bills and maintain its normal business operations. Firms with insufficient liquidity may be unable to pay their employees, their suppliers, or their operating expenses in a timely manner. 31 1-Working Capital Working capital is measured as: Current Assets – Current Liabilities Generally a company’s working capital (Current Assets − Current Liabilities) must be positive. If it is not, that is an indication that the company will not be able to pay its obligations as they come due. If it is too large it indicates that the company is not properly investing its assets. This is because current assets provide little or no return. 2-Current Ratio The current ratio measures working capital as a ratio instead of a dollar amount. It is calculated as: Current Assets Current Liabilities Again, this number should be more than 1. The specific ‘target’ amount depends on the business and the industry.  3-Quick Ratio The quick ratio is a more conservative version of the current ratio, because it does not include inventory in the numerator. This is because the company should not use inventory to pay its liabilities as the company would then have nothing left to sell. Cash + Cash Equivalents + Receivables Current Liabilities This is also called the “Acid-test Ratio”  4-Cash Ratio The cash ratio is measures how liquid the company’s current assets are. Cash Current Assets If a company’s current assets are mostly accounts receivable and inventory, its cash ratio will be low, which indicates a possible liquidity problem. Exercise From the Emirates financial statement, calculate 1- Working capital 2-Current ratio 3-Quick ratio 4-Cash ratio  Financial Account II LO 5 Operational Measures Inventory Turnover Ratio This measures the number of times the company sells its inventory during a year’s time. Annual Cost of Sales Average Inventory If this number is too low, it may indicate that the company has too much inventory and thus has too much cash invested in inventory. If the number is too high it may indicate that they do not have enough inventory and are losing sales because of stockouts.  Days of Sales in Inventory This measures the number of days the average inventory item is held in inventory. 365, 360 or 300 (given in the question) Inventory Turnover The higher the number, the less risk that there is of a stockout; but the more cash is invested in inventory. Accounts Receivable Turnover Like the Inventory Turnover number, this measures how many times during a year the company’s receivables “turn over” (are collected and replaced by other receivables). Net Annual Credit Sales Average Accounts Receivable If this ratio decreases over time, it means the company is collecting its receivables more slowly, an indication of a possible problem. Days of Sales in Receivables This is the number of days of sales that are outstanding and not yet collected (held as receivables) 365, 360 or 300 (given in the question) Receivables Turnover This should be compared with the company’s credit terms and with industry averages. The number of days should not be higher than the credit terms the company offers. Operating Cycle The operating cycle measures the amount of time it takes to convert an investment in inventory back into cash after the collection of the sale. It is: Days of Sales in Inventory + Days of Sales in Receivables Accounts Payable Turnover Accounts payable turnover shows how many times a company pays off its accounts payable during a period. Total Cost of Sales (COGS) Average Accounts Payable Days of Purchases in Payables This measures how many days of the company’s purchases are outstanding and not yet paid for (invoices held as payables) — i.e., how many days the company takes to pay its payables. 365, 360 or 300 (given in the question) A/P turnover Cash-to-Cash Cycle The cash-to-cash cycle represents the number of days that cash is tied up in the operating cycle of the business. It is: Days of Sales in Inventory + Days of Sales in Receivables – Days of Purchases in Payables Exercise From the Emirates financial statement, calculate 1- Working capital 2-Current ratio 3-Quick ratio 4-Cash ratio  Financial Account II LO 6 Profitability Gross Profit Margin This measures the percentage of the sales price that the company gets to keep after paying for the cost of goods sold. This margin will be available to cover other costs (both fixed and variable) and then for profit after costs are covered. It is calculated as Gross Profit Margin= ( Net Sales – Cost of Goods Sold) (operating profit) Net Sales Net Profit Margin The net profit margin is the overall profit margin net of all expenses. Net Income Net Profit Margin = Net Sales  Financial Account II LO 7 Return on Assets and Equities Return on Asset (ROA) ROR measures the return received from the available assets ROA= Net Income/Average Total Assets Du Pont equation: ROA=Net Income/Net Sales* Net Sales/Average Total Assets 51 Return on Equity (ROE) ROE measures the return received from equities ROE= Net Income/Average Total Equity 52  Financial Account II LO 8 Capital Structure Do Not Use Your Money Imagine you are investing AED 1 million in a project. The project income is AED 100,000. Q1- What is the ROA? Q2-If these assets were totally bought by your cash, what is the ROE? Q3-If the assets were financed 50%-50% from your cash and a bank loan. The bank interest rate is 4%. What is the ROA and ROE? -Interest= -New income= -Used equity= -ROA= -ROE= 54 Do Not Use Your Money Imagine you are investing AED 1 million in a project. The project income is AED 100,000. Q4-If the assets were financed 20%-80% from your cash and a bank loan. The bank interest rate is 4%. What is the ROA and ROE? -New income= -Used equity= -ROA= - ROE= Q5-If the assets were financed 10%-90% from your cash and a bank loan. The bank interest rate is 4%. What is the ROA and ROE? -New income= -Used equity= -ROA= - ROE= 55 Financial Leverage Ratio This ratio indicates the amount of debt the company is using the finance its assets. Total Assets Financial Leverage Ratio = Total Equity The more debt the company has, the higher this ratio will be. Summary Assets Net Income ROA% Equity ROE% FL ROE/ROA 1,000,000 100,000 10% 1,000,000 10% 1 1 1,000,000 80,000 8% 500,000 16% 2 2 1,000,000 68,000 6.6% 200,000 34% 5 5 57  Financial Account II LO 9 Solvency Total Debt to Total Capital This ratio measures what proportion of the company’s assets are financed by creditors. It is an indication of the firm’s long-term debt repayment ability. Total Liabilities Total Debt to Total Capital = Total Assets Money for Engineers Cost Accounting I Sameh Al-Shihabi The University of Sharjah Case 1 A factory producing tables only. Production 1000 table per year. Each table need AED 100 of wood and 10 hours of work each hour of work cost AED 5. 1- What is the value of the direct material (DM) needed to produce a table? 2-What is the direct labor (DL) needed to produce a table? 3-What is the cost of the table? 4-If you would like to make a 25% profit, what should be the selling price? Sameh Al-Shihabi, Project Management 2 Case 2 A factory producing tables only. Production 1000 table per year. Each table need AED 100 of wood and 10 hours of work each hour of work cost AED 5. The running expenses of the factory is 100,000 per year 1-What is the manufacturing overheads (MoH)? 2-How much MoH will you allocate to each table 3-What is the new cost of the table? 4-If you would like to make a 25% profit, what should be the selling price? Sameh Al-Shihabi, Project Management 3  Case 3 A factory producing tables only. Production 500 table and 500 chair per year. Each table need AED 100 of wood and 10 hours of work each hour of work cost AED 5. Chairs needs AED 50 of wood, and 5 hours of work, costing AED 5/hour. The running expenses of the factory is 100,000 per year. How much will you sell a table and chair to make a profit of 25%. Item DM DL MoH Cost (DL+DM+MOH) Selling price Table Chair Sameh Al-Shihabi, Project Management 4 Reflection What are the manufacturing processes and inventories involved in manufacturing the security cabins? 5 Metal Metal Bending Semi Assemble Finished Metal cut sheets cutting and welding finished window security to size Glass and door cabins … Sameh Al-Shihabi 6  RM WIP FG Metal Metal Bending Semi Assemble Finished Metal cut sheets cutting and welding finished window security to size Glass and door cabins … Sameh Al-Shihabi 7  FG RM WIP 1 WIP 2 AED 15,000 AED 10,000/ ? AED/ ? AED/ /cabin Cabin Cabin Cabin Metal Metal Bending Semi Assemble Finished Metal cut sheets cutting and welding finished window security to size Glass and door cabins … Sameh Al-Shihabi 8 Summary Value Flow Supplier M1 M2 Customer RM WIP FG Stage Sameh Al-Shihabi, Project Management 9 Product Price/(Kg of meat) Notes Chicken- Whole Frozen Chicken- Boneless Frozen Chicken- Burgers Frozen Checking – Burgers Sandwiches Sameh Al-Shihabi, Project Management 10 Learning Objectives 1. Cost of Goods Sold 2. Overheads 3. Traditional Allocation Method 4. Activity Based Costing  Cost Account I LO 1 Cost of Goods Sold Income Statements Sales -Cost of Goods Sold =Gross Profit (Operating Profit) -Selling and Administrative Expenses =Net Income What is the difference between a manufacturing and a retailing Companies? 13 COGS Manufacturing Merchandizing 14 COGS Manufacturing Merchandizing Manufacturing Purchasing Inventories: Inventory Raw materials (RM) Finished Goods (FG) Work-in-process (WIP) Finished goods (FG) 15 COGS Manufacturing Merchandizing Beginning FG Inv. Beginning FG Inv. + Cost of goods manufactured + Purchases (for a reseller) − − Ending FG Inv. Ending FG Inv. = Cost of goods sold = Cost of goods sold 16 GOGS You became a dealer for a new Chinese car brand. Your starting inventory in 2022 was 80 car, each worthing AED 50,000. During the year 2022, you bought cars for AED 100 million. At the end of the year, you are left with 65 cars, each worth AED 70,000. What is the value of GOGS. 17 GOGS You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. If the manufacturing costs were AED 1.2 million, what is the value of COGS? Start 2022 End 2022 Items AED/item Value Items AED/item value RM 1000 50 1200 80 WIP 500 100 800 90 FG 700 80 600 70 18 Cost of Goods Manufactured (COGM) This is the cost to manufacture the goods that were completed during the period and transferred to finished goods. The formula is: Direct materials used + Direct labor used + Manufacturing overhead applied + Beginning work-in-process inventory − Ending work-in-process inventory = Cost of goods manufactured Direct Material Used Beginning RM (It should be direct material) + Purchases − Ending RM Direct materials used 20 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used Start 2022 Purchases End 2022 Items AED/ite Valu Q AED/ite Item AED/ite value m e m s m RM 1000 50 8000 60 120 80 0 WIP 500 100 800 90 FG 700 80 600 70 21 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used 2) If the factory employs 50 workers in the workshop, each paid AED3000/ month, what is the direct labor used 22 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used 2) If the factory employs 50 workers in the workshop, each paid AED3000/ month, what is the direct labor used 3) The factory produced 500 tables and 2,000 chairs. The allocation factor of manufacturing overheads are AED 10/table and AED 5/chair, what is the manufacturing overheads applied 23 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used 2) If the factory employs 50 workers in the workshop, each paid AED3000/ month, what is the direct labor used 3) The factory produced 500 tables and 2,000 chairs. The allocation factor of manufacturing overheads are AED 10/table and AED 5/chair, what is the manufacturing overheads applied 4) What is the value of COGM? 24 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used 2) If the factory employs 50 workers in the workshop, each paid AED3000/ month, what is the direct labor used 3) The factory produced 500 tables and 2,000 chairs. The allocation factor of manufacturing overheads are AED 10/table and AED 5/chair, what is the manufacturing overheads applied 4) What is the value of COGM? 5) What is the value of COGS? 25 GOGM You are the CFO of a furniture company. The below table shows the inventories at the beginning and end of year 2022. 1) Calculate the value of the direct materials used 2) If the factory employs 50 workers in the workshop, each paid AED3000/ month, what is the direct labor used 3) The factory produced 500 tables and 2,000 chairs. The allocation factor of manufacturing overheads are AED 10/table and AED 5/chair, what is the manufacturing overheads applied 4) What is the value of COGM? 5) What is the value of COGS? 6) If the revenue of your sales is AED 2 million, did you making a positive or negative operating profit? 26  Cost Account I LO 2 Overheads Introduction to Overheads There are two broad classifications of overheads Manufacturing overheads are necessary for the production of the goods or services of the company. Nonmanufacturing overheads are not associated with the production process. These are essentially the period costs of the company that may be expensed as corporate costs.. Period Costs Period costs are costs that are not involved in the production of the product. Period costs are expensed as they are incurred. Examples include: general and administrative, legal fees, marketing, accounting department… Manufacturing Overhead Allocation The categories of costs included in manufacturing overhead are: 1. Indirect materials - materials not identifiable with a specific product or job, such as cleaning supplies, disposable tools, etc., 2. Indirect labor - wages not directly attributable to production, such as the plant superintendent, janitorial services, and 3. General manufacturing overheads - factory rent, electricity and utilities. Overheads may be either fixed, variable, or mixed costs. Fixed overheads are costs that do not change in total over the relevant range of activity or production. (Rent) Variable overheads are costs that change in total as the level of production changes. (Electricity) Manufacturing Overhead Allocation Question: How will you divide the machines depreciation, electricity bills, and repair costs over the products? Because there is no direct connection between the production of a unit and the incurrence of these costs, the manufacturing overhead costs of the company must be allocated to the units that are produced. No matter what method is being used to do the allocation, you must remember that we are simply taking all of the overhead costs and somehow dividing them amongst the units that were produced during the period.  Cost Account I LO 3 Traditional Allocation Method Traditional Allocation Method Under the traditional method, the overhead costs are allocated to individual products based on one allocation basis. The allocation basis is the measure that will be used to divide the costs amongst the units. Examples are direct labor hours, machine hours, kilograms, components… The measure is called the activity base or allocation basis. At the start of the period, the company determines an allocation rate based on the allocation basis. Determining the Allocation Basis (Cost Drivers) The basis that the company uses should be one that reflects the production costs and the way overhead costs are actually incurred. If the company has a very automated process (machine.hours, labour. hours) may be the allocation base. If the production process requires a lot of manual labor (machine.hours, labour. hours) may be the best allocation base. Allocation bases- Manufacturing 1.Direct Labor Hours: Overhead costs are allocated based on the number of direct labor hours worked. 2.Machine Hours: Overhead costs are allocated based on the number of machine hours used. F 3.Direct Material Costs: Overhead costs are allocated based on the cost of direct materials used. 35 Allocation bases- Retailing 1.Sales Revenue: Overhead costs are allocated based on the sales revenue generated by different departments or product lines. 2.Number of Transactions: Overhead costs are allocated based on the number of transactions processed by each department. 3.Inventory Levels: Overhead costs are allocated based on the value or quantity of inventory held by each department. 36  Predetermined Rate An estimated rate needs to be used during the period so that the company will know how much it costs them to produce their product so that they can set the appropriate price. Though this is only an estimate, if the allocation is done reasonably, the estimate will be very close to the actual costs. This predetermined rate will be used throughout the period to allocate overhead to the units that are produced. Any differences between the estimates used and the actual costs will be adjusted for at the end of the period. Calculating the Predetermined Rate The predetermined overhead rate is calculated as follows: Budgeted Dollar Amount of Manufacturing Overhead Budgeted Activity Level of the Allocation Base Both of these amounts are estimates that are made at the beginning of the period. These budgeted amounts come from the financial budget. The budgeted activity level is also called the denominator level. Example Budgeted Dollar Amount of Manufacturing Overhead = $10 million Manual production Activity Level man.hour 10 workers, working 250 days, 8 hours/day, what is the Budgeted $ amount of MoH ……. Budgeted Activity Level of the Allocation Base …… What is the predetermined overhead rate? Two products are produced, what is the value of the allocated MOH Product A. 1 worker worked on this product for 10 hours. ……………………… Product B. 4 workers worked on this product for 5 hours each. ……………………. 39 Determining the Level of Activity to Use More difficult than the estimated costs, the company must carefully determine the estimated level of activity. If the company is too optimistic and estimates that they will produce a large number of units, the predetermined rate will be incorrectly low per unit and their selling price will be too low. They will sell a lot of units, but not make much money. If the company is too pessimistic and estimates that they will produce a small number of units, the predetermined rate will be incorrectly high per unit and their price will be too high. They will not sell many units, but will make a lot of money on each unit they sell. Example Budgeted Dollar Amount of Manufacturing Overhead = $10 million Manual production Activity Level man.hour 10 workers, working 250 days, 8 hours/day, what is the Budgeted Activity Level of the Allocation Base? How much MOH were allocated if the number of products produced are as shown in the table below Amount Allocated MOH Difference (Budgeted-Allocated) 10,000 20,000 30,000 41 Money for Engineers Financial Management Sameh Al-Shihabi The University of Sharjah Learning Objectives 1. Recording Financial Transactions 2. Financial Planning 3. Financial Management Reflections When will the 1-MoH costs be estimated? Are the estimates correct? 2-The budgeted allocation base (man.hour or machine.hour)? Are these estimates correct? 3-When will the allocation rate be evaluated? Sameh Al-Shihabi, Project Management 3 Reflections MoH=AED 1 million 100 tables are forecasted to be produced, each requiring 10 man.hours. Allocation base is man.hours. What is the budgeted allocation base? What is the allocation rate? If DM=AED 500 and DL= AED 200, what is the cost of a table during the production year. If at the end of the year, 200 tables are produced, what was supposed to be the actual cost? Did the manufacturer sell the tables for less or more than their actual cost during the year? Sameh Al-Shihabi, Project Management 4  Financial Management LO 1 Management What is Management? Planning Execution 6 What is Management? Planning Monitor Execution Sameh Al-Shihabi, Project Management 7 What is Management? Planning Compare Monitor Execution Sameh Al-Shihabi, Project Management 8 What is Management? Planning Control Compare Monitor Execution Sameh Al-Shihabi, Project Management 9 What is Management? Planning Control Compare Monitor more resources Execution Sameh Al-Shihabi, Project Management 10 What is Management? Planning Change plan Control Compare Monitor More resources Execution Sameh Al-Shihabi, Project Management 11 Project Management Planning Initiation Change plan Control Compare Monitor More resources Closing Execution Sameh Al-Shihabi, Project Management 12 Financial Management Planning Budgeting Execution Transaction Recording Sameh Al-Shihabi, Project Management 13 Financial Management Planning Budgeting Monitor Variance Aanalysis Execution Transaction Recording Sameh Al-Shihabi, Project Management 14 Financial Management Planning Budgeting Monitor Compare Variance Analysis Execution Transaction Recording Sameh Al-Shihabi, Project Management 15 Financial Management Planning Budgeting Monitor Control Compare Variance Analysis Execution Transaction Recording Sameh Al-Shihabi, Project Management 16  Financial Management LO 2 Budgeting Remember Balance equation. Sameh Al-Shihabi, Project Management 18 Budgeting A budget is a quantitative (numerical) expression of the company’s plans and objectives. The Master Budget is the final, complete budget for the upcoming time period. Who Should Prepare the Budget The budget should be prepared by the people who are most knowledgeable about the different parts of the budget. For example, top management should not be involved in the detailed production budget for each month. The Different Budgets There are a number of budgets that will need to be prepared. Some of them need to be prepared in a specific order. This is because some of the budgets build on each other. The sales budget is the first budget prepared. The cash budget is the last budget prepared. The Sales Budget This is the budget that must be completed first. Everything else the company will do during the year is based on how many units they expect to sell. This is also the hardest budget to do, because it based on the decisions and factors not controlled by the company: Consumers Competitors The economy Sales Budget Assume 10% increase in quarterly sales, prepare the next year sales budget Q1 Q2 Q3 Q4 Total Sales 800 700 900 800 Unit price($) 80 80 80 80 Total sales ($) Q1 Q2 Q3 Q4 Total Sales Unit price($) 80 80 80 80 Total sales ($) Sameh Al-Shihabi 23 The Sales Budget Any relevance to Operations Management? The Production Budget After the sales budget is completed, the company can prepare the production budget. This budget is based on: The expected level of sales, Whether the company wants to change the level of inventory, This budget also needs to include when during the year the units will be produced. The Production Budget 1-Production volumes What are the production volumes each quarter? -Starting inventory is 200. -Inventory kept at the end of each period is 100 Q1 Q2 Q3 Q4 Total Sales 880 770 990 880 Inventory 200 Production Sameh Al-Shihabi 26 GOGS Budget Once the production budget is set, the company can create a number of other budgets that are based on the level of production: Direct materials budget Labor budget Overhead budget Ending inventory budget These are all interrelated so a change in one of these budgets will likely cause a change in another. The Production Budget 2-Purchasing budgets -For each product, 2 units of raw materials are used. -Desired ending inventories should be 10% of next quarter needs. For Q4, use the average of the four quarters -Starting inventory of RM is 300 units -The value of the RM is $5/raw material unit Q1 Q2 Q3 Q4 Total Production Material needed for production Inventory (300) Inventory needs Purchases Purchase cost Sameh Al-Shihabi 28 The Production Budget 3-Direct labor -For each product, 5 man.hours are needed. -Each man.hour cost is $10 Q1 Q2 Q3 Q4 Total Production Direct hours Cost Sameh Al-Shihabi 29  The Production Budget 4-Factory overhead - Factory rent, utilities and other running expenses = $100,000 per quarter - There is a variable cost equal to $5 per DL man.hour Q1 Q2 Q3 Q4 Total Production Direct hours Variable cost Fixed cost Total cost Sameh Al-Shihabi 30 Following Budgets There are also a lot of other budgets that need to be prepared Selling and marketing budget, General and administrative budget, Accounting and finance budget, Research and development budget, and Any budget for other type of revenue or expense that the company has during the budgeted period. Operating and Financial Budgets The operating budget is the budgeted income statement and its supporting budget schedules. It is made up of all the revenue budget and the production, purchasing, marketing, and research & development budgets. The financial budget is the budgeted balance sheet and statement of cash flows, cash budget and capital budget. These budgets are what the company’s financial statements will look like next year if reality exactly matched the budgeted amounts. By looking at them now, the company can see what the ratios will be like, and if they would be in violation of any covenants or loan agreements. Class Exercise 1, 2, & 4 Sameh Al-Shihabi, Project Management 33  Financial Account IV LO 3 Recording Financial Transactions Accounts A separate account exists for each item shown on the financial statement. The T-account is the simplest form of account. 35 Accounts A separate account exists for each item shown on the financial statement. The T-account is the simplest form of account. 101: Petty Cash- Manager Debit Credit 36 Accounts A separate account exists for each item shown on the financial statement. The T-account is the simplest form of account. 101: Petty Cash- Manager ERP system. 101: Petty Cash-Manager Debit Credit Date Explanation Reference Debit Credit 37 Reflecting Debits and Credits in Accounts Why Accounting is hard? Remember the double entry principle Assets and Expenses Liabilities, Equities, and Revenues Debit Credit Debit Credit Increase Decrease Decrease Increase 38 Reflecting Debits and Credits in Accounts Why Accounting is hard? Remember the double entry principle Assets and Expenses Liabilities, Equities, and Revenues Corporate Debit Credit Debit Credit Debit Credit Increase Decrease Decrease Increase 39 Example Ahmad would like to quit university and open a Café in Muwaileh. 1. He dedicated a cash investment of 200,000 AED for this Café 2. He rented a café in Muwaileh for 50,000 AED 3. Bought equipment from Turkey for 60,000 AED to be paid later (on account) 4. He employed 2 workers and paid each 10,000 AED (Note this is expenses to be taken ) 5. Ahmad starting selling and made a revenue of 90,000 in the first year. Cash Equipment A/P Revenue Expenses Equities 40 Ledger All accounts of an entity are kept in a separate book called the ledger The ledger is a classification and summarization of financial transactions and is the basis for the preparation of the balance sheet and income statement 41 A Chart of Accounts The sequence and numbering of ledger accounts is customarily in the order in which they will appear in the financial statement. The larger the company is, the more accounts are needed. Title Numbers Cash Assets 1-250 Petty-Cash manager 1 Current 1-150 Petty-Cash CFO 2 Cash 1-50 Cash- Treasurer 3 A/R 51-110 Cash-SIB 4 Inventories 111-150 Cash-ADCB 5 Non-current 151-250 Cash- Finance 6 Liabilities 251-500 Cash -HR 7 Current 251-400 Cash- Warehouse 8 A/P 251-320 42 Journalizing Transactions Recording transaction Date Accounts Posting Reference Debit Credit (Chart of accounts) 1/10/23 Cash 1 200,000 Equity 301 200,000 Starting company 5/10/23 Expenses 290 50,000 Cash 1 50,000 Café rent 43  Posting Transferring information from the journal to the ledger Date Accounts P.R Debit Credit 1/10/23 Cash 1 200,000 Equity 301 200,000 Starting Cash company 5/10/23 Expenses 290 50,000 Cash 1 50,000 1/10 200,000 5/10 50,000 Café rent 44 Trial Balance 1. Find the nets of each account 2. List the accounts based their number 3. Guarantee debit=credit Cash Account Debit Credit Cash 150,000 1/10 200,000 5/10 50,000 A/R 40,000 150,000 45 Financial Statement From the trial balance, prepare the balance sheet and income statement 46  Financial Account IV LO 4 Variance Analysis Variance Analysis Variance analysis compares the predicted costs or behavior of a business with its actual numbers and outcomes. This comparison can help businesses analyze past data, monitor their costs and better plan for future expenses. The three main types of variance analysis are material variance, labor variance and fixed overhead variance. Sameh Al-Shihabi 48 Variances Variance analysis compares the predicted costs or behavior of a business with its actual numbers and outcomes. This comparison can help businesses analyze past data, monitor their costs and better plan for future expenses. The three main types of variance analysis are: 1- material variance 2- labor variance 3- fixed overhead variance. Sameh Al-Shihabi 49 DM Variance For the first quarter, the budget quantity was 1,000 for a price of $2. The actual quantity bought is 1,200 for a prices of $1.9. Calculate Quantity variance = (Actual quantity x Standard price) − (Standard quantity x Standard price) Sameh Al-Shihabi 50 DM Variance For the first quarter, the budget quantity was 1,000 for a price of $2. The actual quantity bought is 1,200 for a prices of $1.9. Calculate Quantity variance = (Actual quantity x Standard price) − (Standard quantity x Standard price) Price variance = (Actual quantity x Standard price) − (Actual quantity x Actual price) 51 DM Variance For the first quarter, the budget quantity was 1,000 for a price of $2. The actual quantity bought is 1,200 for a prices of $1.9. Calculate Quantity variance = (Actual quantity x Standard price) − (Standard quantity x Standard price) Price variance = (Actual quantity x Standard price) − (Actual quantity x Actual price) Overall variance = Quantity variance + Price variance 52 DL Variance For the first quarter, 100 workers were employed for 8 hours/day, 5 days/week, 4 weeks, and each was supposed to be paid $2/(man.hour). However, 120 workers were employed and paid $2.5(man.hour) Rate variance = (Actual hours x Actual rate) − (Actual hours x Standard rate) 53 DL Variance For the first quarter, 100 workers were employed for 8 hours/day, 5 days/week, 4 weeks, and each was supposed to be paid $2/(man.hour). However, 120 workers were employed and paid $2.5(man.hour) Rate variance = (Actual hours x Actual rate) − (Actual hours x Standard rate) Efficiency variance = (Actual hours x Standard rate) − (Standard hours x Standard rate) 54 DL Variance For the first quarter, 100 workers were employed for 8 hours/day, 5 days/week, 4 weeks, and each was supposed to be paid $2/(man.hour). However, 120 workers were employed and paid $2.5(man.hour) Rate variance = (Actual hours x Actual rate) − (Actual hours x Standard rate) Efficiency variance = (Actual hours x Standard rate) − (Standard hours x Standard rate) Overall variance = Rate variance + Efficiency variance 55 DL Variance For the first quarter, 100 workers were employed for 8 hours/day, 5 days/week, 4 weeks, and each was supposed to be paid $2/(man.hour). However, 120 workers were employed and paid $2.5(man.hour) Rate variance = (Actual hours x Actual rate) − (Actual hours x Standard rate) 56 Class Exercise 3&5 Sameh Al-Shihabi, Project Management 57