Kodak Analysis

Accounting

Basics

ASSETS = OWNER'S EQUITY + LIABILITIES

Creditors are a liability. (You owe them.) = Payables.

Increase of creditors is a source of cash.

Debtors are an asset. (They owe you.) = Receivables.

Increase of debtors is a consumption of cash.

Net Profit = Change in Owner's Equity.

Gross Profit = Sales less Cost of Sales.

Matching Convention: Profit is calculated by matching costs with the revenue recognized during the period.

Allocation Convention: First, determine all costs. Second, allocate costs to sales, inventory, etc.

Cost Convention: Items are valued at the historical cost of all input factors.

Conservatism Convention: Recognize costs immediately and revenue only when it is certain.

Accruals Convention: An obligation from a credit worthy customer may be regarded as a sale.

Cost of Raw Materials in P/L Account = Opening Inventory + Purchases - Closing Inventory

Valuation of Closing Inventory can be done by FIFO, LIFO or Average Value.

High Valuation of Closing Inventory = High Profits, because low valuation of matched materials cost.

Types of inventory: Raw Materials, Work-In-Progress, Finished Goods.

Reserves are unallocated profits. Reserves would be a part of owner's equity, except for some reason are being held back from recognition as such. Bad debt reserves are owner's equity held for the purpose of covering bad debt that may arise in future periods.

Depreciation

* Straight Line: Depreciation = (Purchase Cost - Expected Residual Value) / Service Life

* Reducing Balance: Depreciation = Current Book Value * Calculated Rate

Calculated Rate = where n = years of service, rv = residual value, pc = purchase cost.

* Consumption: Depreciation = where rhy = running hours this year, rhl = lifetime running hours.

Current Cost Accounting

Four adjustments need to be made to convert Historic Cost (normal) statements to Current Cost statements.

Adjustment 1: Fixed Assets & Depreciation

1. List assets at current value (usually replacement cost) less total accumulated depreciation, adjusted for the new value. The current cost revaluation reserve is credited the difference, so that the profit & loss account does not show any gains or losses for revaluation, which is after all not profit from operations.

2. The depreciation charge to be accounted for this year is the difference between the new total accumulated depreciation desired, and the total accumulated depreciation as of last year. The "current consumption" depreciation is calculated per normal practice and reflected on the profit & loss statement. The remaining "backlog" or "top-up" depreciation is DEBITED from the current cost revaluation reserve, because it reflects a lower starting book value of the asset in question than is otherwise shown.

Adjustment 2: Cost of Sales

1. Find a suitable price index for the beginning of the year, end of the year and average through the year. Convert all prices from historic dollars to index-average dollars by dividing by the index at the relevant time and multiplying by the average index.

2. Determine current cost of sales by: (opening inventory + purchases) - closing inventory, all in adjusted current values.

3. Cost of Sales Adjustment is the difference between historic cost of sales and current cost of sales. This adjustment is added to cost of sales (reducing profit) and also added to the current cost revaluation reserve.

4. Closing inventory value must be listed at the current prices. Adjust closing inventory value by the appropriate price index, and add the resulting adjustment to the valuation on the balance sheet and also to the current cost revaluation reserve.

Adjustment 3: Monetary Working Capital

1. Determine the opening and closing MWC (debtors etc. less creditors etc., but not including cash because cash is not WORKING capital). Subtract opening from closing to determine this year's change in MWC.

2. Isolate the volume change component of the change in MWC by taking the difference of the opening and closing values as expressed in current dollars. (Convert to current dollars using indexes as in the Cost of Sales adjustment.)

3. Find the price increase component by subtracting the volume change component from the total change from step 1.

4. Deduct the price increase component from operating profit and add it to the current cost revaluation reserve.

Adjustment 4: Gearing Ratio Adjustment

1. Determine the gearing ratio. Find net borrowings (loans less cash but not including creditors) and net operating assets (net borrowings plus owner's equity plus all reserves). Gearing ratio is net borrowings divided by net operating assets and is usually expressed as a percentage.

2. Multiply the three previous adjustments by the gearing ratio to determine the amount which should be "backed out" (because loan payments are fixed at historical price levels).

3. Credit this amount to operating profits and debit this amount from the current cost revaluation reserve.

Ratio Analysis

Liquidity Ratios:

Current Ratio = Current Assets / Current Liabilities. Measures ability to pay bills. Rule of thumb: 2.

Quick Ratio = (Current Assets - Inventory) / Current Liabilities. Measures ability to pay bills NOW. Rule of thumb: 1.

Profitability