Finance Basics: Production Ventures (B)
What are Production Ventures? What are fixed assets? What is Depreciation?
Posted: Apr 2009
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A company may decide to move from a purely commercial venture (buying and selling) to a production venture, by adding a manufacturing function to its business.
The purchase of an equipment asset, such as a machine, enters the balance sheet as a gross fixed asset.
Fixed assets are items that are owned for relatively long periods of time and which are used in running the business.
The value of the fixed asset appears as a cash outflow on the cash flow statement only when the company actually pays for the purchase.
Depreciation spreads the cost of a machine over its useful lifetime.
The amount of depreciation is determined by the expected life of the machine and the method used for depreciating it.
Depreciation is not a cash outflow, but is a cost which will affect the profit & loss statement.
On the balance sheet
Gross fixed assets
- Accumulated depreciation
= Net fixed assets (also known as book value )
The production costing account calculates the cost of all items going into the production of goods.
• the variable costs depend on the quantity of goods produced.
• the fixed costs do not change according to the quantity produced (depreciation is a fixed cost).
When a larger quantity of goods is produced, the same fixed costs are spread among a larger number of units and thus, the cost per unit goes down.
After yesterday's bad experience with supplies, JS decides not to remain dependent upon Fast Food Chain to supply the sandwiches, but to become self-sufficient.
So he speaks to vendor about buying the equipment for personal use. Vendor of food equipment, actually his cousin, is selling to JS for $150 and will also give generous credit terms. In fact, he allows him to owe him the full amount as a long-term credit with no specified payment date and no interest charged!
JS decides to depreciate the equipment over 15 days. The variable costs of producing the sandwiches in-house include paying a younger brother to do the preparation of sandwiches, and the material costs of the bread, ham and cheese.
The day's sales are calling so JS gets his younger brother to make five boxes of sandwiches...
• Fixed assets appear on the balance sheet at their gross value minus accumulated depreciation.
They only affect the cash flow statement during the period in which the purchase is actually paid.
• Depreciation represents the reduction in value of a fixed asset during each period of its use.
It is a cost and not a cash outflow.
• Production costs are made up of variable costs and fixed costs.
The quantity produced affects the unit cost of the goods and therefore the profit made on them when sold.
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