Discussion

Work in pairs.

The price of raw materials in rising rapidly. Under these circumstances which method of stock valuation would you advise a business to use?

*Review[1]

1.A machine costs £30 000 and has a useful life of five years. At the end of that time it will have a residual value of £5000. The business decides to use the declining balance method of depreciation. The figures are as follows:

Year Depreciation provision Net book value

1. 9035 20965

2. 6314 14651

3. 4412 10239

4. 3084 7155

5. 2155 5000

a. What is meant by the terms:

І residual value?

ІІ depreciation?

ІІІ net book value?

b. From the data given and using the same axes draw graphs to show the effect on the book value of using:

i the straight line method of depreciation,

ii the declining balance method.

c. Give one reason why the business might have decided to use the declining balance method of depreciation.

d. State and explain three factors which influence the life of an asset.

2.The information given below is a summary of the transactions of a small business during its first year of trading.

The following information is also available at the end of the accounting period:

· the business is owed £2000 by its customers.

· there is a stock of goods worth £5000.

· cash and bank balances total £1000.

· the business owes suppliers £4000.

· cost of lease £10 000.

a. Draw up the profit and loss account for the firm at the end of the first year of trading.

b. Draw up the balance sheet of the business at the end of the first year of trading,

c. What other information would you need in order to estimate the business’s chances of survival?

3.A business buys a machine at the beginning of an accounting period for £50 000. It is expected to have a useful life of ten years and a scrap value at the end of the period of £5000.

a. Compare the book value of the machine at the end of five years using both the straight line and declining balance methods of depreciation at 21 per cent (actual percentage 20.567 to three decimal places).

b. In what circumstances might the declining balance method of depreciation be

preferable to the straight line method?

c. The machine was sold for scrap after eight years. Assuming that the business is still operating profitably, give three reasons why it might have taken this course of action.

UNIT 6

Costs and costing