MSE608C – Financial and Cost
Accounting
Introduction
A Change In Management
Wall Street Journal, December 7, 1971
General Motors Corporation [on December 6, 1971] named Richard C.
Gerstenberg, a tough-minded financial man, as it chairman and chief executive
officer. The main reason Mr. Gerstenberg got the job, it’s believed, is his
strong financial background, making him the man of the hour when GM is
increasingly worried about its profit margins and its ability to finance its
growth internally.
The biggest surprise in the executive reorganization was the naming of T.A.
Murphy [another finance man] to the powerful post of vice-chairman.
Observers expressed some surprise that none of the top assignments given out
was to an executive whose career had been in sales or manufacturing.
The Case for Understanding
Finances and Costs
We do not educate enough of our [engineering] students with the broad
perspective and long-term aspirations to be decision makers, strategic
thinkers, opinion shapers, and planners of our corporations to be leaders of
industry… This situation leaves much of the future leadership of industry … in
hands of people trained mainly in business, management, finance, law and
similar fields. Due to their lack of technical backgrounds, very few of these
professionals are equipped to make long-term forecasts about technological
trends. They also lack the knowledge to make decisions on issues. In fact,
many people think that the lack of technical expertise at the executive and
strategic levels of our corporations is a primary reason for our ineptitude in
the international marketplace vis-à-vis our competitors, whose leaders tend to
have strong engineering backgrounds.
Marshall M. Lih, National Science Foundation
WHY STUDY ACCOUNTING?
Why Study Accounting?
Part of the real world
– It will provide useful knowledge and skills relevant to
understanding the successful operation of an
organization. Many engineers tend to focus only on
their task at-hand and ignore the financial implications;
they see the forest and not the trees.
Why Study Accounting?
Requisite for high-level management
The path to higher levels of management require a functional
understanding of accounting and how it is used to make
decisions.
Beneficial to engineers at all levels
• Manufacturing Engineer - analyze the value of equipment and
process changes;
• Design Engineers - analyze the trade-offs required between
design and market demands;
• Project Engineer - analyze the allocation of resources versus
scheduling using accounting information;
• Senior-level Engineering Manager - monitor the gross financial
activities to ensure their profit centers are profitable.
Why Study Accounting?
Well-founded skepticism
Accounting information is important in decision
making but it is at times inexact, subject to
estimates, and can be open to interpretation.
Understanding is POWER
By understanding the accounting function the
engineer can fully participate in important
business decisions.
What is Accounting?
The “language of business”
– provides a common means for communicating
monetary information of an entity.
– Used by individuals and organizations inside and
outside the entity.
What is Accounting?
• It is a organized and standardized process to
observe, measure, record, classify and
summarize activities of an organization into
monetary terms.
• Not all important activities can be valued in
monetary terms and thus cannot be included
in reports and statements.
Who Are the Users of Accounting
Information?
• Business managers
– Plan; organize; direct; control; make decisions
– Use historical data to plan for the future
– Strategic (long-term) and Operational (short-term) planning
• Investors and owners
– Financing the company
– Payment of dividends
– Capital purchases
• Creditors
– What is the perceived risk (interest rate)
– Collateral
• Government taxing and regulatory agencies
– Taxes and compliance
What are Assets?
Assets
– What a company OWNS
– Physical property, intangible rights and financial
resources owned by the company.
– To be an asset it must:
1) possess future value,
2) be under the control of the business, and
3) have an assigned dollar value.
What are Liabilities?
Liabilities
– What a company OWES
– Obligations owed to a creditor for a current benefit
– Must use assets to discharge liabilities.
What is Owners’ Equity?
Owners Equity
– The net difference between Assets and Liabilities
A - L = OE
– Owners’ Equity is a measure of the company’s NET
WORTH
Fundamental Accounting
Equation
A = L + OE
Valuing Assets
• Assets and must be valued in monetary terms.
• Three valuation methods:
– Time-adjusted value method
– Market value method
– Cost value method
Time-adjusted Value Method
• When is Time-adjusted Value Method used?
• Use to determine the Present Value of future cash
flows.
• The Present Value is often calculated for:
–
–
–
–
Loans (actually a Liability)
Common Stock
Annuities
Capital equipment purchased today but will be paid in
the future.
Time-adjusted Value Method
• What factors affect time-adjusted value of
an Asset?
– Timing of expected future cash flows
– Amount of future cash flows
– Interest Rate
• Equivalency Rate
• Risk
– PV = F(P/F,i,n)
Time-adjusted Value Method
• Advantages
– Accurate for assets with long life and
predictable cash flows
• Disadvantages
– Requires predictable cash flows.
Market Value Method
• The value of an Asset in the marketplace.
– Established through second-hand markets
• Advantages
– Easy to establish if efficient marketplace exists.
• Disadvantages
– Difficult to establish if there is not an efficient
marketplace.
– Value can be unreliable if adequate information is not
available (may be under- or over-valued)
Cost Value Method
• The value of an Asset is the price paid when it was
acquired
• Advantages
– Value clearly established
• Disadvantage
– Does not account for appreciation or depreciation.
– Does not account for inflation
• Currently the most popular method
Intangible Assets
• Dictionary of Finance and Investment
Terms:
The right or nonphysical resource that is presumed to
represent and advantage to the firm’s position in the
market place
• International Valuation Standards
Committee
Assets that manifest themselves by their economic
properties, they do not have physical substance, they
grant rights and privileges to their owner and
usually generate income for their owners.
•
•
•
•
•
•
•
•
Intangible Assets
Patent rights
Copyrights
Goodwill
Startup Costs
Secret formula
Trade names
Trademark
Mailing/Customer Lists
•
•
•
•
•
•
•
Internet Domain Name
Construction contracts
Intellectual Property
Fashion Logo
Non-compete agreement
Books
Advertising contracts
Goodwill is the remaining intangible value after all
other tangible and intangible assets have been
valued
Intangible Assets
• When are these valued
–
–
–
–
When an Intangible Asset is purchased
When a company is sold
When used as collateral for a loan
To obtain insurance
Intangible Assets
• Intangible Assets must be valued by
Professional Appraisers or Value Analysts
– Requires investigation and calculations
– Determine fair market value or replacement
cost
• Time-adjusted value
• Market value
– It is expensive
Intangible Assets
• Intangible assets are amortized (same as
depreciated) if they have a limited life.
• Rule SFAS 142
– Use straight-line method
– 15 year asset class
– Eliminated amortization of Goodwill
Accounting/Finance in an
Organization
Typical Organizational Structure
Chief Executive Officer
(CEO)
Chief Financial Officer
(CFO)
Controller
(Inside)
Treasurer
(Outside)
Assessment
1. What are the elements of the Fundamental
Accounting Equation?
2. What is the definition of Owners Equity?
3. What are the three methods for Valuing
Assets?