Generally Accepted Accounting Principles

Generally accepted accounting principles or GAAP is a set of standards developed by accounting professionals. This standard has composed in 1914 and amended in 1992. This improved principle standards are generally accepted and practiced world wide. GAAP is a guideline to get ready a report of economic events. It has following branches which are important for financial statements-

• The Securities and Exchange Commission (SEC)
• The Financial Accounting Standards Board (FASB)
• The International Accounting Standards Board (IASB)
• The Cost Principle

On the basis of GAAP, for external use financial statements are constructed. To reduce fraud and misrepresentation statements are make up by a few common rules. But these statements are not for internal decision making. A limitation of GAAP is it can not afford current market value of asset; it furnishes just on historical cost.

It is not essential to use GAAP while making a financial statement, in accordance internal report managers would apply their own rules. In practice, managers need these statements a lot for collection of costs and analyze this data for decision making. Though there have a few limitations GAAP is important for both internal and external use of financial statements.

Current assets and Liabilities vs. Non-current items- For calculation of balance sheet current assets, liabilities and non-current items or assets essential factor. The balance sheet presents financial position in terms of accounting equation. In an accounting equation liabilities are deducted from total assets to calculate capital of an organization.

Above are the basic differences among current assets, liabilities and non-current assets and their importance in making financial statements.

The balance sheet

Toyota Tsusho (South Sea) Limited. Balance sheet. 31^st March, 2008.

Western Digital. Balance sheet. 31^st December, 2007.

The income statement

Income statement for both of company is present as bellow-

Toyota Tsusho (South Sea) Limited. Income statement. 31^st March, 2008.

Western Digital. Income statement. 31^st December, 2007.

The statement of cash flows (using the annual reports of 2007, 2008 )

Toyota Tsusho (South Sea) Limited. Cash flow statement. 31^st March, 2008.

Western Digital. Cash flow statements. 31^st December, 2007.

For each of the two companies more useful financial statement is- ‘Net income’

Toyota Tsusho (South Sea) Limited and Western Digital for both companies income statement is more useful financial statement in decision making. An income statement makes available information for a company in an easier form. Where as, cash flow statement presents cash inflows and out flows throughout the year. It is easy to identify a company’s transaction over a year from an income statement.

Toyota Tsusho (South Sea) Limited is a car manufacturer company and the Western Digital manufactures instruments for information exchange. Western Digital produces portable computers, memory cards and other accessories for exchanging information. Though they earn 26% more than last year but their market position is not as strong as Toyota.

Session Long Project

Toyota is the market leader in global automobile industry. The Toyota Motor Corporation was established in 1937 in Japan. The company has fifty-three factories in twenty seven countries. It has a wide market over 127 countries with brand name as Daihatsu, Hino, Lexus, and Toyota. The Toyota Motor Corporation has generated a sale of 8.9 million units of different vehicles in 2008¹.

The internal control process in excess to the financial reporting of Toyota has been designed to endow with sensible assertion about the dependability of financial reporting. Toyota prepares its financial statements on behalf of external purposes in accordance of GAAP². Toyota’s internal control in excess of financial reporting consist of those procedures and policies such as –

• It would be appropriate to the preservation of records including rational detail that exactly and practically be a sign of the transactions as well as temperament of the assets of the company;
• It should provide sensible pledge that transactions are evidenced as compulsory to allow grounding of financial statements in harmony with GAAP and that proceeds and expenses of the Toyota has been made in accordance with endorsements of management as well as concerned directors of the company
• It should provide rational guarantee about prevention and well-timed recognition of illegal acquisition as well as disposition of Toyota’s assets those possibly will have an objective consequence on the financial statements.

Case Assignment

Income statements under variable (contribution margin) and traditional (absorption) costing for the Z-Watch Company at the year ended December 31, 2008

The Z-Watch Company

Income statement. (Under variable costing). December 31^st, 2008.

The Z-Watch Company. Income statement. (Under absorption costing). December 31^st, 2008.

Z-watch’s operating income under each costing method (in percentage terms)

• Operating income under variable costing method (in percentage terms) – under variable costing method net operating income is $3,113,270. In percentage terms net income is 40.97%.
• Operating income under traditional (absorption) costing method (in percentage terms) – Net operating income under absorption costing method is $884,650 and in percentage terms income is 11.40%.

The difference in operating income between the two methods

Recommended costing method to the CFO (chief executive officer)

As a manufacturing company it is useful for Z-Watch use variable costing method in calculating unit cost of production. Under this method net operating income is nearer to net cash flows. On the other hand, it is difficult under absorption costing. Thus, the company has faced crisis of potential cash flow. This process is also helpful for cost controlling, identify product’s profitability and data available in this process is supportive for CVP (cost volume profit) analysis. Another important factor is that charges in inventory do not affect the profit in a specific period. These are the issues for which choosing variable costing method is advantageous for the Z-Watch company.

Session Long Project

• The name and nature of the organization- Toyota Tsusho (South Sea) Limited, car manufacturing organization.
• Used activity and time period- Variable costing method at the end of the year, March 31^st, 2008
• Used inputs and the source for those inputs- In calculating per unit production cost here used direct materials, direct labour, variable manufacturing overheads and variable administrative expenses. Source of these inputs is the annual report of the Toyota Tsusho (South Sea) Limited, March 2008.
• Results- under variable costing method net operating income is $1,259,313 and in terms of percentage 21.6% for Fiji that covered the major market of the car industry.
• Any implications from the results- Net operating income, net cash flows, products profitability.

Following are the factors in defining break-even analysis

A unit of measurement for the activity- under variable costing method calculation of cost per unit is as follow.

Variable costs for the activity- variable cost for per unit production is calculated using following chart.

Fixed costs for the activity- Calculation of fixed costs for the activity is as follow.

A break-even analysis using the numerical calculations that include

1. Variable costs
2. Fixed costs
3. Selling price

So, the break-even point = (Fixed costs/ Contribution margin or gross profit)

A graphical presentation of break-even analysis is as bellow-

Case Assignment

A manager’s fundamental function is decision making. In this point managers faced problems in types of products to sell, purchasing materials, selecting price, identifying distribution channels, and conditions of price change. These factors are forced by the expenditure named cost attributable to a specific activity. Where as allocation of cost is a part of cost attribution that charged for per unit production.

Description of the process of allocation of costs in this organization

The approach of allocation costs is acceptable because of its various benefits. Allocation of costs in this organization is divided into three broad steps. They are termed as follow-

• Classify areas where costs will be allocated- types of costs and their benefits are helpful in decision making and executing alternatives. Allocation of costs is basically grouped in two types-avoidable costs and unavoidable costs. Avoidable costs are supportive in carry out alternatives. On the other hand, unavoidable costs have no impact in decision making. Sunk cost or differential costs and future costs are unavoidable costs.
• For project purpose allocate costs- the aim of measuring cost volume and profit (CVP) of the project, here costs are allocated. On the basis of current policy, agreement and legislation of the organization a financial statement is composed. Though component of cost allocation for this financial data can not found in order. A number of steps are needed in computing the component of cost allocation.
• Each project purpose determines refund responsibilities- each stage of a project requires calculation of compensation or refund responsibilities. This calculation includes both avoidable and unavoidable allocation of costs.

Classification of those situations when common costs are allocated

Costs are shared in a proportion for multiple product or services that determine by managers called common costs. Following are the situations for those common costs are allocated-

• Diversification of products- to capture a new market describing idle facilities of the existing product or identify profitability of another new product.
• Fixation of selling prices- selecting product prices considering different situation. Such as- high competition or recession, normal atmosphere, for export, high demand of product.
• Selection of profitable product-mix- multiple products are produced and sold under an identified ratio.
• Problems of limiting factor- when labor, materials and plants are insufficient rather than demand, estimate a limit for production and sales.
• Alternative methods of manufacture- it’s an assessment limiting production on the basis of profit ratio.
• Make or buy- this is a decision identifying profitable component.
• Working extra shift- this policy is applicable when fixed costs are stay constant.
• Level of activity planning- for a constant level of fixed costs identify activity level where it is maximum.
• Effects of change in selling price- select a sound price of the product for a sustainable profit level.
• Closing down, outsourcing or suspending activities- this factor is related to product, department or sometime the organization itself.
• Alternative courses of action- alternative actions sometime generate problem so that choose appropriate decision to protect those problems efficiently.
• Selection of optimum volume and selling price- using break-even chart identify both volume of sales and selling price to reach optimal profit.
• Application of profit/volume ratio- in different problem this formula is used. For instance, identifying break-even point, select a price level, per unit profit etc.
• Advanced problems on decision making- a function that allocates all policies, formulas and concept to identify and solve problem.

Discussion on the impact of allocating common costs for internal decision making

• Performance evaluation- allocation of common costs help an organization evaluates performance, weakness in financial, technological and accounting aspects.
• Fixing targets- cost control, enlarge productivity; ways of scientific tools use etc. are useful for fixing targets.
• Estimating variations in ratios- identify the level of competition in the industry several ratios are used.
• Inter-firm comparison- objectives of inter-firm comparison are range of production, size of units, tools used in production.
• Availability of various data- allocation of costs makes available different data that would be used in preparing financial statements. Internal decision making is mostly depend on this statement.

Explanation of the impacts of not allocating common costs for internal decision making

• Historical costs- historical costs are measured by actual cash payments. But it can not present current market price of product or services.
• Sunk cost- a presentation of historical costs that lost in a mentioned period and situation.
• Opportunity cost- when resources are available rejection or acceptance of alternative production would be possible. This is known as opportunity cost and it can not term as currency.
• Differential costs- differential costs or incremental cost that changes in total costs at a particular level.
• Goodwill- for internal decision making goodwill has no impact.
• Depreciation- consumption or another loss of value of a fixed asset arising from use.

Following are the costs that affect the organization’s decision making

• Administration cost- this cost is not directly related to production, marketing and research and development of the organization. This cost is only for administrative services and also known as cost of management.
• Capital expenditure- capital or revenue expenditure is to increase efficiency and competence of the organization.
• Cost of sales- aggregate amount of costs of sales and factory overhead aspect to the turnover.
• Prime costs- total costs of direct material, direct labor and direct expenses.
• Development costs- costs or expenses used in modernization of the organization through technology, improved materials for new products.
• Direct costs- this category of cost includes direct labor, direct material, direct expense and variable production overhead.
• Distribution costs- costs for delivering products to customers.
• Employment costs- costs for employees in terms of salaries, wages.
• Fixed overhead costs- cost that includes both policy costs and period costs. For more clarification, executive salaries, rent, insurance and rates are fixed overhead costs.
• Indirect costs- indirect expense, indirect labor cost, indirect material cost are included in indirect cost. These expenses do not charge directly to a product.
• Marketing cost- researching the potential markets, promoting products in attractive form and select acceptable price. Production cost- aggregate form of prime costs and absorbed production overhead.
• Research cost-cost of original investigation undertaken in order to gain new scientific or technical knowledge.
• Selling cost- salesmen’s salaries, traveling expense and commissions are under this group.

Session Long Project

Common costs of to a division, product or services and recast that report with unallocated costs and comment on the usefulness of that revised report

1. The name and nature of the organization- The Toyota Tsusha (South Sea) Limited, car manufacturing company of Japan that produced high quality automobiles.
2. The activity and time period you used- here presents common costs that have impact in case of inter decision making, situations that demands allocation of common costs. For this purpose here used variable costing method and time period is March 31st, 2008.
3. The inputs used- administration costs, capital expenditure, costs of sales, direct costs, distribution costs, fixed overhead costs, marketing costs, selling costs. Source of these factors is annual report, 31st march, 2008.
4. Results- per unit cost of production, operating income.
5. Any implications from your results- Per unit production costs, revenue, and break-even analysis.

List of common costs is formed as following chart.

Case Assignment and Activity based costing

Calculate the manufacturing overhead rate based on labor hours and machine hours

Calculation of manufacturing overhead rate based on labor hours-

Rate = (overhead to be absorbed)/ (labor hours for production)

Here,

Overhead to be absorbed = (estimated overhead cost/ expected direct wages) x 100

Or, Labor rate variance = Actual hour x (Actual rate – Standard rate)

= 84,000 x (85 – 70)

= $1,260,000 F

So, the labor efficiency = Standard hour x (Actual hour – Standard hour)

= $70 x (84,000 – 48,000)

= $2,520,000 U

calculation of manufacturing overhead rate based on machine hour-

Machine hour rate = (estimated overhead/ anticipated machine hours)

= (60,000/ 15,300)

= $3.922

Calculation of the costs to manufacturing one unit of each model using two different traditional approaches-direct labor hours and machine hours using direct labor hour calculation of one unit manufacturing cost-

Here,

Hour required per unit= 6

Direct labor charged= $85

Labor efficiency rate = $2

So, cost of per unit production –

Using machine hour rate calculation of per unit production-

Here,

Machine hour required per unit production = 5

Direct labor hour rate required per unit production = $364

So, machine hour rate of per unit production = (364 x 5) /6 = $303.33

Calculation of the cost to manufacturing one unit of each model using the activity-based costing –

Cost to manufacturing one unit using activity based costing.

The Kite surf is as profitable as the company may think it is based on its present system

At present this company used activity based costing (ABC) for it’s per unit cost production. Under this system cost of production is totally different from other methods. ABC method is too helpful for a sustainable profit level. Design of products cost is sketched on the basis of the requirement of the exertion of the target product. As a result, using activity based costing method bring profit for the company.

KiteSurfRUs Company would improve its profitability

Manufacturing company’s use two costing method in calculating their cost of per unit production – activity based costs (ABC) and traditional costing method. Using ABC method this company enjoys product profitability in two ways. They are-

• Costing of product under ABC method is designed as the requirement of the working level of the product.
• Machine hour needed per unit product and cost of the customers orders are the base of ABC costing method.

These two parts are cooperative for sustainable product profitability. Through this technique KiteSurfRUs Company would improve its profitability.

Session Long Project

• The name and nature of the organization- The Toyota Tsusha (South Sea) Limited, car manufacturing company of Japan that produced high quality automobiles. Almost 127 countries they supply their car.
• The activity and time period you used- here presents the activity based costing (ABC) of Toyota and for this reason used time period is March 31^st, 2008.
• The inputs used- in calculating activity based costing (ABC) factors are-sales, direct materials, direct labours, manufacturing overhead, operating expenses, selling and distribution expenses.
• Results- Product margin and customer margin.
• Any implications from the results- this calculation helps managers in decision making and also formulating strategies.

Calculation of activity based costing for Toyota is presented as following table.

Case Assignment

Relevant costing problem and Calculation of the operating income

Calculation of operating income of Air Frisco –

Air Frisco. Net operating income. At the end of the year, December 31st.

Air Frisco is lowers its fair

From the net operating income statement it is estimated that net operating income is a negative figure and this figure point out that Air Frisco has faced loss in operating flights.

Calculation of the other factors for which Air Frisco consider in deciding whether or not to charter its plane to travel international-

Calculation of per flight cost.

Decision

From the above calculation it is profitable for Air Frisco to travel one way international flight because for this they pay $75,000 to the charter.

Session Long Project

Identification on the basis of two relevant and two non-relevant costs in this decision-

1. The name and nature of the organization- The Toyota Tsusha (South Sea) Limited, a car manufacturing company of Japan that produced high quality automobiles.
2. The activity and time period used- for calculating net operating income here used variable costing method and time period is March 31st, 2008.
3. Used inputs- using annual report 2008 of the company calculation of net operating income is present.
4. Results- Net operating income.
5. Implications from the results- make decision whether products should not manufacture.

Calculation table for net operating income is as bellow.

Decision: here net operating income shows positive value. So, it is profitable for Toyota Tsusha (South Sea) Limited to manufacture Fiji.

Bibliography:

Britton Anne, Financial Accounting, Financial Times Prentice Hall, 2006. Web.

Banerjee Bhabatosh, Cost accounting, 10th edition, the World Press Private Limited, Calcutta, 2003.

Jan R. Williams, Susan F. Haka, Mark S. Bettner, Robert F. Meigs, Financial Accounting, 11th edition, 2003, McGraw-Hill, New York. Web.

Needles E. Belverd, Anderson R. Henry, and Caldwell C. James, Principles of Accounting, Houghton Mifflin Co., 1993. Web.

Ray H. Garrison, D.B.A., Eric W. Noreen, Peter C. Brewer, Managerial accounting, 11th edition, 2008, McGraw-Hill, New York. Web.

Paton William Andrew, and Stevenson Russell Alger, Principles of Accounting, Ayer Publishing, 1978. Web.

Stickney P. Clyde, and Weil L. Roman, Financial Accounting: An Introduction to Concepts, Methods, and Uses, Thomson South-Western, 2004. Web.

Toyota Motor Corporation, Financial Summary, FY2008 Third Quarter. Web.

Toyota Motor Corporation, Annual Report 2008. Web.

Western Digital, Annual Report 2007, Form 10-K. Web.

Williams R. Jan, Haka F. Susan & Meigs F. Robert, Financial Accounting, 11th edition, Mc Graw-Hill, 2006. Page no. – 8, (23-27). Web.

CVP Cost Allocation Study Draft Report, Existing CVP plant-in-service cost allocation. Web.

Appendix