Prime Cost And Deminishing Cost Economics

Explanation and Example

Describe about the Prime Cost and Deminishing Cost Economics.

In Company A fixed amount is claimed every year on the basis of the following formula:

Asset Cost × (days held/365) × (100%/ effective life of the asset) (Ato.gov.au, 2015)

Assuming both Company A and B has an asset valuing $ 80,000 since its inception. Given, Asset life = 20 years.

Depreciation: 1^st year- $ 80,000 × (365/365) × (100%/20) = $ 4000

Value of the depreciable asset after 1^st year =$80,000 – 4000 =$76,000

Therefore, the current value of the depreciable asset is $ 64,000.

Double Declining Method is calculated with the following formula:

Base value × (days held/365) × (200%/ effective life of the asset)

Depreciation: 1^st year- $80000 × (365/365) × (200%/20) = $ 8000

Value of the depreciable asset after 1^st year = $80000-$8000 = $ 72,000

Therefore the current value of the depreciable asset is $52,488.

Since, Straight Line depreciation charged by the Company A is same throughout the useful life of the asset, so it reflects a stable and a uniform decrement in the revenues and value of the asset in each of the accounting period of the useful life of the asset. Double-declining balance method adopted by Company B for depreciating its asset records greater amount of depreciation in the course of an asset’s life and considerably lower amount for the remaining later years of the asset (Ato.gov.au). Therefore, resulting in more reduction of assets and revenue in early years followed by, reduction in depreciation expense resulting to minimal impact on company’s assets and revenues. However, higher cost relating to asset repairs and maintenance might impact the revenues of Company B.

Straight Line Method also known as Prime Cost method is a method that presumes the value of depreciable asset declines uniformly over its useful life (Stunguriene and Christauskas, 2014). It is calculated on pro rata basis. The value of the asset includes the additional amount paid for installation, transport and to make it ready for use, besides actual cost of the asset. Double declining method as compared to Straight line method leads to the reduction of net income and operating earnings in the initial years of the life of an asset and increase in later years. Preference of any method of depreciation on the financial statement of the company hardly affects its cash flow, however, double declining method of depreciation for tax reporting reduces the taxable income and outstanding taxes thereby increasing the cash flow of the firm through tax reduction (Stunguriene and Christauskas, 2014). When straight line depreciation is used, an analyst utilizing balance sheet items can easily estimate the average of depreciable asset life and average age and assets relative age can be estimated. Viewing both the methods of depreciation, both have their own merits. Straight line method is simple and easy to use help in simplifying calculations. Decling method on the other hand, generally provides accuracy in accounting of  an assest value. For instance, when we purchase a new electronic gadget such as, a smartphones or new computer for the employees, high reduction in value is experienced in their early life span than they do later (Mueller, 2016).

Calculating Depreciation Using Different Methods

Every business demands to finance for its growth, expansion and to take up new organizational strategies (accaglobal.com). Some of the sources that Kangaroo Company can undertake are:

Trade Credit- It refers to a financial agreement between the company and its suppliers whereby the supplier agrees on providing materials or finished goods in up front with payment on a later date. Firstly, the company will avoid paying cash up front, thereby retaining cash in the short term for other capital requirements for the Kangaroo company has its ongoing expenses and investment decisions to take. With a little delay in payment on its purchases for a short period the company can accomplish its immediate cash need. Secondly, trade credits act as an immediate replenishment to avoid delay in business activity and performance. Thirdly, the suppliers too experience more business than otherwise. However, it has risks associated with it. Firstly, with purchase volume turning higher will produce interest fee. Secondly, if the company is not cautious enough in utilizing the trade credit, then it might end up paying a quite higher cost for the inventory.

Bank loans- The company can also opt for bank loans for its inventory or equipment purchase and its business expansion loans are thought to be a reliable source of financing. Firstly, the loan would be provided on basis of the value of business and the ability perceived to service the loan through timely payments. Secondly, the interest paid on the business, bank loan is tax deductible. Especially when loans are fixed rated, where loan servicing payments are same throughout loan life. This makes budgeting and planning conducive for the company (Mallick and Yang, 2011). However, it has few drawbacks. Firstly the biggest risk to bank loan is that the banks are stringent to pay loans to company having capability to repay. Advancing of loans require providing a personal guarantee, which means personal asset of the marsupials too can be seized. Secondly, interest rates might be considerably high. The high rate of interest for funding might stunt the expansion. The company having 60% of its noncurrent notes can provide security for an availing bank loan.

Equity funding- The company, can even opt for equity investments. It refers to accepting money from a private group or investor for an exchange of partial ownership. This prevents taking of debt after that repaying the investment. This will provide the investors with a certain extent of control in the company. It will demand to keep the investors happy even after majority interest rest with marsupials (Igartua and Albors, 2011).  

Sources of Financing for Business Growth

Management accountants are expected to function ethically. The Institute of Management Accountant has particularized four standards for managerial accountants relating to ethical conduct (Davidson and Stevens, 2013). They are confidentiality, integrity, competence, and credibility. Business owners require all details while reviewing their business operations and decisions were taken. Underlining are influences of  ethical behavior of the company with the following:

Customer- possessing a trustworthy customer base is one of the key elements to aspire long range business gain because providing for an existent customer does not include any marketing cost, as it does in the case of providing for new one. A company’s credibility for ethical behavior can assist in the creation of more positive appearance in the marketplace, which may help to attract new customers by word of mouth referrals. Unethical dealings adversely affect the chances of gaining new customers specially when dissatisfied customers via social networking will disseminate information quickly, relating to their negative experience.

Employees- proficient individuals working at all levels of the company aspire to be compensated for their work and commitment. They urge career advancement in the organization appertaining to their work quality and not on biases. Employees seek to be part of that company whose management team discloses about the working in the organization (Boshoff and Van Zyl, 2011).

Suppliers- Suppliers signify a crucial part of business and sustenance of cordial relationship is a mode to success. It should be ensured not to purchase produced by companies who are held guilty of child labor exploitation, providing wage in inferior working conditions. Complying with suppliers and customers audit requirement and formal quest promotes a healthier relationship between the company and its suppliers.

Analysis of financial statement helps in determining company stability and health. However, a financial statement has its pros and cons in the determination of stability and growth of a supplier. 1. the balance sheet discloses liquidity ratios that reflect the monetary worth of the supplier, which helps in determining the financial stability. 2. financial conditions reflected in the balance sheet are a depiction of assets and liabilities of the company. Use of income statement helps in evaluation of past income performance and assessment of future cash flow uncertainty. 3. the cash flow statement reflects cash exchange between outsiders and the company during a period, therefore assisting the investors to know whether the company has adequate cash to pay of its expenditures and purchase of assets (MacKerron et al., 2014).

Ethical Standards for Managerial Accountants

Limitations of Financial Statements are, 1. Financial statements are provided after completion of specified period. 2. The disclosed information of facts that is historic which might not be adequate from the view point of decision making. 3. During the preparation of Balance Sheet, all the assets and liabilities are reflected at historical prices as they are formulated on the principle of going concern which might influence profitability statement along with incorrect provision for depreciation. 4. Only monetary transactions are taken record of. 5. Financial Statement formulated is considered to be useful to normal users in normal conditions only (Magiera, 2010).

A company’s financial statement comprises of  the Balance Sheet, Income Statement, Return on Earning and statement of cash flow. The liabilities in the balance sheet highlight company’s debts and obligations. Accounts payable crops from the acquisition of goods and services from suppliers on credit without a note or financial written contract. Secondly, ascertain total cost incurred in dealing includes material cost, method of communication and requirement of inventory (Holmes, Marriott, and Randal, 2012).

The balance sheet, cash flow, and income statement are all interrelated. The income statement explains about the utilization of assets and liabilities in a stipulated accounting period. In context to overall growth, the net income is the basic place to initiate analyzing the financial statement of the company. Operating profit margin also reflects about the sufficiency and profitability of the company. It helps in comparing the amount generated from sales before deduction of interest and taxes (Kim, 2015). The margin provides potential investors and analysts with an understanding of the success of the company and role of managers in the generation of profitable revenue.

References

Ato.gov.au. (2015). Prime cost (straight line) and diminishing value methods | Australian Taxation Office. [online] Available at: https://www.ato.gov.au/Business/Depreciation-and-capital-expenses-and-allowances/General-depreciation-rules—capital-allowances/Prime-cost-(straight-line)-and-diminishing-value-methods/ [Accessed 8 Sep. 2016].

Boshoff, E. and Van Zyl, E. (2011). The relationship between locus of control and ethical behaviour among employees in the financial sector. Koers, 76(2).

Davidson, B. and Stevens, D. (2013). Can a Code of Ethics Improve Manager Behavior and Investor Confidence? An Experimental Study. The Accounting Review, 88(1), pp.51-74.

Holmes, K., Marriott, L. and Randal, J. (2012). Ethics and experiments in accounting. Pacific Accounting Review, 24(1), pp.80-100.

https://www.accaglobal.com, A. (2015). Medium-sized businesses | The right finance for your business | Business Finance | ACCA | ACCA Global. [online] Accaglobal.com. Available at: https://www.accaglobal.com/in/en/business-finance/right-finance/medium-sized.html [Accessed 9 Sep. 2016].

Igartua, J. and Albors, J. (2011). The implementation process of innovation management in a medium-sized company. Projects / Proyéctica / Projectique, 7(1), p.105.

Kim, S. (2015). COST-VOLUME-PROFIT ANALYSIS FOR A MULTI-PRODUCT COMPANY: MICRO APPROACH. ijafr, 5(1).

MacKerron, G., Kumar, M., Benedikt, A. and Kumar, V. (2014). Performance management of suppliers in the outsourcing project: case analysis from the financial services industry. Production Planning & Control, 26(2), pp.150-165.

Magiera, F. (2010). Financial Statement Analysis. CFA Digest, 40(1), pp.85-86.

Mallick, S. and Yang, Y. (2011). Sources of Financing, Profitability, and Productivity: First Evidence from Matched Firms. Financial Markets, Institutions & Instruments, 20(5), pp.221-252.

Mueller, J. (2016). Depreciation: Straight-Line Vs. Double-Declining Methods. [online] Investopedia. Available at: https://www.investopedia.com/articles/06/depreciation.asp [Accessed 9 Sep. 2016].

Stunguriene, S. and Christauskas, C. (2014). Benefits of Applying Different Depreciation Methods of Long-term Tangible Assets in a Company. Socscie, 82(4).