Part A: Classification of items as assets or liabilities
Under this section, we will classify each of the given accounting transactions under appropriate category. Below presented is the snapshot of the excel sheet indicating the correct answers followed by the reasons for their classification under the relevant category:
Reasons for classification of each item:
a) An amount of £40K owed in incorporation tax: Since the company owes an amount, it will be classified under the liabilities section.
b) Stock worth £15K in the stock room: Stock/ Inventories are the current assets of the company and hence will be classified under current assets only.
c) An amount of £20K paid to a supplier for a product yet to be received: As the company has not received the benefit of its payment, this would be classified as prepaid expenses under the current asset section of the balance sheet.
d) Company’s brand is worth £80K: The value of company’s brand name is classified as intangible asset as the same do not have any physical presence but provides long-term benefit to the company.
e) Fleet of 5 cars owned by the company: Cars are fixed tangible assets as the same have physical presence and thus, would be classified the same category of the balance sheet.
f) Outstanding repairs worth £12K: Since the company is liable to repair the customer’s goods, the same will be classified under the liabilities section as ‘’Outstanding Repairs’’ amounting to £12K.
g) An amount of £55K owed to PCB supplier: As the company is liable to pay the amount to its suppliers, they will be classified as trade payables under the liabilities section of the balance sheet.
h)Bank Balance of £30K: Bank Balance is classified as Current Asset in the balance sheet.
i)Probable out-of-court settlement with a former employee: As the company expects that it will be liable to pay £10K in out of court settlement, it may create a provision for the same that will be classified under the liabilities section until the amount is paid fully.
j)Client’s portfolio worth £150K: Also known as ‘’Asset Under Management(AUM)’’ the value of client’s portfolio will be classified as fixed intangible asset.
k) VAT worth £18K due to HMRC: This will be classified as liability as the company owes this amount and is liable to pay the same.
l)Interest amounting to £25K owed on mortgage: Interest obligations are classified as liabilities on the balance sheet of the company as the same are owed by the company to the financial institution from where the debt is borrowed.
m) A customer has paid £35k up front for goods, which have not yet been delivered to him:
Since the company has received the amount for goods yet to be delivered, the same will be classified as liabilities.
n)Your production line equipment is now worth £180k: Equipments are classified as fixed tangible assets.
Part 2: Income Statement of the company
In this section, we will proceed to the second financial statement, i.e. Profit and Loss Statement, where considering the present manufacturing strategy, nature of employees and their functions, and other factors, we will frame out the profit and loss statement of the company. Below discussed are the assumptions on which the profit and loss will be prepared:
The cost incurred by the company is divided into two sections:
Direct Cost: These costs are directly related to the manufacturing of the product, here, designing of the product. Hence, all the costs incurred by the company on designing of wireless communication devices will be accounted under direct costs. Important to note, the company also outsources some of the designing activity related to PCB and Mechanical manufacturing, hence this cost will also be accounted din direct costs. In addition, all the other costs related to production activity will be accounted under direct costs. For the purpose of simplification, the summation figure of direct costs will be classified as ‘Cost of Revenue’.
Indirect Costs: Unlike direct costs, these costs are not related to the production activity and accounts for expenses relating to administration, rent, security, etc. As for the company, indirect costs will be majorly related to employee salaries, selling expenses, etc. Below is the detailed description of each of the likely indirect expenses to be borne by the company:
- Rental Expense: Assuming the company premises are on rental basis, the company will have to bear rental expense of £36000/ year for their 3000 sq feet office located on the outskirts of the city.
- Electricity: Since the company operates high end computer system and lab equipment, we assume the electricity expenses to be £18000/year.
- CEO Salary: CEO’s salary is assumed to be indirect amounting to £100000/ year
- Staff Salaries: The Company is having a well-qualified staff which includes:
6 Engineers: Each to be paid £50000/ year
Business Development Manager: The manager will be paid(on fixed basis) £60000/year
Receptionist: The receptionist will be paid £35000/year
Part-Time Finance Officer: Since, he serves only on part-time basis, the cumulative sum to be paid to him is assumed to be £22000/year.
- Depreciation Expense: These are the indirect expenses to be charged by the company on account of wear and tear of its capital assets. As for the company, it has computers and lab equipment that are eligible for claiming depreciation expenses. Below is the assumed depreciation expense for 10 computer system and lab equipments:
- Computer Equipments: £1200
- Lab Equipment: £2500
Since the company provides design services on contractual basis, revenue will only be recognized on percentage-of-completion basis. For Instance, assuming that the company is currently working on project worth £1 Million, but have completed only 60% of the project so far, the revenue to be recognized will be £600000.
Referring to the profit and loss statement prepared under the above discussed assumption, the company has made a net profit of £65300. Although the profit is sustainable for a small company like this, but in order to strengthen their financial and operating roots, they must look for reducing the costs of revenue either by increasing the outsourcing contract or through acquisition of equipment to provide them with cost advantage in the designing industry.
Forecasted Profit and Loss Statement
* Net profit: Gross Profit- Operating Expenses
Direct and Indirect Costs. (n.d.). Retrieved November 23, 2013, from http://accountingexplained.com/managerial/costs/direct-and-indirect-costs
Asset Under Management. (n.d.). Retrieved November 23, 2014, from Investopedia: http://www.investopedia.com/terms/a/aum.asp
Lakhotia, G. (n.d.). Classification of Assets and Liabilities . Retrieved November 23, 2014, from https://accounting-finance.knoji.com/classification-of-assets-and-liabilities/
Operating Expense. (n.d.). Retrieved November 20, 2014, from Investopedia: http://www.investopedia.com/terms/o/operating_expense.asp