Accounting and Financial Management Issues - Assignment Example

PART I Pls refer the Worksheet.doc attached separately. PART I- 2 Treatment of Prototypes: The company has incurred an amount of $23,750 towards development of prototypes. The cost of prototypes should be treated as period expense and charge it to Profit and Loss Account. 1According to SFAS 2, Accounting for Research and Development Costs, requires (Robert H. Colson, 2003) that R&D generally be expensed as incurred and that each year’s total R&D be disclosed in the financial statements. Development includes conceptual formulation, design, and testing of product alternatives; construction of prototypes and operation of pilot plants; but not routine alterations to existing products, processes, or operations Prototypes are generally used for demonstration of the final product to the prospective customers. Prototypes should not be treated as Asset unless there is some future benefit accruing out of this expense and FASB has permitted only certain type of expenditure to be capitalized. Prototypes coming under the category of “Development costs” would be capitalized only after the technical and commercial feasibility of the product for sale or use is established. Thus, the company should be able to show how the asset can generate future economic benefits. Thus, prototypes in this case need to be charged to Profit and Loss account under the head “Research and Development costs”. Treatment of Advertisement costs: The company has incurred an amount of $22,500 towards advertisement for initial promotion. Generally it is required to incur huge amount to promote a new product in the market. This promotion would result in the product capturing a considerable market share that would generate the sales volume for the next few years. The advertisement cost for initial product launch would generate probable future economic benefits and hence is treated as an asset. However, these costs would be capitalized only if the future benefits can be identified and measured. We need to know why sales may occur in a future period as a result of advertising in the current period. First, advertising may build impressions over time until the customer is eventually persuaded to make a purchase. Second, advertising program may be instrumental in introducing a product to a customer who later becomes loyal to the brand. Third, the customer may not be in the market at the time of advertisement but will remember the advertisement in the back of his or her mind until he or she is in the market for the product. In this situation charging the entire expenditure to the Profit and Loss account of the year in which it is incurred would result in decreasing the profit of that year and increasing the profit for the future years. Thus, considering the matching concept this expenditure needs to be amortized over the years. In the present case we have assumed that the benefit on account of this expenditure would last for 3 years and hence this expense would be amortized over a period of three years. For the period ended 31 December 2003 an amount of $7,500(being one third of $22,500) would be charged as expense to the Profit and Loss account. The balance amount of $15,000($22,500 - $7,500) would be treated as an Asset in the Balance sheet. PART2-1 Profit and Loss account for the period ended 31 DEC 2003 (Amount in $) Particulars- EXPENSES Amount Particulars - INCOME Amount Opening Inventory 75,000 Sales 754,500 Purchases 175,000 Credit sales 90,000 Direct Manufacturing Labor and Overhead 350,000 Closing Inventory 55,000 Salaries and Other expenses 80,000     Legal Expenses 7,500     Prototypes 23,750     Patents written off 25,000     Advertisement 7,500     Interest of Short term loan 750     Depreciation 10,625     Profit carried forward to Balance sheet 144,375     TOTAL 899,500   899,500 Balance sheet as on 31 DEC 2003 (Amount in $) Particulars- LIABILITIES Amount Particulars - ASSETS Amount Common Stock 500,000 Patent 100,000 Reserves and Surplus   Machinery 201,875 Profit and Loss Credit balance 144,375 Receivables 159,500     Inventory 55,000     Cash 113,000     Advertisement to be written off 15,000 TOTAL 644,375 TOTAL 644,375 PART 2-2 Has the company made profit? Yes, The Company has made profit to the tune of $144,375 for the Period ended 31 December 2003. During this period the company has achieved turnover to the tune of $844,500. During this period the company has consumed chemicals and plastic of $195,000. The company has incurred $3, 50,000 towards direct manufacturing labor and overhead. Apart from this the company has incurred other expenditure to the tune of $155,125. Why the Cash balance has declined? The company is required to maintain the books of accounts on accrual basis. The profit and Loss account and Balance sheet of the company are prepared on this basis. However, cash balance as on 31 December 2003 is arrived at by deducting the total cash outflow from cash inflow. This has resulted in a situation where the company has made profit but the cash balance has declined. For example, Credit sales to the tune of $159,500 are considered in profit and loss account but would not be taken in arriving at Cash balance. Similarly, non-cash expenditure like Depreciation of $10,625 is included in Profit and Loss account but not taken into account in arriving at the Cash balance. Further, cash is required to be paid for expenditure like Advertisement and patents whose value is there for the next 3 to 5 years. The company has incurred $125,000 towards patents which is an outflow and would reduce the cash balance, however only $25,000 is charged to the Profit and Loss account. Further, Assets like Machinery and Inventory requires for Cash to be paid upfront whereas income would be generated from these in the future years. The company has spent an amount of $212,500 towards purchase of machinery which is again a cash outflow resulting in decrease of Cash balance, however only $10,625 in the form of depreciation is charged to the profit and Loss account. Thus, cash balance represents the cash position on a particular day in this case 31 December 2003. Decline in cash balance does not infer that the business is not doing well or increase in cash balance does not mean business is good. BIBILOGRAPHY: 1. Robert H. Colson, Accounting and Tax Treatment of R&D [Online] Available at: http://www.nysscpa.org/cpajournal/2003/0703/dept/d074603.htm accessed [02nd March 3, 2010 Read More