ACCT11081 Steps 7 - 11 · Web viewAug 18. Sold $60,000 of men’s clothing to Riverstone. Aug 24....

1

ACCT11081 Steps 7 - 11 Jacquelin Watts

ACCT11081 INTRODUCTORY FINANCIAL ACCOUNTING

ASSIGNMENT: Steps 7 - 11

Step 7

China Ting Group Holdings Ltd: Inventory Analysis

For manufacturing companies, like China Ting Group Holdings Ltd. (China Ting),

keeping an accurate record of inventory is a complex, but essential process. Accurate

recording of inventory, ensures the inventory items are valued correctly on the balance sheet

and accurately reflects the company’s gross profit. Furthermore, accurate recording of

inventory leads to efficient and successful inventory management. Managing inventory

correctly is essential as too much inventory can increase expenses (and decrease profit) e.g.,

interest on loans and insurance, and too little inventory can lead to customer dissatisfaction

and loss of sales (therefore, decreasing profit). In China Ting’s 2017 Annual Report,

management infer that ‘in 2018 they will be “expanding stores and implementing inventory

control appropriately”. This statement makes me wonder if China Ting has had difficulties

with its inventory management in the past? Examining China Ting’s annual reports, over the

last three years, will help me to discover if they are successfully, or unsuccessfully managing

their inventory to create a profit for their equity owners.

2


Inventory refers to the products that a company purchases, or makes, but have not yet

been sold. For a manufacturing company it includes raw materials, work in process (or

progress) and finished goods, all of which must be disclosed in the annual report. China

Ting’s inventory includes raw materials (silks, wools, linens, cottons, synthetics), work in

progress (fabric design, weaving, printing, dyeing and sewing) and finished goods (retail

clothing under the brand names of FINITY, ELAINIE RIESE, RIVERSTONE, CALVIN

KLEIN PERFORMANCE, VINCE CAMUTO, as well as home décor, with a focus on

fashion bedding and window coverings). Inventory also includes the cost of labour and any

other expenses, incurred up to the point of sale, or transfer of ownership. Inventory is

classified as a current asset on the balance sheet, as it is easily converted to cash once it is

sold, and it is often the largest current asset and the main way a company utilises its cash.

On the balance sheet, inventory is reported at the lower of cost price or net realisable

value (or market value), so a company does not overstate the value of its inventory, which

will affect its gross profit. Cost price includes the purchase cost and any other costs directly

involved in the production of the inventory, such as labour and overheads. Cost price

generally does not include administrative costs and selling and distribution costs, which are

expensed separately on the income statement. Net realisable value (or market value) is the

estimated selling price of the product less the costs incurred to sell the inventory. In note 2.13

(note 2.14 in 2015) of the financial statements (summary of significant accounting policies)

China Ting states that “inventories are stated at the lower of cost and net realisable value”,

as well as giving a definition of net realisable value. Furthermore, they list the variable costs

that have been included in inventory as raw materials, direct labour, other direct costs and

related production overheads, as well as highlighting the exclusion of borrowing costs from

inventory. The breakdown of China Ting’s inventory can be seen in the following table:

3


Note 4(e) in the notes to the financial statements is a subsection devoted to net

realisable value. I found it interesting that note 4(e) states that estimates are based not only on

the current market condition, but also on the historical experience of manufacturing and

selling similar products, which may “change significantly as a result of changes in customer

taste and competitor actions”. It makes sense that customers and competitors can influence

market value, but I am a little confused about how ‘historical experience’ affects costing

estimates, as market value reflects what is happening in the present day. Perhaps China Ting

is referencing cost price, rather than net realisable value, when they are mentioning historical

experience? Maybe, they are inferring that their historical experience is more accurate, and

they do not necessarily use the lower of cost or net realisable value in all cases? However,

failing to write down inventory to net realisable value would result in overstated assets.

China Ting uses the weighted average method for costing (note 2.13 and note 2.14 in

2015). The weighted average cost method smooths out price changes that may occur when a

company is purchasing inventory. This is particularly relevant to China Ting who, in their

2017 annual report, state that high inflation and unstable economies have been affecting their

international trade. Also, as a manufacturing company they have a large amount of raw

materials that would be purchased at various prices throughout the year. The weighted

average method allows China Ting to source cheaper raw materials, which will reduce their

overall expenses. The weighted average method is calculated by dividing the total cost of

inventory by the total inventory quantity. As China Ting are using the weighted average cost

method for their inventory they may be using either the perpetual or periodic method of

recording inventory. If they are using the perpetual method, they will be calculating the

average cost of inventory after each purchase. If they are using the periodic method they will

calculate the average cost much less frequently, for example, at the end of each month.

With the perpetual method of recording inventory, all purchases and sales of

inventory are constantly monitored in the general ledger account and are constantly changing.

This means at the end of the financial year when a stock take is performed the inventory

should not be ‘too different’ to the physical inventory in the factories and warehouse. The

periodic method of recording is cheaper to utilise as only the purchases of inventory are

recorded, so the cost of sales is not known until the financial statements are prepared. There

is no mention in the annual reports of whether China Ting uses the perpetual or periodic

method to record their inventory. When discussing net realisable value, management states in

note 4(e) that they “will reassess the estimations by the balance sheet date”. This makes me

4


wonder if they are using the periodic method of recording inventory, rather than the perpetual

method. However, the notes to the income statements tend to suggest that they are using the

perpetual method, rather than the period method, as starting and finishing inventory is not

recorded in notes. If China Ting are using the perpetual method of recording inventory I am

not convinced that they are using it well, as in 2017 their provision for inventories increased

by 52%, from 2016. Even though their inventories recorded a 29.4% increase, from 2016, this

still seems like a lot of ‘wastage’, compared to previous years (as seen in the table below).

HKD ($) in Thousands Dec 31 2017 Dec 31 2016 Dec 31 2015 Dec 31 2014Finished goods 837,186 651,003 608,799 547,097

28.6% 6.9% 11.3%Work in process 163,994 111,791 127,969 151,995

46.7% -12.6% -15.8%Purchased/Raw materials

150,779 103,657121,812 129,512

45.5% -14.9% -5.9%Inventories 1,151,959 866,451 858,580 828,604

33.0% 0.9% 3.6%Less: Provisions for 207,553 136,516 114,716 114,853 inventories 52.0% 19.0% -0.1%TOTAL INVENTORIES 944,406 729,935 743,864 713,751

29.4% -1.9% 4.2%

Despite the high rate for provisions for inventories in 2017, China Ting are

finally making a profit, after three years of losses. They have also taken on two new major

clients, so perhaps they are ‘writing off’ old stock and replacing it with new stock? Provisions

for inventories is the amount of inventory that a company writes off because of theft,

spoilage, obsolete or damaged inventory. Companies use provision for inventories to ensure

the inventory amounts in their ledgers accurately reflect the physical stock. As a

manufacturing company I imagine China Ting would also be susceptible to inventory loss

through theft, and damage during the production process. Having a large provision for

inventories does have its advantages for China Ting, as they will be able to get a tax

deduction for their losses, which will decrease their tax expense, which was the case in 2017.

However, in 2018 I would suspect a much lower provision for inventories if China Ting is

managing its inventories well. Too much inventory remaining on the balance sheet puts a

company at risk of having obsolete products and increases cost of sales as provisions for

inventories are recorded as an expense.

5


As well as their provision for inventories increasing in 2017, China Ting’s total

inventories was also 29.4% higher than in 2016, after accounting for provisions for

inventories, and their finished goods increased by 28.6%. However, despite the increase in

inventory China Ting’s revenue only increased by 8% from 2016. This suggests that a change

in sales may be partly responsible for the build-up of inventory in 2017. A build-up of

inventory generally indicates a slowing sales pace. Slower sales will generally result in a

decline in gross profits. However, this is not the case with China Ting’s gross profits (gross

profits = net sales – cost of goods sold) which increased by 2.2% in 2017 (as seen below). By

working out the inventory

HKD ($) in Thousands Dec 31 2017 Dec 31 2016 Dec 31 2015 Dec 31 2014Revenue $ 2,335,429 2,151,522 2,386,175 2,539,001

8.5% -9.8% -6.0%Cost of Sales 1,670,143 1,500,291 1,691,292 1,808,136

11.3% -11.3% -6.5%Gross Profit $ 665,286 $ 651,231 $ 694,883 $ 730,865

2.2% -6.3% -4.9%Total Inventories 944,406 729,935 743,864 713,751

29.4% -1.9% 4.2%

turnover ratio I will be able to ascertain if sales have been slowing down, as the ratio will

show how long it is taking China Ting to turn its inventory into sales. A higher inventory

turnover ratio is better as it shows a company is effectively using its inventory to generate

income. China Ting’s inventory turnover ratio has been decreasing slightly in the last three

years (as seen below) and is lower than the industry average of 5%. Similarly, the days of

inventory ratio also

HKD ($) in Thousands Dec 31 2017 Dec 31 2016 Dec 31 2015 Dec 31 2014Total Inventory 944,406 729,935 743,864 713,751

29.4% -1.9% 4.2%Average inventory 837,171 736,900 728,808 n/a

13.6% 1.1% n/aInventory turnover 1.99 2.04 2.32 n/a

Days of inventory 206.39 177.58 160.53 144.08

indicates that it is taking longer each year to sell their finished products. Holding unsold

inventory can be costly for a company, as their cash is tied up and cannot be used to generate

revenue in other ways. It is also costly to store inventory, and the longer inventory remains

unsold it is more likely to become obsolete. I would expect to see an increase in China Ting’s

6


inventory ratio’s in 2018 because of the new clients they have taken on in 2017, and their

expansion domestically which includes a new children’s line of clothing.

China Ting’s inventory to sales ratio (shown below) also suggests that sales are

HKD ($) in Thousands Dec 31 2017 Dec 31 2016 Dec 31 2015 Dec 31 2014Total Inventory 944,406 729,935 743,864 713,751

29.4% -1.9% 4.2%Revenue $ 2,335,429 2,151,522 2,386,175 2,539,001

8.5% -9.8% -6.0%Inventory to sales 40% 34% 31% 28%

19.2% 8.8% 10.9%

decreasing, as the ratio has increased by 19.2% from 2016 to 2017. The inventory ratio’s,

along with the large provision for inventories in 2017, and inventory build-up, all suggest that

China Ting could manage their inventories better. However, their comments in the 2017

annual report suggest that they are aware of the need to implement “inventory control

appropriately” so it will be interesting to see if this occurs in the 2018 financial year. While

inventory could be managed better, I am a little confused with regards to how the inventory

increases are affecting the income statement. The cost of sales (or cost of goods sold) on the

income statement includes all the costs associated with getting the inventory ready for sale,

e.g., the cost of raw materials and direct labour costs. As shown in the table below, in 2017,

China Ting’s cost of sales increased by 11.3%, from 2016, and they made a net profit of

$309,435, after three years of making a loss. Their gross profit (revenue minus cost of sales)

also increased by 2.2%. Furthermore, China Ting’s inventory (averaged) is rising faster

(13.6%) than their revenue (8.5%) and total assets (averaged) (1.9%), as shown below.

HKD ($) in Thousands Dec 31 2017 Dec 31 2016 Dec 31 2015 Dec 31 2014Revenue $ 2,335,429 2,151,522 2,386,175 2,539,001

8.5% -9.8% -6.0%Cost of Sales 1,670,143 1,500,291 1,691,292 1,808,136

11.3% -11.3% -6.5%Gross Profit $ 665,286 $ 651,231 $ 694,883 $ 730,865

2.2% -6.3% -4.9%

Total Inventory 944,406 729,935 743,864 713,75129.4% -1.9% 4.2%

Average inventory 837,171 736,900 728,808 n/a13.6% 1.1% n/a

7


Average total assets 3,366,548 3,303,165 3,513,787 n/a1.9% -6.0% n/a

Total assets 3,538,547 3,194,548 3,411,782 3,615,79110.8% -6.4% -5.6%

Net income 309,435 -63,045 -158,617 -352,569

China Ting’s increase in inventory in 2017 also increased their cost of sales

(expenses). However, when cost of sales increases gross profit should decrease, but this has

not happened with China Ting’s figures, which show an increase in both gross profit and net

income. However, in 2017 China Ting’s cash, along with their trade and other receivables has

also increased substantially from 2016, so perhaps this explains the increase in net profit.

Total assets 3,538,547 3,194,548 3,411,782 3,615,79110.8% -6.4% -5.6%

Analysing China Ting’s inventory in the financial statements has been revealing and slightly

confusing, and I look forward to looking at my peer’s inventory analysis of their firms for

comparison. As I learn more about financial accounting I am sure I will gain a better

understanding of the financial statements, and China Ting’s statements will make more sense.

The figures in the financial statements really do tell a ‘story’ about what is going on in a

business, and it is fun trying to figure out the ‘plot’.

8


Step 8

Learning how to use MYOB AccountRight

9


10


11


12


Step 9

China Ting Group Holdings Ltd: MYOB Accounts

Ten hypothetical business transactions for China Ting Group Holdings Ltd

Date Transaction

Aug 2 Purchased wool from Fox and Lillie, Australia for $50,000

Aug 3 Sold $60,000 of women’s active performance wear to Calvin Klein stockists

Aug 4 Sold $40,000 of women’s casual sportswear to Bernard Chaus Inc. USA

Aug 15 Purchased silk worms from local silk worm farm for $10,000

Aug 15 Purchased flax plant from Belgium for $22,000

Aug 16 Sold $75,000 of designer clothing to Vince Camuto, Hong Kong

Aug 18 Sold $60,000 of men’s clothing to Riverstone

Aug 24 Purchased cotton from local cotton farm for $8,000

Aug 25 Purchased silk worms from local silk worm farm for $10,000

Aug 26 Sold $55,000 of women’s active performance wear to Calvin Klein stockists

13


All Journals

1/08/2018 To 7/09/2018China Ting Group Limited

27th Floor

ID No. Account No. Account Name Debit Credit Job No.

PJ 2/08/2018 Purchase; Fox and Lillie Wool, Australia

00000006 2-1000 Trade Creditors $50,000.0000000006 6-3000 Cost of Goods Sold $45,454.5500000006 2-4000 GST Paid $4,545.45

SJ 3/08/2018 Sale; Calvin Klein USA00000001 1-5000 Trade Debtors $60,000.0000000001 4-1000 Revenue $54,545.45

00000001 2-3000 GST Collected $5,454.55

SJ 4/08/2018 Sale; Bernard Chaus Inc. USA00000002 1-5000 Trade Debtors $40,000.0000000002 4-1000 Revenue $36,363.64

00000002 2-3000 GST Collected $3,636.36

PJ 15/08/2018 Purchase; Flax plant merchant, Belgium

00000003 2-1000 Trade Creditors $22,000.0000000003 6-3000 Cost of Goods Sold $20,000.0000000003 2-4000 GST Paid $2,000.00

PJ 15/08/2018 Purchase; Silk worm farm, Hong Kong

00000007 2-1000 Trade Creditors $10,000.0000000007 6-3000 Cost of Goods Sold $9,090.91

00000007 2-4000 GST Paid $909.09

SJ 16/08/2018 Sale; Vince Camuto, Hong Kong

00000003 1-5000 Trade Debtors $75,000.0000000003 4-1000 Revenue $68,181.82

00000003 2-3000 GST Collected $6,818.18

SJ 18/08/2018 Sale; Riverstone, Hong Kong00000004 1-5000 Trade Debtors $60,000.0000000004 4-1000 Revenue $54,545.45

00000004 2-3000 GST Collected $5,454.55

PJ 24/08/2018 Purchase; Cotton farm, Hong Kong

00000004 2-1000 Trade Creditors $8,000.00

14


00000004 6-3000 Cost of Goods Sold $7,272.73

00000004 2-4000 GST Paid $727.27

PJ 25/08/2018 Purchase; Silk worm farm, Hong Kong

00000005 2-1000 Trade Creditors $10,000.0000000005 6-3000 Cost of Goods Sold $9,090.91

00000005 2-4000 GST Paid $909.09

SJ 26/08/2018 Sale; Calvin Klein USA5 Trade Debtors $55,000.005 Revenue $50,000.00

5 GST Collected $5,000.00

Grand Total: $390,000.00 $390,000.0

0

Analysing China Ting Group Holdings Ltd.’s Financial Statements

China Ting’s financial statements are not very exciting because I only entered

purchases and sales transactions, in this hypothetical scenario. Therefore, I will assume that

August is China Ting’s first month of business, and they have started a risky venture by not

having any cash in the bank. However, analysing the purchases and sales that China Ting has

made can still tell me a lot about their current financial standing, and their ability to perform

in the future, in the manufacturing and retail industry.

AssetsTrade Debtors $290,000.00Total Assets $290,000.00LiabilitiesTrade Creditors $100,000.00GST Collected $26,363.64GST Paid ($9,090.90)Total Liabilities $117,272.74Net Assets $172,727.26EquityCurrent Year Earnings $172,727.26Total Equity $172,727.26

As of 7/09/2018

China Ting Group Limited27th Floor

King Palace Plaza55 King Yip Street

Kwun Tong

Balance Sheet

15


China Ting’s balance sheet gives me a snapshot of their financial position for the

month of August 2018. As I only entered hypothetical sales and purchases transactions for

China Ting, the only current asset they have is accounts receivable (trade debtors). The

balance sheet shows that China Ting is still owed money for all its sales made during the

month of August ($290,0000). Furthermore, it shows that the accounts receivable are debits

(an increase in an asset is a debit) because the firms who bought China Ting’s products have

an obligation to pay their bill to China Ting. I would expect that China Ting would receive all

its money from its sales by the end of September. If money remains owing on the balance

sheet it could indicate that China Ting are not very efficient at collecting their debts or are

extending credit which could result in a cash flow problem.

China Ting’s current liabilities include payments it owes to its suppliers for inventory

(accounts payable or trade creditors). I am hypothesizing that Hong Kong businesses must

pay GST. The GST collected amount shows a liability that is owed to the government,

whereas the GST paid amount is the amount refunded by the government for payments made

to suppliers. By looking at China Ting’s assets and liabilities I can determine if they can pay

their liabilities (accounts payable and GST) with their assets (accounts receivable), by

working out the current ratio (current ratio = current assets/current liabilities).

290,000/117,272.74 = 2.47

China Ting’s current ratio indicates that it has plenty of current assets to cover its liabilities.

It shows that for every $1 of current debt, it has $2.47 available to pay for its debt.

China Ting’s equity amount is equivalent to what it has earnt during the month of

August, which can be seen in the fundamental accounting equation (assets = liabilities +

equity).

290,000 = 117,272.74 + 172727.26

290,000 = 290,000

China Ting have had a great first month of business and have earnt $172,727.26 for their

equity owners.

16


IncomeRevenue $263,636.36Total Income $263,636.36Gross Profit $263,636.36ExpensesCost of Goods Sold $90,909.10Total Expenses $90,909.10Operating Profit $172,727.26Net Profit/(Loss) $172,727.26

1/08/2018 To 7/09/2018



Kwun Tong

Profit & Loss Statement

China Ting’s income statement is very simple and shows the total revenue they earnt

from sales ($263,636.36), which is equivalent to their accounts receivable ($290,000) minus

their GST collected ($26363.64), as seen on their balance sheet. China Ting’s expenses (cost

of goods sold) ($90,909.10) is equivalent to their total liabilities ($117,272.74) minus their

GST collected amount ($26363.64) on their balance sheet. This leaves China Ting with a net

profit of $172,727.26, which equals the total equity for the owners (on the balance sheet). I

am glad I chose to only include sales and purchases in my hypothetical transaction list

because it makes it really clear how the balance sheet and income statement interrelate. This

is something I never saw so clearly before doing this exercise.

By looking at China Ting’s income statement I can work out the net profit margin for

the month, by dividing net profit by sales.

172,727.26/263,636.36 = 0.66 or 66%

The net profit margin shows how much profit has been made after expenses and indicates that

China Ting are off to a good start in their business.

17


Account NameCash Flow from Operating ActivitiesNet Income $172,727.26

Trade Debtors ($290,000.00)Trade Creditors $100,000.00GST Collected $26,363.64GST Paid ($9,090.90)

Net Cash Flow from Operating Activities $0.00Cash Flow from Investing Activities

Net Cash Flow from Investing Activities $0.00Cash Flow from Financing Activities

Net Cash Flow from Financing Activities $0.00Net Increase/Decrease for the period $0.00Cash at the Beginning of the period $0.00Cash at the End of the period $0.00

1/08/2018 To 7/09/2018



Kwun Tong

Statement of Cash Flow

In my example of China Ting’s cash flow statement, it is clear to see that the amounts

are simply a juxtaposition of the income statement. The net income, or net profit, is broken

down to reflect what is currently happening in China Ting’s business.

This is the first time I have used MYOB software and I haven’t really enjoyed the

experience. However, I do like how it can produce the financial statements, and I can see the

benefit of how quick it is to record purchases and sales once the card list is set up. I thought I

might use it for paying invoices to my daughter’s NDIS suppliers (which is why I practiced

creating an account for her, in Step 8) but at this stage I am not sure I will. Perhaps, with

more practice I will choose to use it over using excel.

18


Step 10

China Ting Group Holdings Ltd: Depreciation Policies and Journal Entries

Depreciation of non-current assets, such as property, plant and equipment are an

important expense item for most firms and must be considered carefully by management as

depreciation is a non-cash transaction based on assumptions. Depreciation refers to the

process of allocating a cost to a tangible asset, or turning an asset into an expense, to reflect

the changes in its value over time. This prevents a significant expense being charged when

the asset is initially purchased, which would significantly reduce a firm’s net income

(profitability). It also helps firms to match the amount of expense that occurs from using an

asset, with the amount of revenue the asset is likely to generate, thereby giving a more

accurate representation of expenses incurred during the year. Furthermore, depreciation helps

firms report property, plant and equipment (fixed assets) correctly at their net book value

(original purchase cost minus total accumulated depreciation expense from previous years).

Depreciation also has tax advantages for a firm, as it can claim the depreciation expense as a

business expense, which reduces the firm’s taxable income.

The balance sheet reports the net book value (original cost minus accumulated

depreciation) of its fixed assets. Accumulated depreciation is recorded in a contra asset

account with a credit balance to reflect that the assets value is decreasing over time. Each

time a depreciated expense is debited the accumulated depreciation asset account is credited.

Recording depreciation this way on the financial statements allows interested parties to see

how much of the cost of an asset has been depreciated, or used up, and how much future

economic benefits remain. China Ting Group Holdings Ltd.’s. (China Ting’s) net book value

(net amount or carrying amount) is reported on its balance sheet in Property, plant and

equipment, with a reference to Note 6 in its 2015 to 2017 annual reports. Note 6 lists the

original cost of each group of assets, minus the accumulated depreciation, which gives the net

amount, which is transferred to the balance sheet, as shown in Table 1. Note 6 also lists the

breakdown of the net book, or carrying amount of accumulated depreciation, and includes

values attributed to exchange differences, additions, transfers, disposals, transfer to

investment properties, as well as the depreciation expense for the current financial year.

19


Table 1China Ting Group Holdings Ltd.Year ending 31 December

Leasehold Leasehold Plant & Vehicles Furniture, Construction TOTALland & improvements machinery fittings & in progressbuildings equipment

2017 Cost 722,865 223,360 478,206 42,046 70,784 1,047 1,538,308 Accumulated depreciation 302,794- 180,573- 381,173- 41,331- 64,387- 970,258- Net amount 420,071 42,787 97,033 715 6,397 1,047 568,050




Table 1 shows that China Ting’s total accumulated depreciation is increasing from

2014 to 2017, and its net book value, or net amount, is decreasing as the asset is being used

up. I found it interesting that plant and machinery, vehicles and furniture, fittings and

equipment do not increase/decrease in the same way as the total depreciation amounts. I

suspect that this is because of disposals made throughout the year, which results in the

accumulated depreciation and cost being removed to profit or loss, and when I look at Note 6

I can see that disposals have been made, that correspond with the highlighted amounts.

Furthermore, Note 2.5 (2015), and Note 2.7 (2016, 2017) states that “gains and losses on

disposals are determined by comparing proceeds with the carrying amount and are included

in consolidated profit or loss”. However, disposals have been made in other groups and years

also, which leaves me a little confused.

Perhaps, the group increases/decreases are partly due to the depreciation standards

being amended at the beginning of the 2016 financial year (Note 2.1, 2016 Annual Report). I

suspect this amendment or “clarification of acceptable methods of depreciation and

amortisation” mentioned in Note 2.1/2016, may be a result of the resignation, on the 3rd

March 2016 of Dr. Cheng, an independent non-executive director and chairman of the audit

committee. On the 18th December 2015, the Disciplinary Committee of the Hong Kong

Institute of Certified Public Accountants reprimanded and fined Dr. Cheng for breaches in

20


auditing, which included “recognition of depreciation and disclosure of the carrying amount

of the plant and machinery” (Pg. 27, 2015 Annual Report).

Construction in progress is also included in Note 6, but it has not been allocated a

depreciation amount because it is an asset that is not yet ready for its intended use. China

Ting state in Note 2.5 (2015), and Note 2.7 (2016, 207), that when the construction in

progress is complete, and ready for its intended use, the costs will be transferred to the

respective property, plant and equipment and depreciated from that time forward. At first, I

thought it was strange for China Ting to include construction in progress along with the

depreciated fixed assets, but after reading Note 2.5 it makes sense because it is ‘depreciation

waiting to happen’. It also shows how China Ting are using assets to create more revenue for

the firm.

The income statement shows China Ting’s depreciation expense, which is the amount of

depreciation that is charged to expenses for fixed assets, during one financial year. This

amount is considerably less than the depreciation amount on the balance sheet which is the

total depreciation accumulated over many years. Like the balance sheet, China Ting does not

include depreciation as a separate entry on its income statement. Rather, it is included in its

Cost of sales, and Administration expenses, with reference to the notes which gives a further

breakdown of expenses (Note 6, all years and Note 27, 2017, Note 28, 2015, 2016).

Depreciation expense that is allocated to Cost of sales should only include assets that

are directly related to the production of goods, such as overhead costs China Ting incurs in its

factory, and any other costs directly related to their manufacturing business. When

depreciation is included in Cost of Sales, it is also included in a firm’s gross profit. However,

an adjustment to depreciation is made so the depreciation expense gets added back to the net

income, so the statement of cash flows can be prepared accurately (Note 31, 2017, Note 32,

2015, 2016).

Depreciation does not account for a large amount of China Ting’s expenses as

identified in Note 6 (3.39% to 13.02%) and seen in Table 2. However, I thought the

depreciation expenses would be higher for the cost of sales items, rather than administrative

items because of the manufacturing nature of China Ting’s business.

21


Table 231-Dec-17 31-Dec-16 31-Dec-15 31-Dec-14

Cost of Sales 1,670,143 1,500,291 1,691,292 1,808,136 Administrative expenses 312,478 304,840 309,935 318,130

Cost of Sales deprec. Expense 56,629 60,591 73,649 75,493 Percentage of Cost of Sales 3.39% 4.04% 4.35% 4.18%Administration deprec. Expense 40,677 33,029 38,971 40,039 Percentge of Administration exp 13.02% 10.83% 12.57% 12.59%Deprec. of property, plant, equip 97,306 93,620 112,620 115,532 Total Deprec percent of PPE 16.41% 14.87% 16.93% 16.76%

Additionally, when depreciation expense is broken down into manufacturing (OEM) and

Retail expenses, as listed in Note 5, the percentage of depreciation allocated to OEM is

significantly higher, as seen in Table 3. This clearly suggests that China Ting’s depreciation

expenses are mainly attributed to its OEM business. Furthermore, it suggests to me that China

Ting must have many expenses, attributed to Cost of Sales, that cannot be depreciated.

However, it is still a little confusing as Property, plant and equipment is the largest non-

current asset on the balance sheet, as seen in Table 4. Therefore, shouldn’t the depreciation

expense be much more than approximately 16% across all years, as seen in Table 2?

Table 331-Dec-17 31-Dec-16 31-Dec-15 31-Dec-14

OEM 71,027 68,984 88,616 71,459 Percentage of Depr. To OEM 73% 74% 79% 62%

Retail 26,279 24,636 24,004 44,073 Percentage of Depr. To Retail 27% 26% 21% 38%

TOTAL DEPRECIATION EXPENSE 97,306 93,620 112,620 115,532

Table 4

31-Dec-17 31-Dec-16 31-Dec-15 31-Dec-14Total non-current assets 870,359 971,559 1,104,284 1,282,065 Property, plant, equip 568,050 619,848 660,399 741,296 PPE percentage of assets 65% 64% 60% 58%

22


In Note 2.5, China Ting states that Property, plant and equipment are stated at

historical cost, less accumulated depreciation and accumulated impairment losses. They also

highlight that historical cost refers to all the costs necessary to bring the asset into use. They

go on to state that other costs incurred by the asset are generally included in the carrying cost,

and any replacement parts are derecognised. I presume they derecognise replacement parts

because they are not part of the original cost. Note 2.5 also states that China Ting use the

straight-line method of depreciation to allocate costs to the residual values of their assets and

state the estimated useful lives of the different categories of Property, plant and equipment.

China Ting’s method of depreciation has not changed from 2014 to 2017, even though in

2016 they note that they are amending/clarifying their depreciation methods (Pg. 27, 2015

Annual Report).

The straight-line depreciation method reduces the cost of a fixed asset uniformly over

its useful life, so the depreciation expense on the income statement will be the same in all

years. This is the most common depreciation method and it is suitable for most assets. As

illustrated in Table 5, if China Ting purchased a van for $19,000, which had a residual value

of $4000, and was depreciated over 3 years, the van would have a depreciation expense of

$5000 each financial year.

$19,000 – $4,000 = $15,000

$15,000/3 = $5000 per year

Table 5

Depreciation Carrying ValuePurchase of Van 0 19,000Year ended 31 Dec 2014 5,000 14,000Year ended 31 Dec 2015 5,000 9,000Year ended 31 Dec 2016 5,000 4,000

However, I still find myself thinking that China Ting would be better using a different

depreciation method for its vehicles, as their value decreases more rapidly in its initial years

of purchase. I must remind myself that depreciation does not reflect market value, but rather a

cost that illustrates how the asset is benefiting the firm over time or being used productively

to generate revenue. It is hard to debunk a firmly entrenched myth one has learnt, such as

depreciation reflects a decline in market value.

23


Depreciation expenses are recorded in a firm’s general ledger, and recorded in a

contra asset account, called ‘accumulated depreciation’. Using the example above in Table 5,

where China Ting purchased a van their journal entry would be recorded as:

Depreciation expense 5,000Accumulated depreciation - Vehicles 5,000

This same journal entry will be posted at the end of each financial year, until the end of its

useful life (2016) because under the straight-line method of depreciation the same amount is

charged to expenses each year. When China Ting sells the van at the end of its useful life for

$4000, the journal entry would be recorded as:

.

Cash 4,000Accumulated depreciation - Vehicles 15,000Vehicles 19,000

Other examples of journal articles that China Ting’s accountants would have entered to arrive

at the net book amount, or carrying amount, as seen in Note 6 are listed below:

ID No. Account No. Account Name Debit Credit Job No.GJ 15/09/2018

GJ000004 6-4000 Depreciation $33,252.00GJ000004 1-9998 Acc depr plant & machinery $33,252.00

GJ 15/09/2018GJ000005 6-4000 Depreciation $26.00GJ000005 1-9997 Acc depr furn fitt & equip $26.00

GJ 15/09/2018GJ000006 6-4000 Depreciation $1,053.00GJ000006 1-9999 Accum depr vehicles $1,053.00

Grand Total: $34,331.00 $34,331.00

1/01/2017 To 31/12/2017



Kwun Tong

General Journal

24


China Ting appear to be following all the accounting standards when calculating

depreciation, and after the disciplinary action taken against Dr Cheng for incorrectly

recognising and disclosing depreciation, I imagine they will be even more careful with their

calculations. However, depreciation, like inventory, is susceptible to manipulation. Fictitious

fixed assets can be entered in the journal and the useful life can be extended to inflate the

value of an asset. It seems odd to me that China Ting have stated an amendment to their

depreciation policy in the 2015 and 2016 Annual Report, but none of their wording has

changed in any of the notes from 2014 to 2017. This makes me wonder if they made any

changes at all, as mentioned in my blog post ‘More Reasons to Doubt China Ting’s Ethical

Behaviour’.

When I completed an income tax course at H & R Block several years ago, I struggled

with the concept of depreciation. I have now discovered it was difficult to work out the

depreciation schedules, at the course, without understanding the concepts behind

depreciation. Depreciation is not a scary word to me anymore, and I can see the real benefit

in writing so many key concepts and questions in this course.

https://makingcentsofaccounting.wordpress.com/2018/09/15/more-reasons-to-doubt-china-tings-ethical-behaviour/

https://makingcentsofaccounting.wordpress.com/2018/09/15/more-reasons-to-doubt-china-tings-ethical-behaviour/

ACCT11081 Steps 7 - 11 · Web viewAug 18. Sold $60,000 of men’s clothing to Riverstone. Aug 24....

Documents

Transcript of ACCT11081 Steps 7 - 11 · Web viewAug 18. Sold $60,000 of men’s clothing to Riverstone. Aug 24....