24 ACCT11081 INTRODUCTORY FINANCIAL ACCOUNTING ASSIGNMENT BY ANGELA ENGELBRECHT -12048737 Blog: https://aengelbrechtblog.wordpress.com/ Aluminium Bahrain - Website and Annual Reports STEP 7 Exploring the inventory practices of your firm Firstly, I must admit that I have very limited knowledge when it comes to inventory. So much so that I delayed starting this step until after I had completed the MYOB set-up, training and online quiz. Then I scolded myself for tackling what I thought would be the easier task first. I try to live by the method of tackling the hardest option first to get that out of the way before moving on to the easier options and I did not do that in this case. So, after completing Step 8, and before starting Step 9, I dragged myself back to Step 7 to continue along my path of completing the hardest tasks first. On that note I might start by describing my experience with inventory. Years ago, I worked for a gaming company in Sydney. We sold and serviced gaming equipment to casinos, pubs and clubs; and had some stock on hand at our warehouse. Yearly we would have to take inventory of that stock by doing a physical count of every item and then we would enter the amounts into a spreadsheet. This information was then passed on to the accountant and that was the end of my involvement. I did wonder how that information was then incorporated into the company financials, and now years later I am beginning to find out. The building company I work for now has very little inventory as items are usually purchased for specific jobs and are delivered
BY ANGELA ENGELBRECHT -12048737Blog: https://aengelbrechtblog.wordpress.com/
Aluminium Bahrain - Website and Annual Reports
STEP 7
Exploring the inventory practices of your firm
Firstly, I must admit that I have very limited knowledge when it comes to inventory. So much so that I delayed starting this step until after I had completed the MYOB set-up, training and online quiz. Then I scolded myself for tackling what I thought would be the easier task first. I try to live by the method of tackling the hardest option first to get that out of the way before moving on to the easier options and I did not do that in this case. So, after completing Step 8, and before starting Step 9, I dragged myself back to Step 7 to continue along my path of completing the hardest tasks first.
On that note I might start by describing my experience with inventory. Years ago, I worked for a gaming company in Sydney. We sold and serviced gaming equipment to casinos, pubs and clubs; and had some stock on hand at our warehouse. Yearly we would have to take inventory of that stock by doing a physical count of every item and then we would enter the amounts into a spreadsheet. This information was then passed on to the accountant and that was the end of my involvement. I did wonder how that information was then incorporated into the company financials, and now years later I am beginning to find out.
The building company I work for now has very little inventory as items are usually purchased for specific jobs and are delivered to site. They are then debited straight to the cost of sales ledger account. We do have a very small inventory of consumables like silicone, glue, asbestos suits and associated items, and PPE; like earplugs, vests, safety glasses and other safety items. We have such a small amount on hand that we debit these straight into cost of sales expense accounts when we purchase them and then journal them, by crediting and debiting the cost of sales account, into the jobs when we use them; keeping them in the cost of sales ledger account. We could use an inventory asset account to debit these items into when we purchase them
and then credit the asset account and debit the cost of sales expense account when we use them on a job, but I do not think this is necessary for small consumable items. The larger inventory items need to go into an asset account because they can have an impact on the profit and loss of a firm.
Inventory for Aluminium Bahrain (Alba)
Alba’s inventory is quite large at around BD 150 million each year (~AU $503 million). The inventory figures are slightly up or slightly down from this figure each year but are relatively consistent. This figure represents around 14% of their total assets for 2016 and 12%, 13% and 12% in the years 2013 to 2015. The inventory on the balance sheet has not changed much in the past 4 years and I think Alba must have a very tight inventory monitoring system to keep the levels consistent and to make sure that a certain amount of inventory is always on hand. Too much inventory can be costly for a firm because high stock levels can tie up valuable cash reserves and there can also be costs related to storage of the excess inventory. On the other hand, if a firm does not have enough inventory on hand they face the risk of running out of inventory, and that could be catastrophic, especially in Alba’s case. The nature of an aluminium smelting factory requires the pot lines to run continuously. It is not easy for a smelter to be stopped and restarted. A disruption of more than four hours causes the aluminum in the pots to solidify and it requires a very expensive rebuild process. Shutting the lines down because they have run out of inventory would be an extremely costly disruption.
In 2013 the inventory was at its lowest at BD 145 million and in 2016 it was at its highest at BD 163 million. The inventory figures are low in comparison to the revenue, approximately 24% in 2016, 19% in 2015, 19% in 2014 and 19% in 2013. What I found interesting is that the inventory figures are not directly related to the sales figures. In 2016 the inventory was at the highest level at BD 163 million and the sales for that year were the lowest at BD 587 million but in 2014 the inventory was BD 152 million with sales that year of BD 821 million which was the highest in the 4 years. I always thought that they would be linked but now I realise that the inventory is the closing balance for the period and they would have purchased and used up inventory within the period, so the inventory balance would be only what they have on hand at the end of the period.
I did notice that the inventories recognised as an expense in cost of sales do seem to be directly related to the sales figures. In 2016 they had their
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lowest cost of sales and their lowest revenue and 2014 had the highest cost of sales and the highest revenue over the 4 years. It is good to see they can keep their costs consistent even with the volatile metal prices. The cost of sales is 86%, 82%, 87% and 88% of the revenue for 2013 to 2016 and the inventories recognised as an expense in cost of sales are 62%, 57%, 59% and 62% of the revenues for 2013 to 2016. These costs of goods sold ratios show the efficiency and performance of the firm. They tell us how much of the sale of the goods has been used up in costs to make those goods. Another profitability ratio we can us is the profit margin ratio. This ratio differs from the cost of goods sold ratio in that it takes all expenses into consideration and shows how much profit the firm makes. Alba has a profit margin of 10.6%, 10.5%, 7.8% and 7.3% in the years 2013 to 2016. We can see that even though the cost of sales is relatively consistent this does not equate to consistent profit margins.
Inventory figures for the past 4 years as at 31 December
I could not find anywhere in the annual reports where Alba discloses which inventory system they use. The two inventory systems that can be used are periodic and perpetual. A periodic inventory system is one where a stock count is completed at the end of a period and the firm only knows how much stock they have on hand once a stock count is completed. A perpetual inventory system is updated continuously and as inventory is used up it is recorded, which allows the firm access to inventory levels at any time within the period. A perpetual inventory system requires information about the quantity, unit cost and the total cost for purchases and sales so that the inventory balances. The cost of sales is then calculated by adding the net purchases of inventory to the beginning inventory and taking the ending inventory away from the total. In the manufacturing industry the inventory
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recognised as an expense in cost of sales is finished goods inventory. The perpetual system is much more time consuming and costly, but it allows managers access to figures throughout the period and is very beneficial to the firm.
According to the textbook, in the periodic system the average method is called the weighted average and in the perpetual system it is called the moving average. If this is correct then Alba must be using the periodic system, but I doubt that they do. I would be very surprised if Alba uses the periodic inventory system. They are such a large firm and that is why I believe they use the perpetual inventory system. They would continuously need to know how much stock they have on hand to enable them to re-stock, as well as to forecast production. Management can use the information from a perpetual inventory system to control and plan inventory and determine profit. They can also use the unit costs to set selling prices and manage costs, whereas the periodic inventory system does not utilise unit costs and is not very timely. Alba knows their yearly capacity and to maintain the maximum capacity they would have to top up their raw materials accordingly. The volatility of the price of aluminium is also a reason Alba would want to use the perpetual inventory system because pricing is continuously changing, and they would need to know how much stock is on hand at the current prices.
Alba uses two methods of inventory, being the weighted average and the absorption costing method. They are described in Note 2 of the financial statements as below:
Raw Materials – Purchase cost on a weighted average basis. Finished goods and work in process – Cost of direct materials,
labour plus attributable overheads based on normal level of activity. (Absorption costing)
Spares – Purchase cost calculated on a weighted average basis after making due allowance for any obsolete items
The weighted average is an average cost method. It is calculated by dividing the Cost of goods available for sale by the number of units available for sale. The weighted average will give different cost of sales and inventory figures under the periodic and perpetual systems because of the timing of the purchases. Under the periodic system, at the end of the period all costs for the period are added up and divided between the units for sale. Under the perpetual system only the costs to date are considered and that may be at
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any time during the period, which would cause the figures to be different under the two systems. I believe Alba uses the weighted average method for raw materials because of the volatility in the price of alumina and aluminium. If they used FIFO or specific identification there could be a dramatic difference in the cost prices and with raw materials like alumina it would be hard to separate the purchases because I should imagine they keep adding to the stock of raw alumina and it is not identifiable with the original purchase.
I was not sure what spares were, but I did some research and I now think they are spares for the manufacturing machines (assets) which are used to manufacture the inventory. If this is correct, then Alba has BD 24 million worth of spares for their machines in inventory. I initially thought this was a huge amount but when I think about it and all the machinery they have I presume it is not so much. They have BD 847 million in property, plant and equipment. These comprise of buildings, power generating plant, plant and machinery and other equipment. It makes sense that they would have spares essential to maintain the equipment, or in the event of a breakdown, because it would cost the firm a large amount if the pot lines were to stop due to malfunction of machinery and no spare parts to fix them. I was surprised to find out that these are listed under inventory as I thought they would be an expense and they are repairs and maintenance. I did some research and it seems to be frequent practice for manufacturing firms to have spares for machine parts in the inventory as they would be part of the product cost. These spares are also calculated on a weighted average.
Alba does not specifically say what cost method they use for finished goods and work in process, they only say that they are worked out using the cost of direct materials, labour plus attributable overheads based on normal level of activity. In trying to figure out what cost method Alba uses for finished goods and work in process I was surprised to read in the textbook the effects technology has had on the mix of production costs. In the 1950’s direct materials made up 35% of the costs with direct labour at 40% and factory overheads at 25%. In the 2000’s the breakup was direct materials 40%, direct labour 10% and factory overheads 50%. It is very interesting to see the shift and realise the implications that the advance in technology has had on businesses. Now we have machines to complete many of the tasks that were done by staff and the staff costs have come down from 40% to 10% and the machinery has done the opposite going from 25% to 50% or more. I would be interested to see what it is today.
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I presume Alba uses absorption costing for finished goods and work in process. Even though they have not listed the actual method used from their description I know they do not use FIFO or specific identification methods, and in the textbook in chapter 8 manufacturing costs the two options, absorption costing and direct costing, are discussed. Direct costing is not an option for listed companies as it is not allowed in accounting standard IAS2/AASB 102 Inventories. Absorption costing takes all the direct materials, labour and factory costs as product costs. Although the financial reports will use the absorption costing, the managers at Alba may use the direct costing method for internal reporting as this method shows cost behaviour and allows managers to see how cost is affected by the level of activity. Alba have not changed inventory practices in the past 4 years.
Inventory and the Financial Statements
Inventory is purchased and recorded as a current asset on the balance sheet at cost. It is a current asset because inventory is expected to be used up within a 12-month period. Conducting a days of inventory ratio (inventory/average daily cost of goods sold (cost of sales/365)) BD 163,422,000/(BD 587,381,000/365) = 102 days and an inventory turnover ratio (cost of sales/average inventory (beginning inventory + ending inventory/2)) BD 587,381,000/ BD 154,923,000 = BD 3.79, I can see from the days of inventory ratio that Alba takes 102 days from purchase of raw materials to sale of the finished product and the inventory turnover ratio shows that Alba sells its inventory 3.79 times in a year. As a manufacturing company I think the ratios look reasonable as it would take a fair amount of time to manufacture the alumina into aluminium and then cast it into billets, slabs, ingots or foundry and then freight it to the customers. I could not find much on the industry standard for days of inventory ratio for an aluminium smelter, but I did see some figures of between 106 and 118 days and therefore I believe 102 days is a good amount of days to turn over inventory.
It was interesting to read about the transfer of ownership and goods on consignment. I did not realise that the type of freight used could impact the financial statements. Learning that if goods are shipped EXW (Ex Works) where the freight is paid by the buyer, then the ownership of the goods is transferred to the buyer when the freight company picks up the goods and that if the goods are shipped DDP (Delivered Duty Paid) where the freight is paid by the seller, the ownership of the goods only transfers when the goods are delivered was very surprising to me. If Alba sells a large consignment of
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aluminium and they pay the freight, it could take months for delivery because of the weight of the goods and the fact that they may be transported by ship. In that case the goods are still owned by Alba, but they may have already been paid for those goods. How is that recorded in the financial statements?
Alba values their inventories at the lower of cost and net realisable value. This means estimating the selling price in the normal course of business less the costs of the product and the costs to sell the product. At the end of the period the inventory is assessed and if it is valued at higher than net realisable value it is written down to net realisable value. They state in Note 3 that ‘Inventories are held at the lower of cost and net realisable value. When inventories of spares become old or obsolete or if their selling prices have declined, an estimate is made of their net realisable values. For individually significant amounts this estimation is performed on an individual basis. Amounts which are not individually significant, but which are old or obsolete, are assessed collectively and a provision applied according to the inventory type and the degree of ageing or obsolescence, based on anticipated selling prices.’ In the 2016 financial statements gross inventories of spares was BD 25.9 million and they had provisions for slow moving spares of BD 1.7 million. In 2015 the gross inventories of spares were BD 27.1 million with a provision for slow moving spares of BD 1.7 million. 2014 and 2015 were much the same.
When searching inventories in the annual reports of Alba I came across Note 21 which contained Inventories Recognized as an Expense in Cost of Sales. I understand that inventories as stated in the Balance Sheet are the ending inventory for the period and the inventories in cost of sales are the cost of the inventories to make the sales. I noted that the inventories recognized as an expense in cost of sales figure was different to the cost of sales figure in the Income Statement, so I decided to explore this further. I searched cost of sales in the annual reports and I noticed the cost of sales was made up of a few categories, including inventories. In 2016 the cost of sales was BD 587 million. The inventories recognized as an expense in cost of sales was BD 415 million. The balance of BD 172 million consisted of depreciation, staff costs and related party costs which was made up of the purchase of natural gas and diesel, purchase of electricity and royalty.
I also found in Note 24, which is Related Party Transactions, that Alba purchases services from parties related to the Government of the Kingdom of Bahrain and a royalty which is based on production is also paid to the
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Government of the Kingdom of Bahrain. During my research I found an interesting section in Note 4 stating that “The Group is using land leased from the Government of Bahrain for the operation of lines 3, 4 and 5 and land leased from The Bahrain petroleum Company B.S.C. for its calciner operations. These leases are free of rent.” Lucky them!
Inventories are shown on the Balance Sheet as current assets. When they are sold they are transferred to the cost of sales account which is shown on the Income Statement. They are also shown on the Statement of Cash Flows where in the operating activities there is a provision for slow moving inventories – net. This is explained in Note 6 where they show the breakup of inventory and the movements in the provision for slow moving spares. The provision is already considered in the inventories on the Balance Sheet as the spares stock is shown net of the provision. Inventories are also shown under working capital changes on the Statement of Cash Flows. I am unsure where this figure comes from and how it is related to the other financial statements. There is no reference to notes for these.
I believe Alba could face issues with aluminium pricing and that is a big problem for inventory management. Because of the timeliness of manufacturing, if they carry too much stock and the price of alumina drops then they will have stock on hand at the higher price which will not be completed into a sale for many months but if they have too little stock and the price of alumina increases then they will have to buy in at the higher pricing. They also face fluctuations in exchange rates and global uncertainty. Alba could improve its inventory management by finding innovative ways to be more sustainable and to cut costs. They have already implemented a strategy to improve costs and I think continued training and up-skilling their staff would add to their cost saving strategy and help to improve inventory management.
STEP 8
Learn how to use MYOB AccountRight
Screenshot of MYOB Set-up
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Screenshot of Using AccountRight Training
Online Skills Training Test
Question 1 Question 2
Question 3 Question 4
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Question 5 Question 6
Question 7 Question 8
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Question 9 Question 10
Question 11 Question 12
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Question 13
STEP 9
Creating a set of business transactions for your company
Background on Aluminium Bahrain
Aluminium Bahrain is a manufacturing company. They extract aluminium from its oxide, alumina, and they then manufacture products from the aluminium like billet, foundry, slabs and molten metal, which they sell to downstream industries who make finished products from the aluminium products that Aluminium Bahrain manufacture.
The tax in Bahrain is very interesting. It is outlined in a document by Deoiltte International Tax Bahrain Highlights 2017. Bahrain does not currently have a value added tax. According to this document the government is considering implementing a goods and services tax from 1st
January 2018. Further research tells me that this timeline has been stretched out to mid-2018 and the rate will be between 3% and 5%. What is also interesting is that there is no corporate tax in Bahrain, it is levied only on oil, gas and petroleum companies engaged in exploration, production and refining. The tax rate on the net profits for these companies is 46%.
Bahrain trade in Bahraini dinar. For the purpose of this step I have used Australian Dollars and a goods and services tax rate of 10% to show how GST is calculated and how it impacts the financial statements.
Transactions for the month of December 2017
DATE Transaction #
Description
01/12/17
1 Purchase 2800 metric tonnes of Alumina from Alumina Limited @ $405.00 / metric tonne GST inclusive on Net 30 after EOM credit termsPurchase price $1,030,909.09Freight In $29,090.91GST collectable $106,000.00
5/12/17
2 Received and entered electricity bill from the Government of Kingdom of Bahrain on Net 30 credit termsPurchase $3,623.12GST payable $362.31
07/12/17
3 Sale of 265 tonnes foundry to Ronal Wheels @ $2,281.00 / metric tonne GST inclusive on 2/7 Net 14 credit accountSale price $549,513.64Freight outward $15,272.72GST payable $56,478.64
07/12/17
4 Sale of 274 tonnes molten metal to Midal Cables Limited @ $1,842.00 / metric tonne GST inclusive on Net 30 after EOM credit accountSale price $458,825.45Freight outward $11,181.82GST payable $47,000.73
09/12/17
5 Purchased a vehicle from Toyota Bahrain – spend money total of $55,000.00 GST inclusiveVehicle price $46,163.64 excluding GSTStamp duty $2500.00 N-TDealer delivery $909.09 excluding GSTPrepaid registration total $720.00- split $420.00 excluding GST- $258 GST Free (CTP Insurance)GST collectable $4,749.27
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14/12/17
6 Paid fortnightly wages by electronic clearing account for 5 administration staff members – inclusive of union fees, PAYG Tax and SuperannuationRonald Able $5,166.67Susan Bester $3,749.99Steven Cessner $6,250.00Peter Delware $5,166.67Karen Ealing $3,999.99
14/12/17
7 Processed electronic payment for wagesTotal $19,332.66
14/12/17
8 Payment received from Ronal Wheels for invoice 1 within the discount terms of 2/7 Net 14Total $608,839.70This payment included a discount given of $12,425.30Discount $11,295.73GST Payable $1,129.57MYOB automatically processes a credit for the discount price and applies it to the sale
27/12/17
9 Pay invoice from Bahrain Telephone Company by spend moneyTelephone charges $2,690.91 GST exclusiveTelephone charges $320.00 GST FreeGST collectable $269.09
31/12/17
10 Part payment received from Midal Cables Limited for Invoice 2 on Net 30 from EOM credit terms – invoice not due until end of JanuaryTotal Paid $258,504.00 GST inclusive
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All Journals Report
ID No. Account No. Account Name Debit Credit Job No.PJ 1/12/2017 Purchase; Alumina Limited
IncomeSales Income - Molten Metal $458,825.45Sales Income - Foundry $549,513.64Freight Income $26,454.54Total Income $1,034,793.63Cost Of SalesCost Of Sales $605,003.45Freight In $29,090.91Total Cost Of Sales $634,094.36Gross Profit $400,699.27ExpensesGeneral ExpensesElectricity Expenses $3,623.12Telephone Expenses $3,010.91Discounts Given $11,295.73Total General Expenses $17,929.76Payroll ExpensesWages & Salaries Expenses $24,333.32Superannuation Expenses $2,311.66Total Payroll Expenses $26,644.98Total Expenses $44,574.74Operating Profit $356,124.53Total Other Income $0.00Total Other Expenses $0.00Net Profit/(Loss) $356,124.53
December 2017
Aluminium Bahrain B.S.CKing Hamad Hwy
Askar, Bahrain
Profit & Loss Statement
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AssetsCurrent AssetsBank AccountsCheque Account $789,731.04Total Bank Accounts $789,731.04Other Current AssetsTrade Debtors $258,504.00Prepaid Registration $678.00Inventories $425,905.64Total Other Current Assets $685,087.64Total Current Assets $1,474,818.68Non-Current AssetsMotor VehiclesMotor Vehicles #1 At Cost $49,572.73Total Motor Vehicles $49,572.73Total Non-Current Assets $49,572.73Total Assets $1,524,391.41LiabilitiesCurrent LiabilitiesGST LiabilitiesGST Collected $102,349.80GST Paid ($111,380.67)Total GST Liabilities ($9,030.87)Payroll LiabilitiesPAYG Withholding Payable $4,879.00Superannuation Payable $2,311.66Union Fees Payable $121.66Total Payroll Liabilities $7,312.32Other Current LiabilitiesTrade Creditors $1,169,985.43Total Other Current Liabilities $1,169,985.43Total Current Liabilities $1,168,266.88Total Liabilities $1,168,266.88Net Assets $356,124.53EquityCurrent Year Earnings $356,124.53Total Equity $356,124.53
As of December 2017
Aluminium Bahrain B.S.CKing Hamad Hwy
Askar, Bahrain
Balance Sheet
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Account NameCash Flow from Operating ActivitiesNet Income $356,124.53
Net Cash Flow from Operating Activities $839,303.77Cash Flow from Investing Activities
Motor Vehicles #1 At Cost ($49,572.73)
Net Cash Flow from Investing Activities -$49,572.73Cash Flow from Financing Activities
Net Cash Flow from Financing Activities $0.00Net Increase/Decrease for the period $789,731.04Cash at the Beginning of the period $0.00Cash at the End of the period $789,731.04
December 2017
Aluminium Bahrain B.S.CKing Hamad Hwy
Askar, Bahrain
Statement of Cash Flow
Income Statement
The Profit & Loss Statement, also known as the Income Statement, is a summary of the information from the temporary accounts of revenue and expenses for a specified amount of time. It summarises the income, cost of sales, operating expenses, finance expenses and tax expenses; and shows the firm’s financial performance and position. At first, I wondered why the net GST amount was not shown on the statement, but then I recognised that the tax expense would be the company tax expense which would be calculated at year end after all the years data had been recorded. This statement allows the reader to have a look at the profit of the firm over the period selected. The Profit & Loss Statement shows figures exclusive of
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GST. I can see from the Profit & Loss Statement above that Alba have a total income of $1,034,793.63, which is made up of sales of foundry and molten metal and freight to deliver the goods to the customer. Of the total income 44% is from molten metal sales and 53% is from foundry sales. They have total cost of sales of $634,094.36, which is cost of sales and freight to transport the inventory to the factory. Cost of sales comprises of raw materials, direct labour and factory overheads used in the process of manufacturing the product. The total cost of sales is 61% of the income. They have expenses of electricity, telephone and discounts given of $17,929.76 and wages and superannuation expenses of $26,644.98. These expenses are those that are not directly related to the manufacture of the product, like administration and office expenses. If the electricity bill paid was for the factory and only for manufacture of the product it would have gone into cost of sales and not expenses.
Total income less total cost of sales gives a gross profit of $400,699.27, less expenses gives a net profit of $356,124.53. This net profit represents the income that is left over after all expenses for the period have been considered and is the retained earnings for the period. At the end of the accounting period it is closed off to equity. To assess the firm’s financial health, I can conduct a gross profit margin ratio which is revenue-COGS/revenue – $400,699.27/1,034,793.63 x 100 = 38.72%. This tells me that after cost of sales the percentage of total sales revenue left is 38.72%, which is then available to fund the other expenses of the firm. The gross profit margin shows how much a company makes in selling its product. Another ratio I can conduct from the Profit & Loss Statement above is the net profit margin ratio, to see how much every dollar of revenue is converted into profit. This ratio considers all the expenses, not only the expenses directly related to the manufacture of the product. The net profit margin ratio is net profit after tax/sales - $356,124.53/$1,034,793.63 x 100 = 34.42%. From this ratio I can see that Alba is turning 34.42% of every dollar into profit. This is an excellent outcome. There are other ratios which are helpful to stakeholders to assess a firm, like the operating margin, but since I do not have any other income and expenses other than operating these would not be useful in this instance.
The Profit & Loss Statement can be used by managers to realise how much income is being generated from various products and what their cost of sales and expenses are to generate those products. They can also see the overall expenses in comparison to revenue. This statement is very important
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for internal and external parties, especially if it is compared with Profit & Loss Statements from other periods to realise changes in revenue or costs. For example, if a cost cutting system has been put in place, managers can use this statement to see the outcomes of those cost cutting systems on the overall expenses of the firm over time. In an accrual accounting firm, the Profit & Loss Statement is also good to compare with the Statement of Cash Flows because the cash does not necessarily take place when the revenue or expenses are recorded.
Balance Sheet
The Balance Sheet shows the firm’s assets, liabilities and shareholders’ equity at a specific point in time. The Balance Sheet is usually produced at the end of the financial period and shows what the firm own, owes and what has been invested into the firm. This is where the accounting equation comes into play because the in the Balance Sheet Assets = Liabilities + Owner’s Equity. The balance of the liabilities plus equity is equal to the assets. The principle is that the assets must be funded in some way either by borrowing money or from what the shareholders have put into the firm, including retained earnings from selling their product.
In the Balance Sheet above, under current assets, we have the cheque account at $789,731.04, which is the total amount for bank accounts. Then there are other current assets of trade debtors $258,504.00, prepaid registration $678.00 and inventories of $425,905.64, totalling $685,087.64 of other current assets. These assets are represented in order of liquidity. The bank account being the most liquid as the cash is readily available and then trade debtors as they are expected to be paid within 12 months. The prepaid registration and inventories being the least liquid of the current assets. The current assets total is $1,474,818.68. We have non-current assets of $49,572.73. This represents assets which are not very liquid and are expected to be used up in more than one accounting period. This brings the total assets to $1,524,391.41. Under current liabilities we have a GST liability of $9,030.87 being the difference between the GST collected and the GST paid. In this period, we paid more GST than we collected and therefore we have a negative GST liability due to be collected from the Australian Taxation Office. We have wages expenses of $7,312.32 being for PAYG payable, superannuation payable and union fees; and we have trade creditors of $1,169,985.43. The liabilities are usually listed in order of their due date and the current liabilities are those that are due within 12 months.
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The total of all the assets minus the liabilities gives us the net assets of $356,124.53.
From the figures in the Balance Sheet it looks like Alba are in a very favourable financial position. Having said this, cash in the bank and positive profits do not mean that a firm is profitable or efficient. To demonstrate this, I can do a liquidity ratio which shows liquid assets against current liabilities, and this will show how well Alba are equipped to pay off their debts. The current ratio is current assets/current liabilities - $1,474,818.68/1,168,266.88 = 1.26. This tells me that Alba have 1.26 times more assets than liabilities. This is not so great, but it does show that they are able to pay their debts. This ratio could be used over time to compare different periods to see what changes have happened in the firm. I could also conduct a debt/equity ratio which compares the firm’s debt to the equity the firm has. Debt/equity ratio = total liabilities/shareholders equity – 1,168,266.88/356,124.53 = 3.28 which shows Alba has 3.28 times more debt than equity and that is not so good. In comparison, if I do a profitability ratio like return on assets, which is net profit after tax/total assets x 100 ($356,124.53/$1,524,391.41 x 100) = 23.36%. This shows the percentage of profit Alba is earning in relation to its assets. This figure looks very good.
There are many ratios that can be used to assess the health of a firm but as with the Profit & Loss Statement these figures need to be assessed over multiple periods to see what trends are happening in the firm. These figures also should be compared at with other firms in the same industry to see what others in the industry are doing and how they compare.
Statement of Cash Flow
Looking at the Statement of Cash Flow I just realised that the cash at the end of the period is the total of the cash at bank. I think I knew this previously, but the Statement of Cash Flow has been a bit of a mystery to me so far and I have battled to understand what it represents. Having a simple set of financial statements created by myself makes it easier to see what is happening within the statements themselves. In the operating activities, I can see that the net income is the profit & loss for the period. Then I presume the non-cash assets are deducted as they do not represent cash in the firm even though they are current assets, because they are expected to have a future economic benefit to the firm, but they still need to be converted into cash. The GST collected, and GST paid are lumped together and create either an amount of cash that needs to be paid to the
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ATO or an amount of cash the ATO will refund the firm. Then the cash liabilities are added in to arrive at a net cashflow from operating activities amount. Cash flow from investing and financing activities are added to or take away from the net cash flow from operating activities showing the net increase/decrease for the period. This is then added to or taken away from the cash balance at the beginning of the period to arrive at the final figure for the cash at the end of the period. This amount should represent the bank balances and cash.
In the Statement of Cash Flow above, under cash flow from operating activities, we have net income of $356,124.53. Then we have a deduction of assets being trade debtors $258,504, prepaid registration $678.00 and inventories $425,905.64. The GST collected $102,349.80 is then added and the GST paid $111,380.667 is deducted. Then we have additions of PAYG withholding payable $4,879.00, superannuation payable $2,311.66, union fees payable $121.66 and trade creditors $1,169,985.43 giving us a net cash flow from operating activities of $839,303.77. Cashflow from investing of $49,572.73 is then deducted giving a net increase for the period of $789,731.04. As there was no cash at the beginning of the period this amount is also the cash at the end of the period. This amount represents the bank balances and cash in the Balance Sheet.
Financial Statements
I saw that some things did not look correct once entered in MYOB. I tracked one of the changes I made to show what effect those changes had on the financial statements. I altered the amount I had allocated to the journal from inventories to cost of sales when recording a sale, because initially I had the percentage of the full cost of sales deducted from the sales amount as my inventory amount used up. I then realised that I needed to use the ratio of inventories recognised as an expense in cost of sales/sales x 100%, which gave me an average of 60% over the 4 years.
I noticed that the total amount in the all journals report had changed because I had changed the inventory amount journaled. In the Profit and Loss Statement the income remained the same because I had not altered the sales amount, but I had changed the cost of sales, causing the gross profit to change. The operating profit and net profit/loss changed because the cost of sales had changed. In the Balance Sheet the inventories changed causing the other current assets and total current assets to change. The net assets changed because the inventories had changed.
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Consequently, the total assets changed too. The current year earnings and total equity also changed because the profit and loss had changed and that is closed off to equity. In the Statement of Cash Flow, the net income changed, as this total is the profit and loss, which is also the current year earnings. In my financial statements the net income is the same as the net asset and total equity amount but in reality the net assets and total equity would be different as they would have previous balances of assets, liabilities and equity, which do not get closed off at the end of the period, and the net assets and total equity would balance. The inventories figure also changed. The cash at the end of the period remained the same as it was an internal amendment that I made to inventories and cost of sales. Tracking the changes assisted me to physically see the interconnection of the financial statement.
This is also where the extended accounting equation comes into effect between the two financial statements, the Income Statement and the Balance Sheet, Assets + Expenses = Equity + Revenue + Liabilities. Being able to analyse financial statements is an important part of understanding what is going on in a firm. We need to look at all the statements together and we also need to look at multiple periods to compare market trends and to realise where things need to be changed and where the firm is successful.
STEP 10
Describing your firm’s Depreciation policies and creating Depreciation journal entries
Depreciation is calculated on the non-current assets of a firm, those being the assets that are expected to be used over more than one period in the production of goods or services to be sold by the firm. The reason we depreciate these non-current assets is because they are used up in the process of generating the goods or services to be sold, and therefore they must be recognised as not being at the same value as when they were purchased, and they also must be recognised as an expense to the firm.
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Reading through Alba’s annual reports from 2013 to 2016 I found depreciation mentioned in several places. Alba’s annual reports for the past 4 years have not changed very much, and their depreciation policies have not changed at all in those years. Depreciation is not mentioned in the Income Statement or the Balance Sheet of Alba’s financial statements.
Depreciation and amortisation 2016BD’000
2015BD’000
2014BD’000
2013BD’000
Depreciation for the year 71,380 73,775 79,419 77,831Amortisation for the year (192) (192) (96) -
The only mention of depreciation in the financial statements is in the Statement of Cash Flows. This same figure is also shown in Note 4 in the notes to the financial statements, property, plant and equipment, as the total depreciation charge for the year over all depreciation categories. Alba has recorded depreciation for the past 4 years as listed above, and as you can see Alba’s depreciation figures have not changed significantly over the years from 2013 to 2016. Depreciation for Alba is a reasonable, but not large, amount in comparison to their total expenses. Depreciation as a ratio to total expenses is calculated at 11.5% in 2016, 10.5% in 2015, 11% in 2014 and 11.5% in 2013. The depreciation figure in 2014 was higher than in 2013, which tells me that Alba acquired some depreciable assets in 2014. The depreciation declined steadily in 2015 and 2016.
Alba also has depreciation relating to disposals and write-offs. They also have amortisation of land leased as shown below. I was confused by the difference between disposals and write-offs. After some research I think that disposals are selling or exchanging an asset and write-offs are scrapping an asset. Alba has disposed of assets in all 4 years but they wrote-off assets only in 2013.
Depreciation and related accounts as at 31 December
2016BD’000
2015BD’000
2014BD’000
2013BD’000
Property, Plant and Equipment cost
2,121,226
2,021,413
1,976,548
1,933,643
Depreciation for the year 71,380 73,775 79,419 77,831
Depreciation relating to disposals (7690) (2,530) (5,953) (10,228)
Depreciation relating to write-offs - - - (234)
Accumulated depreciation 1,273,726
1,210,036
1,138,791
1,065,325
Total expenses for the year 621,370 706,725 725,270
669,561
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Land lease rights 4,320 4,512 4,704 -Amortisation for the year (192) (192) (96) -
Alba’s depreciation policies and depreciation method
Alba states in the notes to the financial statements that the policies used are consistent with previous years. The only change is in Note 2, summary of significant accounting policies, where Alba notes an amendment to IAS 16 and IAS 38 stating ‘Property, Plant and Equipment and Intangible Assets (Amendments): Clarification of acceptable methods of depreciation and amortisation;’. They stated that the adoption of these amendments did not have any effect on the Group’s financial position, performance or disclosures. Property, plant and equipment is stated at cost, net of accumulated depreciation and/or accumulated impairment losses, if any. In Note 4 of the notes to the financial statements property, plant and equipment is broken down into Land and buildings; Power generating plant; Plant, machinery and other equipment; and Assets in the process of completion. When looking at the breakdown of property, plant and equipment in the notes I can see that there is an opening balance for accumulated depreciation for each category and then a charge for the year and a deduction relating to disposals. They state that ‘An item of property, plant and equipment and any significant part initially recognised is derecognised upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated statement of comprehensive income when the asset is derecognised.’ These figures are accounted for in the Income Statement in the total for Cost of Sales.
Alba calculates their depreciation on a straight-line basis over the estimated useful lives of property, plant and equipment. I believe Alba uses the straight-line method because they have a lot of long term useful life assets and they must believe that the firm uses these assets evenly throughout the useful life of the asset. Alba states that ‘The Group’s management determines the estimated useful lives of its property, plant and equipment for calculating depreciation. These estimates are determined after considering the expected usage of the asset or physical wear and tear. Management reviews the residual values and useful lives annually and the future depreciation charges would be adjusted where the management
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believes the useful lives differ from previous estimates’. The useful lives are listed as:
Freehold buildings 45 years Power generating plant 23-25 years Plant, machinery and other equipment 3-23 years
Depreciation is calculated by deducting the residual value of the asset from the cost of the asset and calculating the difference over the useful life of the asset. The useful lives and residual values of depreciable assets must be reviewed annually to reflect consumption. If there are changes to the asset it must be netted off to the value of the difference between the cost and accumulated depreciation and then depreciation can start accumulating on the new value. There are four ways that depreciation can be calculated, straight-line method, diminishing balance method, sum-of-years’-digits method and units-of-production method. Depreciation is calculated according to a system because these non-current assets are expected to have future economic benefit to the firm over more than one period and the depreciation must reflect how the asset is used up during the useful life. My understanding of the four methods is:
Straight-line method – This method is most commonly used. It is calculated by taking away the residual value from the cost of the asset and then dividing this by the useful life of the asset to the business.
Diminishing balance method – This method is calculated by diminishing the amount of depreciation over the useful life of the asset to the business until your reach the residual value. The formula for working out the depreciation rate is square root to the power of the useful life the calculation of residual value divided by the cost of the asset. The diminishing balance method depreciates the full cost of the asset by the rate in the first year and then the balance of taking the rate away from the full value is the opening balance for the next period. Then the opening balance is depreciated by the rate and so on. This method would be used if the economic benefit of the asset to the company is used up more in the beginning years and less in subsequent years.
Sum-of-years’-digits method – This method calculates depreciation by taking the residual value away from the cost of the asset and then multiplying it by a fraction. The fraction is calculated by adding all the years together. In a 3-year useful life the numerator of the fraction is calculated by adding all the years together, for example 1+2+3 = 6
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and the denominator is the actual year. So, year 1 would be 1/6, year 2 would be 2/6 and so on. As with the diminishing balance method this method is used to accelerate the depreciation in the earlier years and is used for assets that are used up more in the beginning years.
Units-of-production method – This method calculates depreciation according to the usage rather than the years. It is calculated by dividing the sum of the cost of the asset minus the residual value buy the operating hours. The result is a monetary amount per operating hour and is used for machines that are not used up consistently over the periods but are used inconsistently. This would ensure the depreciation is spread in line with the usage of the asset.
To determine how much of the asset has been used up we can use the ratio of average percentage of useful life expired – Accumulated depreciation/average recorded cost. From the figures in the 2016 financial statements I can conduct a calculation to determine the average percentage of useful life expired as follows:
- Land and buildings BD 124,612,000/278,463,000 x 100 = 45%- Power generating plant BD 275,048,000/436,691,000 x 100 = 63%- Plant, machinery and other equipment 874,066,000/1,277,369,000 x
100 = 68%
These figures could be used to determine how long before a firm will need to outlay for new assets and to tell the approximate age of the assets. This ratio is only useful if the assets have not had revaluations carried out and have not had the accumulated depreciation and cost netted off. This ratio would also not be useful for land and buildings when they have been lumped together as land is not depreciated therefore the accumulated depreciation shown below for land and buildings would be accumulated depreciation on the buildings alone. The average useful life ratio could also be used to determine the useful life of an asset if the firm has not disclosed it. This is calculated by dividing the average recorded cost by the depreciation expense.
Property, Plant and Equipment and AccumulatedDepreciation as at 31 December 2016
CostBD’000
Accumulated Depreciation
BD’000Land and buildings 278,463 124,612
Power generating plant 436,691 275,048Plant, machinery and other equipment 1,277,369 874,066
Assets in process of completion - -
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Non-current asset categories
In determining the cost of the asset to be recorded on the Balance Sheet I was surprised to learn that the cost includes the purchase price and taxes, duties, transport, installation and training as well as dismantling, removing and restoring. I thought the amount that was recorded as a capital acquisition was only the price paid for the actual asset excluding GST. I was wondering what Assets in process of completion could be. I noticed that in addition to Additions and Disposals there was a line in the changes for the year which was titled Transfers and every year there was a deduction in Assets in process of completion which added up to all the additions in the other categories in the Transfers column. I then realised that Assets in process of completion were transferred to Land and Buildings, Power generating plant and Plant, machinery and other equipment once complete.
Assets in process of completion are not depreciated until complete and no depreciation amounts are recorded in charge for the year. All of that was clear to me but I still did not know what assets there could be in the process of completion under non-current assets. What are they? After some research I realised that Assets in the process of completion are additions or modifications to assets. For example, if Alba has made additions to its power generating plant and the additions are not yet complete then the amount spent would be recorded as Assets in process of completion under Property, Plant and Equipment in non-current assets on the Balance Sheet. Once the additions are complete they will be recorded in Power Generating Plant. This transfer does not change the amount of Property, Plant and Equipment recorded as a non-current asset on the Balance Sheet as the amounts are only transferred from one category to another, but depreciation will change because there is no depreciation on Assets in process of completion, but all other Property, Plant and Equipment is depreciated, except for land.
Depreciation broken down into categories in Property, Plant and Equipment
2016BD’000
2015BD’000
2014BD’00
0
2013BD’00
0Land and buildings 6,697 6,767 6,649 6,599
Power generating plant 16,410 16,986 16,807 16,232Plant, machinery and other
equipment 48,273 50,022 55,963 55,000
Assets in process of completion - - - -
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Goodwill and lease rights
Amortisation is calculated on intangible non-current assets. Intangible assets are those that are not physical in nature such as trademarks, copyrights, patents, goodwill; and as I found out also lease rights. Alba has no amounts allocated to Goodwill. As far as I can ascertain the company was started from scratch and has not changed hands. If they have acquired other companies, they have obviously not paid more than the cost of the assets for those companies. This is good for investors to note as it shows that they have not used up equity for no return as my opinion is that that goodwill does not equate to a future economic benefit to the firm. The purchase of a firm may come with an already established clientele and reputation, but the ongoing support of those clientele and the continued good reputation is dependent on how the new owners manage the firm and on market trends continuing. It is also dependant on the nature of the firm remaining as it is. The goodwill is not guaranteed to be an economic benefit to the firm as are the assets being purchased.
In Note 5, Other Assets, Alba states ‘The Group acquired the lease rights of the land adjacent to the Company from the Ministry of Industry, Commerce and Tourism on 28 May 2014 for a term of 25 years effective 1 July 2014 and the amount of BD 4,800 thousand is being amortised over the lease period.’ This amount of BD 4,8 million is shown on the Balance Sheet under non-current assets as other asset. I cannot find anywhere in the Balance Sheet under non-current liabilities or in the notes that relate to these liabilities where Alba has credited a liability account for this amount owning. Is this not a requirement of IAS 17/AASB 117 Leases if this is a finance lease? And if it is an operating lease it should not be depreciated. Is this why Alba has amortised rather than depreciated this asset? I did find some information in AASB 117 stating ’Leases of land and of buildings are classified as operating or finance leases in the same way as leases of other assets. However, a characteristic of land is that it normally has an indefinite economic life and, if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not receive substantially all of the risks and rewards incidental to ownership in which case the lease of land will be an operating lease. A payment made on entering into or acquiring a leasehold that is accounted for as an operating lease represents prepaid lease payments that are amortised over the lease term in accordance with the pattern of benefits provided’. That clears this up for me and explains the reason Alba has amortised the lease.
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This lease is amortised at BD 192 thousand per period. What I found interesting when looking at the 2014 financial statements is that it was only amortised at BD 96 thousand, but then I remembered learning that depreciation and amortisation is calculated pro-rata and since they only leased the land on 1st July 2014 and the financial statements are as of 31st
December 2014 therefore the amortisation amount was halved to reflect the period. The lease period is 25 years and the amortised amount of BD 192 thousand x 25 = BD 4,8 million therefore there is no residual amount, as you would expect with a lease agreement.
Amortisation Expense – Lease Accumulated Amortisation – Lease(Amortisation expense for the year)
16,41016,410
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The depreciation journal entries above represent the actual amounts of depreciation change that Alba recorded in their 2016 annual report. The journal entries credit a contra account of accumulated depreciation or amortisation, which sits underneath the non-current asset account to reduce the asset and credit the expense account for that category, to show the expense of the asset used up. In doing this they decrease the assets and increase the expenses. Over depreciation can cause the assets and the profit & loss to be understated and under depreciation can cause the assets and the profit & loss to be overstated. These entries could be manipulated by the estimation of useful life and residual value. They could also be manipulated by the method of depreciation used.
To show the effects depreciation can have on a firm I have calculated the same item using the four methods. Let us say Alba purchases a vehicle for BD 55,000 and it is expected to have a useful life of 5 years with a residual value of BD 10,000. As we can see from the figures below, there can be a vast difference when calculating the depreciation using the different methods. At the end of the useful life of the asset the depreciation amount will be the same with all the methods used but during the life the amounts can be quite different.
Method Calculation Depreciation for the period
Straight-line 55,000 – 10,000 5 years
9,000
Diminishing balance 1-⁵√10,000 55,000 = 30%
16,500
Sum-of-year’s-digits 55,000 – 45,000 x (5/15)
15,000
Units-of-production(used for 5000km this period)
55,000-10,000 40,000km = 1.13 / km
5,650
Once again, we can see that assumptions and judgements must be made and that the figures we see may not necessarily reflect what is really going on in a firm. The more knowledgeable we become, the more we know what
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to look for, and the better equipped we will be to delve into the financial statements and let them tell their true story.
STEP 11
Feedback
As with previous assignments, the feedback step in this assignment has been invaluable. have gained so muck knowledge and excellent ideas from constructively reading other students assignments, which I believe have assisted me in completing my assignment to a standard I am happy with. Obtaining others knowledge and understanding through the process of completing feedback is priceless because I learn so much and further develop my understanding of the contents learned.
I find giving feedback more useful as a tool for myself than a tool for the other students I give feedback to. I appreciate feedback from others and I take it on board and incorporate it into my assignment if I feel it will help, but the real benefit for me is the knowledge and ideas I obtain from other assignments, which I incorporate into my assignments. So, thank you once again to all those students whose assignments I read and who inadvertently assisted me in the completion of my assignment.
Feedback I gave to others
PEER FEEDBACK SHEET: Assignment Steps 7-10
Feedback From: Angela Engelbrecht
Feedback To: Makamas Silrat
D
My Comments
Step 7
Inventory
You have given a wonderful description of your working experience and how they relate to inventory. Maybe you could describe the actual process of how inventory is maintained at one of the places you have worked to demonstrate exactly what you know of inventory practices.
Your background about your company and the figures for inventory have been expressed well and I really enjoyed reading about your interpretations of the inventory for your firm.
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You said, “The increase in inventories also drops significantly in 2016 comparing to 2015, this leads me to wonder why that is?” maybe you could give a suggestion of why you think this is or what you think may have caused this.
You have a great foundation for this step but there are a few more questions asked in the assignment brief that you could talk about. For instance, are the numbers for your inventory large or small and what do the numbers mean? Has your firm changed its inventory practices over the years and if so why, and what affect did it have on the financial statements.
You could also add something in about what costs your firm may be facing with inventory management, why this is, and how could they improve their inventory management, and how did you identify these areas.
Step 8
MYOB set up
MYOB training
MYOB quiz
Your MYOB set-up screenshot is there and appears to be correct
Your MYOB training screenshot is there and appears to be correct
You have included all 13 questions from the MYOB quiz.
I am sure you were already going to do this, but before you submit your assignment make sure that the presentation is all good. You have a blank page in the middle of your quiz answers.
Step 9
Business transactions
You have provided great background information about your firm which helps us to understand your transactions.
Just so you know, goods and services tax (value added tax) and corporate income tax are not the same thing. Goods and services tax is the tax on consumption where corporate income tax is the tax on profit. I believe China uses a goods and services tax (VAT) of 17% and Hong Kong does not have any.
Your 10 transactions look great. They are industry specific and they are realistic transactions that may have been used for your company. I do wonder why you chose such high utility amounts? Did you find somewhere in your annual reports that showed these amounts being so high?
Your all journals report does not look correct to me. You have an all journals report on the ledger accounts, but you needed it to list the transactions you entered. You can get this report by going to REPORTS on the bottom tab of the front screen in MYOB and click on the dropdown box. In the dropdown click ACCOUNTS and then scroll down to the title TRANSACTION JOURNALS. Click on GENERAL
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All Journals report
Financials and discussion
JOURNAL under transaction journals and then put the specified dates that your transactions fall under and click on ADVANCED FILTERS. Find SOURCE JOURNAL on the top tab and dropdown next to general and select ALL. Then click RUN REPORT on the top left. This should generate the report you are looking for. You can then export it to Excel and copy and paste it into your document.
Your Income Statement, Balance Sheet and Cash Flow Statement all look correct. All your transactions appear to be from 01/01/17 to 05/01/17 and therefore your statements only need to be for these dates, the same with your all journals report.
Your discussion on the financial statements was very interesting to read and I think you have showed your interpretation very well
Step 10
Depreciation
You have gone into great detail with your depreciation and have explained your understanding well. I believe you have a great understanding of depreciation. I think you have covered all the requirements of the assignment in this step and I think you have written and excellent piece on depreciation.
Your journal entries look correct to me.
Overall Well done Minty!
I believe you have a great basis for an excellent assignment. I would do some work on step 7 – Inventories as I believe you need to show more understanding and answer more questions in this area. You also need to have a look at step 9 with your all journals report. If you need any help with this please let me know.
