Essay Example on Income and cash flow differ as they are Calculated

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Income and cash flow differ as they are calculated using a different basis therefore it is inevitable that operating profits for a period will not coincide with net cash flows in the question the term net cash flows net cash flow from operations taken for the same period The differences arise due to the following Non cash expenses such as depreciation or gains losses on the disposal of fixed assets bad debt provisions etc The application of the accruals principle in the income statement in order to include all the revenue and expenses relating to a specific period requires provisions for accrued expenses to be included whilst prepayments are excluded Similarly for deferred income or expenditure Working capital adjustments i e where sales exceed cash receipts it means that receivables are likely to increase and vice versa whilst similar considerations apply for purchases creditors and stocks In the question if one looks at the six month period as a whole the company is projected to incur a loss even though during the sixth month it returns to profitability The loss for the six month period is 576 000 As a result an amount of 576 000 needs to be financed negative cash flow


This amount will vary due to the above factors Fixed expenses exceed payments by 60 000 over the period this amount probably relates to non cash expenses depreciation Opening receivables are 206 000 per the credit terms Accounting for rounding errors it appears that increased receivables require additional working capital of 152 000 Calculating purchases from payables calculations and comparing to cost of sales and closing stocks it appears that increased inventories require additional working capital of 106 000 Closing payables are 164 000 per the credit terms compared to opening payables of 81 000 an increase of 83 000 which is offset by the decreased payables accruals of operating expenses of 117 000 Overall payables decrease by 34 000 and this needs to be funded adds to the working capital need Based on the above the net operating cash flow comprises the operating loss per the income statement of 576 000 reduced by 60 000 non cash expenses but increased by 292 000 additional working capital need to 808 000 as shown in the tables below a The original cost absorption method included direct labor which was used to apportion indirect labor overheads


This basis assumed that indirect costs incurred had a direct impact on the production of the product Floor area was another basis used to apportion both heating and rent overheads relating to the area occupied by each department or cost center Machine value was used as the basis of apportioning machine depreciation and insurance overheads Machine hours were used as the basis of apportionment for machine power and re apportionment maintenance since both machine power and maintenance influence the number of hours a machine will run Lastly number of employees is the basis used for the apportionment of re apportionment administration since this overhead is determined by the number of employees in the company In conclusion apart from the indirect labor apportioned on the basis of number of employees the apportionment of the other overheads was well reasoned in the original costing method In the proposed costing method indirect labor was apportioned on the basis of the number of employees since the amount of indirect labor cost was related to the number of employees Further rent and heating were also apportioned on the basis of number of employees The reasoning was that the rent and heating overheads paid were dependent on the number of employees per cost center Machine insurance depreciation and power were apportioned on the basis of machine hours the reasoning was that all these overheads determined the machine hours 



Reapportion maintenance was apportioned on the basis of machine value the reasoning was that reapportion maintenance affected the value of the machine while reapportion administration was apportioned on the basis of floor area In a nutshell the apportionment of rent and heat on basis of employees machine insurance and depreciation on basis of machine hours and reapportion administration on basis of floor were based on poor reasoning in the proposed costing method b The Sales Director s view that the proposed costing method is superior because it reduces the overheads chargeable to the Sports Clothing and Sports Equipment cost centers is biased and myopic in nature This is because although the overheads chargeable to these two cost centers reduced from 687 423 to 657 735 for Sports Clothing cost center and from 711 452 to 664 209 for Sports Equipment cost center this made the total reduction in costs in these two cost centers amount to 76 931 However the same amount of 76 931was transferred to the Sports Shoe cost center whose cost increased from 531 125 to 608 056 making the overall total overhead cost in the proposed costing method remain 1 930 000 as in the original costing method Hence the Sales Director s view that the proposed costing method was superior was not right since the proposed costing method did not reduce the total overhead costs incurred by the company instead the costs were shifted from one cost center to another A new costing method should ideally lead to overall decrease in costs increase in efficiency and productivity and hence a more cost effective use of the available resources



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