Link between Present Value of Growth Opportunities (PVGO) and Dividend Valuation
Valuing a corporation is a complex exercise. This is partly because there are multiple ways of looking at the same information. One such example is mentioned in this article. Dividend discount valuation and present value of growth opportunities may seem to be two completely different topics. However, there exists a link between them. In fact […]
Financial Doping and Financial Fair Play
The business of sports leagues is inherently intertwined with the finances that the franchises have. It may appear that the success of a club is determined by the performance of its players on the field. However, that is not the entire truth because, at the back end, there is an entire team of professionals who […]
Accounting for Player Contracts – Advanced Scenarios
In the previous article, we have already seen that accounting for sporting franchises involves certain scenarios that are specific only to the sporting industry. We saw how the accounting for player contracts was unique and why it was important to understand the accounting implications. In this article, we will continue to have a look at […]
Reverse Mergers
The profession of investment banking has become quite innovative over the years. Traditionally, raising capital was an expensive as well as time-consuming process. However, over the past few years, investment banks have devised ways to help their clients raise funds. These ways are neither time consuming nor expensive. A reverse merger is one such innovative […]
The Impact of Bankruptcy on Shareholders
Companies that file for bankruptcy also have a capital structure just like normal companies. This means that their capital structure is comprised of debt as well as equity. In the past few articles, we have been continuously talking about the interests of the debt holders i.e., how they will get paid in the event of […]
The relationship between when cash is spent and when it is recognized as an expense is fairly complex in job order costing. Costs flow through the inventory accounts and finally become an expense when the sale is complete. This relationship and the complexities that arise have been tracked in this article.
To understand this relationship better we have to take a back track to financial accounting. There, we defined the difference between an outlay and expenditure. An outlay is when resources are utilized whereas expenditure is defined as a loss of value. Hence, when a firm spends money to create inventory it is not an expense. It is an outlay of cash. Cash has changed form and is now another asset called inventory. There is no loss of value, instead there is only transfer of value.
Also, in the previous article, we defined the types of costs that are likely to be incurred in a job costing scenario. They were direct materials, direct labor, manufacturing and non-manufacturing overhead. We classified non-manufacturing overhead as period costs and all others as product costs.
When costs are incurred one of the two things happen depending upon the type of costs. If the cost is product related, we add it to the inventory. This cost is not recognized as an expense until the sale is complete and loss of value has occurred. On the other hand, when it comes to period costs, they are expensed immediately because they have no cause and effect relationship with production.
It is important because the treatment of two costs is very different. When direct materials are purchased, they are directly allocated to their respective jobs. Same is the case with manufacturing related overhead and direct labor. They can be seen immediately in the job cost sheet. On the financial statements, they are considered as inventory. Inventory shows up under assets and not under the expense column.
The problem does not end there. Firms have to carefully calculate the breakup of inventory. Inventory is a big account with 4 sub accounts viz. raw material, work in progress, cost of goods manufactured and cost of goods sold. Companies need to carefully check the manufacturing overheads to ensure that they are not overstating or understating the value of any of these assets.
Once again, companies follow subjective treatments while allocating costs to separate sub inventory accounts. The amount of manufacturing overhead that is actually spent on work in progress cannot be precisely known. Accountants make estimates stating that relative proportions that they think have been spent on work in progress.
From an examination point of view, calculating the values of WIP, raw materials and finished goods may not be such a hassle since the percentage allocations are already given. However, in reality, determining these percentage allocations is a tough task that needs a lot of expertise and experience.
Your email address will not be published. Required fields are marked *
