This report has been prepared to analyse the true financial position of the newly set-up company which has initiated its business of manufacturing and selling of outdoor play gym for the children. As this being the first year of business of Bob Earl where the business is set up on 1st January of this year, it is quite obvious to expect that there will more of cash outflows than its inflows. This is so because of the requirement to invest in the purchase of various fixed assets and inventories for the subsequent periods of the business. Fixed assets are those assets which are generally not held to be sold as a part of normal business activities and hence it is considered as the capital expenditure (Foster, 2004). The cost incurred to acquire such assets must not be treated as an operating expense of the business. Rather, the cost must be taken to the statement of final position with proper adjustments of yearly depreciation on such assets. The income statement of the company must be charged for the depreciation on the fixed assets held by the company for its business. Therefore, in the present case, where Bob has charged the purchasing cost of fixed assets such as factory equipment, office equipment and the sales vehicle, the recording of such assets is incorrect in the income statement. The cost of purchase of these three fixed assets must be shown in the Balance sheet of the company after making the adjustment of current year’s depreciation. Depreciation on any fixed asset is started to be charged from the year in which such asset is actually put to use (Radu & Marius, 2011). Assuming that in the present case, the company has started using its fixed assets, the depreciation on such assets will be calculated in this particular year using the straight line method. The said depreciation will be taken to the current year’s income statement account as a debit item (Garrison et. al., 2010).
Further, the operating expenses and manufacturing expenses of the business must be shown separately as there is a clear difference in such expenses. Manufacturing expenses are those expenses that are directly related to the production process of the company. These expenses could be variable or fixed in nature. In the present case, the raw material purchases, direct labour (wages of factory employees) must be shown separately under the heading Cost of goods sold. However, the other expenses which are not directly linked to the manufacturing process must be recorded as the operating expenses as they are incurred to undertake to operate the business. It will include manager’s salary, office staff salary, rent, electricity expenses, advertisement, cleaning, advertisement cost and sales staff salary. The rent must be bifurcated among the factory cost, office cost and selling department cost in the proportion of space of building occupied for each of the above purpose. Even the factory manager’s cost must be clearly classified among the factory cost and operating cost in the proportion of time devoted by him with each department. The income statement must be prepared by deducting cost of goods sold from the sales to calculate the gross profit of company (Zimmerman & Yahya-Zadeh, 2011). The cost of goods sold must be determined taking into account the closing balances of raw material, inventories and finished goods. Thereafter, the operating expenses must deducted to reach at the net profit of the company.
Foster, G., 2004. Financial Statement Analysis, 2/e. Pearson Education India.
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.
Radu, D. and Marius, D., 2011. Issues related to the accounting treatment of the tangible and intangible assets depreciation. Annals of the University of Oradea: Economic Science, 1(2), pp.498-502.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.