Capital Budgeting

Fonte:http://accountingexplained.com/managerial/capital-budgeting/

Capital budgeting (or investment appraisal) is the process of determining the viability to long-term investments on purchase or replacement of property plant and equipment, new product line or other projects.

Capital budgeting consists of various techniques used by managers such as:

  1. Payback Period
  2. Discounted Payback Period
  3. Net Present Value
  4. Accounting Rate of Return
  5. Internal Rate of Return
  6. Profitability Index

All of the above techniques are based on the comparison of cash inflows and outflow of a project however they are substantially different in their approach.

A brief introduction to the above methods is given below:

  • Payback Period measures the time in which the initial cash flow is returned by the project. Cash flows are not discounted. Lower payback period is preferred.
  • Net Present Value (NPV) is equal to initial cash outflow less sum of discounted cash inflows. Higher NPV is preferred and an investment is only viable if its NPV is positive.
  • Accounting Rate of Return (ARR) is the profitability of the project calculated as projected total net income divided by initial or average investment. Net income is not discounted.
  • Internal Rate of Return (IRR) is the discount rate at which net present value of the project becomes zero. Higher IRR should be preferred.
  • Profitability Index (PI) is the ratio of present value of future cash flows of a project to initial investment required for the project.

The above techniques are explained in detail in next pages.

Written by Irfanullah Jan

Process Costing – Weighted Average Method

Fonte: http://accountingexplained.com/managerial/cost-systems/process-costing-weighted-average

Process costing system is used for standardized production processes. Whenever a process cost sheet is prepared for a department, the department most likely has some unfinished units either in its beginning work in process, closing work in process or both. In such a situation, it is important to determine a cost flow assumption, i.e. to agree on the order in which costs are transferred out to the next department. There are two cost-flow assumptions: first-in-first-out (FIFO) and weighted average.

In the weighted average method of process costing, the costs are averaged out and evenly applied to both units transferred out and units in closing work in process. Unlike FIFO method, which assumes costs introduced first into a department are transferred out first, weighted average method does not assume any specific order.

Process costing under weighted-average method involves the following steps:

  1. Preparing the quantity schedule: i.e. finding units in the beginning work in process for the period, units started or units transferred-in from prior departments, units transferred out to next department or units of finished goods, and units in closing work in process.
  2. Bringing forward the cost of units in the beginning work in process from last period. The cost should be broken up into all its components: direct materials and conversion costs (=direct labor and manufacturing overheads).
  3. Finding the costs added in the current department under different heads: direct materials, direct labor and manufacturing overheads.
  4. Finding total cost to be accounted for under each head i.e. direct materials, direct labor and manufacturing overheads. This would involve adding the cost included in the opening work in process on account of direct materials, direct labor and manufacturing overheads to the corresponding amounts added during the period on account of the relevant cost component.
  5. Finding total equivalent units.
  6. Finding cost per equivalent unit for each cost component by dividing the total cost for the cost component by total equivalent units for the relevant cost component.
  7. Allocating the cost between the units transferred out and units included in the closing work in process.

Example

Let us prepare a process cost sheet under weighted average method using the following data for Company ABC’s packaging department for the month of December 2013.

  • 20,000 units in work in process as at 1 December: $20,000 direct materials and $40,000 for conversion costs (i.e. $10,000 direct labor and $30,000 manufacturing overheads)
  • 200,000 units transferred in from production department during the month: at a total cost of $555,000.
  • Costs added included: direct materials of $22,000 and conversion costs of $20,000.
  • 180,000 units transferred to finished goods
  • 40,000 units in work in process as at 31 December: 100% complete as to costs transferred-in, 80% complete as to materials and 50% complete as to conversion costs.

Solution

Let us prepare the quantity schedule.

As at 1 December 20,000
Transferred in 200,000
Units to be accounted for 220,000
Transferred out 180,000
As at 31 December 40,000
Units accounted for 220,000

Next, calculate the equivalent units.

Transferred-
in
Direct
Materials
Conversion
Costs
Transferred out (A) 180,000 180,000 180,000
Units as at 31 December (B) 40,000 40,000 40,000
Percentage of completion (C) 100% 80% 50%
Equivalent units as at 31 Dec (D=B×C) 40,000 32,000 20,000
Total equivalent units (A+D) 220,000 212,000 200,000

Next, calculate the cost per equivalent unit.

Transferred-
in
Direct
Materials
Conversion
Costs
Total
As at 1 December $0 $20,000 $40,000 $60,000
Added during the month $555,000 $22,000 $20,000 $597,000
Costs to be accounted for $555,000 $42,000 $60,000 $657,000
Total equivalent units 220,000 212,000 200,000
Cost per equivalent unit $2.52 $0.20 $0.30 $3.02

Now, we need to find the cost of units transferred out. It equals $543,600 [= $3.02 × 180,000].

We also need the figure for cost of work in process as at 31 December. It can be calculated as shown in the table below.

Transferred-
in
Direct
Materials
Conversion
Costs
Total
Units as at 31 December (A) 40,000 40,000 40,000 40,000
Cost per equivalent unit (B) $2.52 $0.20 $0.30 $3.02
Percentage of completion (C) 100% 80% 50%
Total cost (A×B×C) 100,909 6,340 6,000 113,249

Since cost of opening WIP plus cost added must equal cost transferred out and cost in closing WIP, the cost of closing WIP can be calculated using as short-cut formula given below:

Cost of closing WIP = Costs to be Accounted for − Costs Transferred Out

In this example, it turns out a figure of $113,400 (total cost to be accounted for of $657,000 minus costs transferred out of $543,600). The minor difference is due to rounding off.

The final process cost sheet should look like as follows:

Company ABC
Packaging Department
Cost of Production Report
Dec-13
QUANTITY SCHEDULE
As at 1 December 20,000
Transferred in 200,000
Units to be accounted for 220,000
Transferred out 180,000
As at 31 December 40,000
Units accounted for 220,000
COST SCHEDULE
Direct materials 20,000
Conversion costs 40,000
As at 1 December (A) 60,000
Costs-transferred in (B) 555,000
Direct materials 22,000
Conversion costs 20,000
Costs added (C) 42,000
Total costs to be accounted for (A+B+C) 657,000
Transferred to finished goods (D) 543,751
Costs transferred-in 100,909
Direct materials 6,340
Conversion costs 6,000
As at 31 December (E) 113,249
Total costs accounted for (D+E) 657,000

Written by Obaidullah Jan, ACA, CFA <— Hire me on Upwork