Lecture 3 Cost of sales, depreciation, asset disposal PDF

Introduction to Accounting and Finance Lecture 3 Dr Rosie Cao  TODAY LECTURE Preparing financial statements: - Income statement (profit & loss account) - Statement of financial position (balance sheet) Adjustments: - Cost of sales - Depreciation of Fixed Asset...

Introduction to Accounting and Finance Lecture 3 Dr Rosie Cao  TODAY LECTURE Preparing financial statements: - Income statement (profit & loss account) - Statement of financial position (balance sheet) Adjustments: - Cost of sales - Depreciation of Fixed Asset - Fixed asset disposal 2 3  Cost of sales Cost of sales (CoS) is the value of goods removed from inventory because they have been sold – their value is converted from an asset to an expense. 4  Cost of sales 200 pens Assets £500 Cost £500 Produced 200 pens SOLD 100 pens £250 Closing Expenses stock £250 Assets £250 Left 5  The calculation of cost of sales £ £ Cost of sales Inventory at start of year X Add: Purchases After deducting returns X Add: Carriage In X Cost of goods available for sale X Less: Inventory at end of year (X) (X) 6  The calculation of cost of sales £ £ Cost of sales Inventory at start of year (50 pens * £2 each) 100 Add: Purchases (150 pens * £2 each) 300 Add: Carriage In (free delivery) 0 Cost of goods available for sale (200 pens available) 400 Less: Inventory at end of year (100 pens leftover) (200) (200) 7  Cost of sales example Opening inventory =10 Purchases = 20 Closing inventory = 12 CoS = Opening inventory + Purchases – Closing inventory 18 = 10 + 20 – 12 8  The structure of the income statement ABC Income statement for the year ended.. £ £ Revenue X Less: cost of sales (X) Gross profit X Less: Selling and distribution costs X Administrative expenses X Finance costs X Tax X (X) Net Profit/(Loss) for the period X 9  The calculation of cost of sales and gross profit £ £ Revenue After deducting returns X Cost of sales Inventory at start of year X Add: Purchases After deducting returns X Add: Carriage In X Cost of goods available for sale X Less: Inventory at end of year (X) (X) Gross profit X Notes: - Revenue and purchases are after deducting returns. - This level of detail is unlikely to be shown on the face of the statement; it may be disclosed through notes to the accounts. 10  Student Activity S. Mann, whose accounting year ends on 30 April, buys and sells aluminium engines for sports cars. Opening inventory, on 1 May 20X0 cost £55,000. During the subsequent accounting year, purchases were £500,000 and sales revenue was £775,000. Closing inventory, on 30 April 20X1 cost £80,000. Compute the gross profit for the year. 1) £475,000 2) £775,000 3) £555,000 4) £300,000 11  Answer EXAMPLE 14.1 S.Mann Income Statement for the year ended 30 April 20X1 £ £ Revenue 775,000 Cost of Sales Inventory of goods at 01/05/X0 55,000 Add: Purchases 500,000 555,000 Less: inventory of goods at 30/04/X1 (80,000) Cost of sales (475,000) Gross profit 300,000 12 13 The valuation of non-current assets Two possible ways to value non-current assets under IFRS: – Historical cost accounting – Fair value 14  Valuation of non-current assets: historical cost accounting In historical cost accounting: – non-current assets are valued at their cost less the aggregate/accumulated depreciation from the date of acquisition to the date of the statement of financial position. This value is known as the written down value (WDV), net book value (NBV) or net carrying amount. Assets are reported in the statement of financial position at the NBV. 15  Valuation of non-current assets: historical cost accounting A company bought a machine for £30,000 3 years ago and it is used till now. Note that the machine depreciates every year by £3,000 per annum. NOW: 1st Jan 31 Dec st 31 Dec st 31st Dec 2014 2014 2015 2016 £30,000 Historic £3,000 £30,000 cost £27,000 £3,000 £9,000 Accumulated £24,000 depreciation £3,000 £21,000 £21,000Net Book Value (NBV) 16  The nature of depreciation IAS 16 requires all tangible non-current assets except land and investment properties to be depreciated. 17  Accounting for depreciation Say asset X was depreciated by £A during the accounting year 1) An annual depreciation of £A is recorded as an expense in the P&L account for that year 2) In the balance sheet, NBV = Cost – Accumulated depreciation Provision for depreciation 18  Two depreciation methods Two depreciation methods are widely used: – Straight line method – Reducing balance method 19  The straight line/ fixed instalment method Same amount of depreciation charged to the income statement in respect of an asset each year throughout its useful economic life. Depreciation p.a. = Cost - Residual value Useful economic life 20  The essential data to compute depreciation 1. Historical cost. Machine : £30,000 2. The length of the asset's expected useful economic life to the business. 10 years 3. The estimated residual value of the asset: value at the end of its useful economic life. £0  Depreciable amount = cost – residual value. 30,000 – 0 = 30,000 4. Straight line depreciation Depreciation per year = = = 3,000 21  The reducing balance method 1. Convex profile – faster depreciation in earlier periods. NBV, £ Cost Straight line Reducing balance Residual value 0 Time Useful Life 22  The reducing balance method 1. Convex profile – faster depreciation in earlier periods. 2. Operates by applying depreciation rate to net book value brought forward, e.g. (with rate=50%): Period 1 Cost 200 REDUCING BALANCE Depreciation (50%) (100) Depreciation p.a. NBV c/fwd 100 = Depreciation rate * NBV Period 2 Depreciation (50%) (50) STRAIGHT LINE NBV c/fwd 50 Depreciation p.a. Period 3 = Depreciation rate * COST Depreciation (50%) (25) etc. 23 24  No provision for depreciation has been made for the year ended 31 March 2022. Company policy is to calculate depreciation on the straight-line method for motor vehicle and reducing balance method for warehouse plant. Warehouse plant is depreciated at 12% p.a. assuming a zero-scrap value. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value. Vehicle depreciation is charged to cost of sales; warehouse plant is charged to administration costs. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. Calculating annual depreciation: - Vehicle – straight line: % of cost  £16,400 * 20% = £3,280 Charge to cost of sale (expense in IS) - Plant – reducing balance: % of NBV (year ended 2021)  (cost – acc. Dep) * 12% = (21,000 – 5,900) * 0.12 = £1,510 Charge to admin cost (expense in IS) 25  No provision for depreciation has been made for the year ended 31 March 2022. Company policy is to calculate depreciation on the straight-line method for motor vehicle and reducing balance method for warehouse plant. Warehouse plant is depreciated at 12% p.a. assuming a zero-scrap value. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value. Vehicle depreciation is charged to cost of sales; warehouse plant is charged to administration costs. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. In the Balance Sheet as at the year ended 31 March 2022: - Vehicle: COST – ACC. DEP = NBV  £16,400 – (3600 + 3,280) = 9,520 - Plant: COST – ACC. DEP = NBV  £21,000 – (5900 + 1,510) = 13,590 26  Disposals of non-current assets Profit on sale if Proceeds of sale > NBV Loss on sale if Proceeds of sale < NBV 27  Example (continued) profit on disposal Alpha Ltd bought a machinery (previous example) on 1 January 20X1, cost: £1,000. Expected useful economic life: 3 years. Estimated residual value: £343. Depreciation method: straight line. Straight line method: (£1,000 - £343)  3 = £219 p.a. NBV after fully depreciated = £1,000 – 3*£219 = £343 At the end of its useful life, the machine SHOULD BE WORTH £343 Assume that the machinery was sold on 31 December 20X3 for £400 (i.e. more than NBV before the sale). The payment is made through a bank transfer. – Profit on sale = £400 - £343 = £57  INCOME in IS 28 During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 1) Calculate the Accumulated depreciation of the sold vehicles 2) Does the disposal yield a loss or profit? 3) What is the annual depreciation charge (on the still-owned vehicles)? 4) What is the NBV of vehicles at the end of the year? 5) What is the influence on the bank account? # During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 1) Calculate the Accumulated depreciation of the sold vehicles COST OF SOLD VEHICLES: 650 * 5 = £3,250 PURCHASED ON 30 NOV 2019 – SOLD DURING THE YEAR 2022 30 NOV 2019 - 31 March 2020 + 1 April 2020 – 31 March 2021: 2 YEARS 1 April 2021 – 31 March 2022: DO NOT COUNT “no depreciation in the year of disposal” #  ACCUMULATED DEPRECIATION FOR 2 YEARS: % OF COST * 2 During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 2) Does the disposal yield a loss or profit? COST OF SOLD VEHICLES: 650 * 5 = £3,250 ACCUMULATED DEPRECIATION FOR 2 YEARS: £1,300 NBV AT THE SELLING POINTS  £3,250 - £1,300 = £1,950 SOLD FOR: £1,690  LOSS OF: £1,950 - £1,690 = £260 #  EXPENSE IN IS During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 3) What is the annual depreciation charge (on the still-owned vehicles)? COST OF SOLD VEHICLES: 650 * 5 = £3,250 ACCUMULATED DEPRECIATION FOR 2 YEARS: £1,300 - COST OF STILL-OWNED VEHICLES: £16,400 - £3,250 = £13,150 - PROVISION FOR DEPRECIATION – STILL-OWNED VEHICLES: £3,600 - £1,300 = £2,300 #  ANNUAL DEPRECIATION CHARGE: £13,150 * 0.2 = £2,630 During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 3) What is the annual depreciation charge (on the still-owned vehicles)? COST OF SOLD VEHICLES: 650 * 5 = £3,250 ACCUMULATED DEPRECIATION FOR 2 YEARS: £1,300 - COST OF STILL-OWNED VEHICLES: £16,400 - £3,250 = £13,150 - PROVISION FOR DEPRECIATION – STILL-OWNED VEHICLES: £3,600 - £1,300 = £2,300 #  ANNUAL DEPRECIATION CHARGE: £13,150 * 0.2 = £2,630 During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 4) What is the NBV of vehicles at the end of the year? - COST OF STILL-OWNED VEHICLES: £13,150 - PROVISION FOR DEPRECIATION – STILL-OWNED VEHICLES: £2,300 - ANNUAL DEPRECIATION CHARGE: £13,150 * 0.2 = £2,630  COST – ACCUMULATED DEPRECIATION # = £13,150 – (£2,300 + £2,630) = £8,220 During the year the company sold five motor vehicles which had been purchased on 30 November 2019 at a cost of £650,000 each and the company received £1,690,000 in total for these vehicles. This transaction has not been included in the accounts. Motor vehicles are depreciated at 20% p.a. assuming a zero-scrap value using straight line method. It is company policy to charge a full year of depreciation in the year of acquisition and no depreciation in the year of disposal. 5) What is the influence on the bank account? BANK INCREASES BY £1,690 (FROM THE SALE OF VEHICLE) #  Conclusion In this lecture we started discussing the preparation of the financial statements. We also focused on two adjustments - Cost of sales - Depreciation of fixed assets - Disposal of fixed assets In Lecture 4 we will see more adjustments needed to prepare the financial statements from the trial balance. 36