CQUniversity

ACCT11081

Distance – Townsville

Haitham Daniel Haddad

12066074

Steps 7 to 11

Due Date: 22nd May 2018

Lecturer: Dr Martin Turner

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Step 7

I’ll be honest... I never thought (until after completing week five) that inventories held such significance in the realm of accounting. After completing the lecture and readings for week five I became aware of why inventories and the way they are calculated and measured are so important.

What were my initial thoughts?

My first thoughts after reading through the past four years worth of annual reports for my firm was that there was a limited amount of information about inventories contained within the reports. The information that was in the reports was restricted to the inventories figure on the balance sheet and some notes on inventories. I was very surprised about this, as the very nature of Amber Tech’s operations is so heavily focused on inventories. After reading the annual reports I am still not sure of how the firm actually manages its inventories. Further, Amber Tech purchases its inventories (via its exclusive rights to its manufacturers) and then re-sells them to its retail and commercial clients, therefore, I would think that this would be a necessary talking point for the firm in its annual report, however, no such extra information was provided.

What is the size of the inventories and change over the years?

Amber Tech is a distributor of broadcasting, media and entertainment related products. Due to this type of operation of buying wholesale and re-selling on to its own customers, the firm (at any given time) has a lot of inventory. Over the past four years the firms total value of inventory fluctuated by a few million, with a low of 12 million in 2017 and a high of 14.9 million in 2015. The total value of inventories steadily decreased from 2015 to 2017 (end of financial year to end of financial year respectively). Whilst I am not sure if the firm is intentionally reducing its inventory or not (as there was nothing noted in any of the annual reports about this) I did some research and discovered there were several advantages in doing so. I discovered that the benefits include reducing costs and waste, having fresher stock and improving working capital, but whether or not the quantity of inventories has actually decreased or the net realisable value has simply dropped, I am yet to find out.

What do the inventories notes say?

The first note about inventories is under the ‘significant accounting policies’ and talks about the ‘provision for impairment of inventory’. The content seems pretty straightforward and basically says that an educated guess is used to determine the provision for impairment of inventory. A photo of the note is below (the below note is exactly the same in the past three annual reports).

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Figure 1: The Provision for impairment of inventories taken from the ‘significant accounting policies’ notes in the 2017 annual report.

Further notes about inventories were included separately to the ones above. These notes stipulated that inventories include both finished goods and goods in transit, that inventories are measured at the lower of weighted average cost and net realisable value, that the first-in-first-out method (FIFO) and that the costs include direct material, direct labour and an appropriate proportion of variable and fixed overhead expenses. These notes were pretty straightforward and were exactly the same (word for word) for the past three annual reports for the firm. I also noticed that the FIFO method was also used throughout the past three annual reports. A photo of the note is below:

Figure 2: A note in regards to inventories extracted from the 2017 annual report.

Figure 3: A note in regards to the breakdown of inventories extracted from the 2017 annual report.

Something I did find interesting was the ‘provision of obsolescence (a)’. The title of the provision suggests that its purpose is to allow for inventory that can no longer be sold and is essentially ‘out of date’ (hence obsolete). As illustrated below, the provision includes an opening balance, which is simply the previous year’s closing balance, a charge for the year, and amounts written off. I did some research on the internet to determine what the ‘charge for the year’ means, but I could not find anything definitive. However, I will make an assumption and say that the charge for the year is simply the amount of inventory management estimated will be written off for the year, whilst the ‘amounts written off’ is what was actually written off, thus the difference between the two is added to the opening balance giving the closing balance. I am not quite sure that I have comprehended this provision correctly, so I have made a note to raise this topic with fellow students to see their thoughts.

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Figure 4: A breakdown of the Provision of obsolescence (a) note from the 2017 annual report.

I attempted to find information in the last three annual reports for the firm in regards to which method of accounting for inventory (periodic or perpetual) they use, however I could not find any information regarding this.

Any costs and issues associated with inventories, as well as any opportunities to improve inventory management?

Whilst I understand and appreciate that the way a firm manages its inventory will have quite a significant effect on a firm’s financial statements and most notably its gross profit, I do not think there is enough information in the firm’s annual reports for me to be able to accurately identify any issues or potential opportunities for improvements associated with the firm’s inventory and it’s costs (other than the paragraph below regarding inventory ratios). Something I will mention however is that the firm does have a high cost of sales. The cost of sales takes up a significant portion of Amber Tech’s revenue – approximately 70 percent on average of it each year over the past four years (which is quite similar to other firms’ with similar business models).

In 2017 ‘sales of goods and services’ made up 99.96 percent of the firm’s revenue whilst ‘interest income’ made up the rest. As a reader of the firm’s annual report, I would appreciate if more detail was supplied in regards to the sources of its revenue. For example, does the sale of goods contribute more to revenue than the services it provides? Further information like this would be useful in assessing the firm’s financial position and its inter-relationship with inventories. Unfortunately, a breakdown of the cost of sales was not provided in any of the firm’s annual reports.

Below are two sets of inventory ratios: Number of day’s inventory is held in stock and the inventory turnover ratio. The former tells us how long the firm’s inventory sits in a warehouse before being sold on to its customers. Obviously, the lesser amount of days means the firm is making more sales. The latter tells us much of the same thing except in the form of a much smaller number, which allows one to use it as measure of performance to other firms in the same industry, or to the same firm but to measure its performance over a number of years; for the inventory turnover ratio, the higher the number the better. So, what do the ratios tell us? It shows that the firm progressively increased their inventory management between 2015 and 2016, which makes sense as Amber Tech retuned a net profit in 2016. However, the days inventory on hand increased by 151% from 2016 to 2017. This suggests that the firm sales decreased significantly in the 2017 financial year. Whilst this does not actually suggest any potential areas for improvement, it does identify the issue that Amber Tech is struggling to sell its inventory.

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Figure 5: A graph illustrating two ratios regarding inventory management.

Do I have any stock-take experience in my own life?

I have had very limited stock take experience in a professional capacity. My limited experience includes, watching the manager do it at McDonald’s where I use to work seven or so years ago and also helping out on completing stock-takes of the armoury from when I was in the Army. Whilst the stock-take for the Army was not for commercial purposes so there was no cost of sales or inventory to put on a balance sheet, the principal of completing the stock-take was the same. Every weapon and piece of equipment had a serial number that was unique, and periodically everything would have to be accounted for and several signatures were required to confirm that the stock-take was complete and satisfactory.

Overall, Amber Tech has large amounts of inventory and a high cost of sales to go with it, however, limited information in regards to its management of inventories was provided in any of its past three annual reports. Whilst the information contained within the reports was limited, it was enough for me to gain a basic understanding of how a real and active firm account for its inventories within their financial statements and annual reports more broadly. I look forward to reading fellow students key concepts and questions about their firms’ inventories and I hope their firms’ annual reports discussed more about inventories than mine did.

Step 8

First phase of the training for the MYOB platform:

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Figure 6: A screenshot of the final page of the ‘start learning’ training tool.

Figure 7: A screenshot of the final page I was working on when completing the setting up phase (I initially was working the Clearwater file before creating my own).

Second phase of the training for the MYOB platform:

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Figure 8: A screenshot of the final page of the ‘how to use Account Right’ training tool.

Figure 9: A screenshot of the final page I was working on when completing the training tool ‘How to use Account Right ‘.

Completing the MYOB platform test:

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Figure 10 to 22: Screenshots of the MYOB test questions and my answers.

Total result = 11/13

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Step 9

Figure 23: The ‘All Journals Report’.

Background to my firm: Amber Tech is one of Australia’s largest distributors of technological, broadcasting and home entertainment goods and services who service both the commercial and retail markets.

Transactions for the period of May 2018:

Transaction 1: Processing the ‘bill’ from ABC supplies for the purchase of inventory. The goods have been received but not yet paid for. $700,000 is now owed to trade creditors (ABC supplies) and inventory has now increased by $636,363.64 ($700,000 – GST paid).

Transaction 2: Processing the invoice for the sale of goods (that are yet to be paid) to ABC broadcasting. $1,000,000 is now owed to us from trade debtors, the cost of sales has now increased by $636,363.64 as this expense has now been recognised, inventory has decreased by the same amount as the cost of sales, and the GDT collected and the revenue raised for the sale has also been recorded.

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Transaction 3: This is a refund (note yet paid) for faulty goods that were sold to ABC broadcasting in transaction two. The sales and GST collected from the previous sales have now been reversed proportionately for a sale of $50,000. Inventory has now increased by $35,000 for the goods returned and the cost of sales has decreased by $35,000 as well. The amount that the trade debtors owe us has been reduced $50,000.

Transaction 4: Processing the ‘bill’ from XYZ supplies for the purchase of inventory. The goods have been received but not yet paid for. $50,000 is now owed to trade creditors (XYZ supplies) and inventory has now increased by $45,454.55 ($50,000 – GST paid).

Transaction 5: Transaction five is for the payment of transaction one. $700,000 is deducted from the firm’s cash account and the same amount is reduced from the liability ‘trade creditors’.

Transaction 6: This transaction is for the payment of rent. The cash has been deducted from the bank account and the rent and the GST component has been paid.

Transaction 7: This transaction is for the actual payment of the refund for transaction three.

Transaction 8: This transaction is for the actual payment for transaction four.

Transaction 9: This transaction is for the actual payment received for transaction two.

Transaction 10: This transaction is for the recording of interest earned from cash in the bank.

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What ‘story’ are the financial reports trying to tell?

Figure 24: The balance sheet for the firm I created in MYOB.

As a result of the small number of transactions that has been processed, has cause the balance sheet to look quite bare. However, this balance sheet can tell us a number of things. Firstly, you can see that the firm has net assets (rather than net liabilities) and its assets are made up of cash in the bank and inventories. Moreover, the liabilities are simply made up of net GST collected. At this stage there is no money owed from trade debtors and also no money owed to trade creditors, so you could say at this stage that all purchases and sales have been settled. Overall, in the limited life span of this company it is looking quite healthy.

Quick Ratio = (Current Assets – Inventories) / Current Liabilities

= (272,454 – 80,454) / 17,272 = 11.11

Research (and a little bit of thinking about the ratio itself) tells me the higher the ratio the better. So for this firm the quick ratio is great!

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Figure 25: The profit & loss statement for the firm I created in MYOB.

The profit & loss statement also looks quite healthy. It shows quite a large amount of sales (for a company with such a short life span) and also a cost of sales that absorbs almost 70% of the firm’s total sales leaving a gross profit of $262,272.72. Fortunately, there is only one fixed cost to take away from the gross profit and that is rent (I had accidently mischaracterised the expense on MYOB as an insurance expense). Other income included ‘interest earned’ leaving $254181.81 for the net profit for the period.

Sales-to-assets ratio formula: Net sales divided by assets

= 191,000 / 271,454 = 0.7 – which means that for every dollar of the firm’s assets the firm generates 70 cents in net profit.

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Figure 26: The cash flow statement for the firm I created in MYOB.

The cash flow statement does not tell as much. What it does tell us is that after the value of inventory and the net GST collected is deducted from the firm’s net income it leaves a total cash position of $191,000. It also shows the difference in the cash position since the opening of the period but since this is the first period and no cash was initially injected in to the business the difference equals the current total cash position.

Operating Cash Flows Ratio = Cash flows from operations/current liabilities

= 191,000 / 17,272 = 11.05 – which suggests that the firm has a sufficient cash flow to cover its short term obligations.

Step 10

Introduction:

I will be honest. After completing the study guide readings, lecture and tutorial for week eight in regards to non-current assets I was left slightly confused. I felt that I did not understand the concept of depreciation well enough to complete this step. In response to this feeling of a lack of comprehension, I hit YouTube and Google and watched countless videos explaining the different concepts of depreciation as well as the cost and revaluation models. After doing this, I felt much more comfortable and confident in my ability to complete Step 10. I think the reason I struggled to understand it in the first place was simply because I am a strong visual learner. So seeing examples and animated videos of the journal entries and other

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examples explaining the core idea of depreciation helped me understand the concepts much easier.

Before I delve in to the key concepts and questions on depreciation specific to my firm, I would like to explain what I understand depreciation to be and its purpose: in my own words, depreciation is the allocation of an expense over-time for an asset, and as follows, its purpose is to not record the expense of a purchase of an asset in one period, but rather allocate the expense of the purchase of the asset over the assets useful. This allows the expense of the asset to match the period in which revenue is generated from the asset, in accordance with the Australian Accounting Standards Boards (AASB) framework.

To provide an example, a fictional firm purchases a delivery van in order to deliver its stock to customers; this van represents an asset to the firm – something that is expected to deliver future economic benefits. Let us say that the firm purchases this vehicle for $10,000. Instead of the firm posting the entire $10,000 as an expense for the reporting period in which it was purchased, it debits its asset by $10,000 and credits its cash account by $10,000. Every reporting period after that, the firm allocates a portion of that $10,000 as an expense (and the same portion to accumulated depreciation) until its useful life has expired. The amount that it allocates as an expense depends on which method of depreciation it chooses to use. As previously mentioned, recording an expense this was allows the recording of an expense to match the period in which the firm expects to generate revenue from the delivery van.

General Key Concepts and Questions:

After having gone through Amber Tech’s past four years worth of annual reports and reading the notes in regards to its depreciation policies the one thing that stands out to me is that all the notes in each of the past three annual reports are exactly the same. More notably however, a lot of the notes describing the firms accounting policies seemed to be almost directly taken out of the AASB framework for depreciation. Amber Tech’s policies talk about how property plant and equipment is recorded at cost less any depreciation and impairment, and that the cost includes any expenditure that is directly attributable to the acquisition of the items.

Whilst going through the depreciation policies in the past three annual reports I noticed that the firm mentioned that it uses the straight-line method for both depreciation and amortisation of its plant property equipment and its intangible assets and goodwill over the past four years. By the firm using the straight-line method to record depreciation, this means to me that firm expects their assets to generate revenue gradually and equally over the useful life of the asset. This is in-line with the AASB framework which states “the depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity” (AASB Para 60).

Below is a list of some of some of the more important notes in regards to Amber Tech’s depreciation policies and the useful life of its different class of assets.

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Figure 27: A list of the class of assets and their useful life’s from note 2 (h) in the 2017 annual report.

Over the past four years, depreciation and amortisation has made up a low of 0.49% of total revenue as an expense (in 2016) and a high of 0.59% (2014). In relation to expenses itself, depreciation and amortisation makes up a low of 1.59% (2017) and a high of 1.86% (2014). These minimal changes over the past four years suggest that the amount the firm records as an expense each year has not drastically changed, this is despite the firm purchasing new property plant and equipment each and every year of the past four years. As you can also see, depreciation makes up a very small amount of the total expense for the firm each year. This is likely due to the firm only increasing their additions to plant property and equipment by a small amount each year and by the firm also keeping their measurement of depreciation and amortisation consistent over the past four years.

Journal Entries:

Some of the three fictional journal entries shown below are based off actual figures from Amber Tech’s annual reports and others are not. The ones that are not are based off transactions that were highly likely to have been recorded by the firm’s accountants with a few assumptions in lieu of missing information.

The journal entry below illustrates the allocation of depreciation as an expense, as well as the crediting of accumulated depreciation. The entry itself is a $252,000.00 debit (increase) in depreciation expense and a $252,000 credit (increase) in accumulated depreciation. A credit is an increase of the accumulated depreciation account because it is a contra-asset account.

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Figure 28: A journal entry of debiting an expense account and crediting accumulated depreciation with actual information taken from the 2017 annual report.

What is the effect of this transaction? This transaction allows the firm to spread the cost of the purchase of its non-current assets over their useful lives, thus matching the period in which the expenses and revenues have occurred.

This second journal entry is a fictional transaction recording the sale of property plant and equipment at a profit. Amber Tech had an item of property plant and equipment with a book value/carrying amount of $3000.00 (cost of PPE) - $1000.00 (accumulated depreciation) = $2000.00 (book value/carrying amount) and then sold that item for $3000.00 (cash received) thus recording a net profit on disposal of $1000.00 (the difference between the carrying amount of the asset and the cash received). The $1000.00 credit of ‘net profit on disposal of property plant and equipment’ was identified in Note 3 under other income in Amber Tech’s 2017 annual report. The book value/carrying amount was taken from Note 9: property plant and equipment and the amount was identified under disposals of $2000.00. Therefore, once I knew the carrying amount and the net profit, I deduced the rest.

Figure 29: A journal entry recording the sale of an asset at a profit with some figures taken from the 2017 annual report.

As you can see, property plant and equipment, which is an asset is credited (decreased), accumulated depreciation which is a contra-asset account is debited (decreased), cash is debited (increased) and net profit on disposal of plant and equipment is credited (increased). Whilst this journal entry is not clear-cut - as one debit and one credit is an increase, whilst the other debit and the other credit is a decrease, overall there is a net increase on both sides of $1000.00. This is explained further below:

Property plant and equipment – ($3000.00)

Accumulated depreciation - $1000.00 (increases the value of a balance sheet as it reverses previously credited accumulated depreciation)

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Cash - $3000.00

Net increase in debits = $1000.00

Net profit on disposal of plant and equipment - $1000.00 (revenue account)

Net increase in credits = $1000.00

As discussed in Steps 3 to 6, the net increase in debits and credits need to match in order for the two sides to balance.

What is the effect of this transaction? This transaction allows the firm to record a net profit for the sale of a non-current asset, due to the firm selling the asset for a price over and above its carrying amount.

This third journal entry is opposite to the one above and is a fictional transaction recording the sale of property plant and equipment at a loss. Amber Tech had an item of property plant and equipment with a book value/carrying amount of $5000.00 - $3000.00 = $2000.00 and then sold that item for only $1000.00 thus recording a net loss on disposal of $1000.00 (the difference between the carrying amount of the asset and the cash received). The $1000.00 debit of ‘net loss on disposal of property plant and equipment’ was identified in Note 4: expenses in Amber Tech’s 2015 annual report. The book value/carrying amount was taken from Note 10: plant and equipment and the amount was identified under disposals of $1000.00. Therefore, once I knew the carrying amount and the net loss, I deduced the rest.

Figure 30: A journal entry recording the sale of an asset at a loss with some figures taken from the 2015 annual report.

What is the effect of this transaction? This transaction allows the firm to record a net loss for the sale of a non-current asset, due to the firm selling the asset for a price lower than its carrying amount.

Are there any potential areas at risk of manipulation?

I cannot identify and room for manipulation specifically within the aforementioned transactions. However, I can identify two areas at risk more broadly in regards to depreciation itself. The first would be the fact that a firm may extend the useful life of an asset, longer than what it would reasonably suspect it to be, thus recording less of an expense each year on its income statement for depreciation. The second would be to use the straight line method, when the asset is likely to generate more revenue earlier in its life, hence the diminishing balance method should have been used. This would allow the firm to record a more even

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expense of depreciation over its life rather than be hit with a big expense earlier on. However, if a firm was to do either of those actions, a savvy reader of a firm’s annual report would be able to easily identify the wrongdoings of the firm by comparing their useful lives of their assets and their method of depreciation and compare it to the firm’s competitor – assuming their business model is similar.

Other key concepts and questions:

After scouring through Amber Tech’s past three annual reports I realised that there was no mention of any land held by the firm. This does not surprise me as I cannot think of a reason for my firm to hold any land but I thought it was worth a mention.

The other thing I think is worth a mention is the fact that my firm records no Goodwill in its non-current assets. This is in stark contrast with Wesfarmers, whose Goodwill made up majority of the firm’s non-current assets. In the notes of the 2017 annual report, it explains the reason no Goodwill is listed as an asset is because the Goodwill is fully impaired. Also, Amber Tech only has three subsidiaries so their Goodwill could have only come from the purchase of those. Again, this is in contrast with Wesfarmers who has at least 37 subsidiaries (noted by Wesfarmers different businesses on their website here).

Final thoughts:

In summary, once I finished this week’s worth of readings and lectures I was left confused, however after completing this step of the assignment (specifically the journal entries) and doing hours of research on Google, You Tube and even reading the AASB framework I felt that I understood the concept of depreciation much better and more deeply. More specifically about my firms depreciation however; depreciations makes up a very small percentage of the firm’s total expenses, the firm uses the straight-line method for depreciation, and its policies and notes on depreciation are almost copied straight out of the AASB framework.

The end