Lesson 6 Measurement levels in Accounting.pptx

In accounting, measurement levels refer to the different ways financial elements (assets, liabilities, revenue, expenses) are valued and reported in financial statements. Here are the key levels of measurement in accounting:

1. Historical Cost
📌 Definition: Assets and liabilities are recorded at their original purchase price.
📌 Example: A building bought for $500,000 five years ago is still recorded at $500,000, even if its market value has changed.

2. Current Cost
📌 Definition: The amount required to replace an asset at present market conditions.
📌 Example: If a machine originally bought for $10,000 now costs $12,000 to replace, the current cost is $12,000.

3. Fair Value
📌 Definition: The price at which an asset could be sold (or a liability settled) in an open market.
📌 Example: A stock bought at $50 per share is now worth $70 per share—its fair value is $70.

4. Realizable Value
📌 Definition: The expected amount that can be received from selling an asset.
📌 Example: If accounts receivable is recorded at $5,000, but only $4,800 is expected to be collected, its realizable value is $4,800.

5. Present Value
📌 Definition: The current worth of future cash flows, discounted for time value of money.
📌 Example: A bond that pays $1,000 in five years might have a present value of $800 today based on interest rates.

Each measurement level is used based on accounting principles and financial reporting requirements (such as IFRS and GAAP).

1. XYZ COMPANY For the Year Ended December 31, 2024 Net Income: ₱250,000 Depreciation Expense: ₱30,000 Increase in Accounts Receivable: ₱15,000 Increase in Inventory: ₱20,000 Increase in Accounts Payable: ₱10,000 Purchase of Equipment: ₱50,000 Sale of Land: ₱100,000 Issued Common Stock: ₱80,000 Payment of Dividends: ₱40,000 Repayment of Loan: ₱60,000 Beginning Cash Balance: ₱50,000

2. 1. Which section of the Statement of Cash Flows shows cash from day-to-day business operations? 2. Why is depreciation added back in the operating section? 3. What type of activity is issuing common stock?

3. ABC COMPANY For the Year Ended December 31, 2024 Given Data (For the Year Ended December 31, 2024) Net Income: ₱200,000 Depreciation Expense: ₱20,000 Increase in Accounts Receivable: (₱10,000) Increase in Accounts Payable: ₱5,000 Purchase of Equipment: (₱40,000) Sale of Land: ₱50,000 Issued Common Stock: ₱70,000 Payment of Dividends: (₱30,000) Beginning Cash Balance: ₱100,000

4. Measurement levels Liquidity Solvency Stability profitability

5. Measurement levels: liquidity 1. Liquidity – the company’s ability to pay debts that are coming due/short term debt. a. Current Ratio – the ratio of current assets to current liabilities, meaning the firm’s ability to pay its current debt.  

6. Measurement levels: liquidity Example: Dale’s Apparel Store applies a loan for the store’s remodeling. He presented his detailed Statement of Financial Position for the bank to compute its Current Ratio. The Statement of Financial Position includes the following accounts: Cash P25,000 Accounts Receivable 18,000 Merchandise Inventory 8,000 Investments 10,000 Prepaid Expense 1,500 Current Liabilities 18,000

7. Measurement levels: liquidity Current Ratio computation is:  

8. Measurement levels: liquidity Interpretation: Dale’s current ratio of 3.47 means that the store is liquid considering it can pay off all of its current liabilities with current assets and still have some current assets that will be left for them.

9. Measurement levels: liquidity 1. Liquidity – the company’s ability to pay debts that are coming due/short term debt. b. Quick Ratio – Also called the Acid Test Ratio , is a stricter measure of liquidity. It does not consider all the current assets, only those that are easier to liquidate such as cash, cash equivalents, short-term investments or marketable securities and accounts receivable are referred to as quick assets. Quick assets are current assets that can be converted to cash within 90 days or shorter period.

10. Measurement levels: liquidity Example: Using the same example above, Dale’s Apparel Store applies a loan for the store’s remodeling. He presented his detailed Statement of Financial Position for the bank to compute its Quick Ratio. The Statement of Financial Position includes the following accounts: Cash P25,000 Accounts Receivable 18,000 Merchandise Inventory 8,000 Investments 10,000 Prepaid Expense 1,500 Current Liabilities 18,000

11. Measurement levels: liquidity Quick Ratio computation is:  

12. Measurement levels: liquidity Interpretation: Dale’s quick ratio of 2.94 means that the store can pay off all of its current liabilities with its quick assets and still have some current assets that will be left for them

13. Measurement levels: liquidity 1. Liquidity – the company’s ability to pay debts that are coming due/short term debt. c. Working Capital Ratio – pertains to the business’ ability to pay its current liabilities with the use of its current assets. There are four examples of changes that can affect the working capital: Current Assets increase = increase in working capital Current Assets decrease = decrease in working capital Current Liabilities increase = decrease in working capital Current Liabilities decrease = increase in working capital

14. Measurement levels: liquidity 1. Liquidity – the company’s ability to pay debts that are coming due/short term debt. c. Working Capital Ratio – pertains to the business’ ability to pay its current liabilities with the use of its current assets. There are four examples of changes that can affect the working capital:  

15. Measurement levels: liquidity Example: Amor’s Water Station has made loans from banks to purchase its water and sanitation equipment five years ago. This made its working capital decreases because these loans are becoming due. At the end of the year, Amor’s statement of financial statement showed a balance of P350,000.00 for its Current Assets and P180,000.00 for its Current Liabilities. Compute for its Working Capital.

16. Measurement levels: liquidity Working Capital Ratio computation is: Interpretation: Amor’s Water Station showed a positive working capital ratio shows that the business can pay all its current liabilities and still have current assets left over.  

17. Measurement levels: solvency 2. Solvency – pertains to the company’s capacity to pay long term debts or liabilities. a. Debt to Asset Ratio – it pertains to the ratio of total debt to total assets. It shows a company’s ability to pay off its liabilities with its assets.  

18. Measurement levels: Solvency Example: Annie’s Tailoring Shop would like to expand its shop and buy additional sewing and tailoring equipment. The owner consulted the bank for a new loan. She presented the shop’s financial statement. It showed total assets of P250,000.00 and total liabilities of P 85,000.00. Debt to Asset ratio is computed as:

19. Measurement levels: Solvency Debt to Asset computation is: Interpretation: The debt to asset ratio of the shop shows that the shop’s total liabilities is 34% of its total assets. It can be considered as less risky because the owner owns more of the shop  

20. Measurement levels: Solvency 2. Solvency – pertains to the company’s capacity to pay long term debts or liabilities. b. Debt to Equity Ratio – it pertains to the ratio of total debt to owner’s equity/shareholders equity (Asset – Liabilities = Equity).  

21. Measurement levels: Solvency Example: Let us assume that a business has P250,000.00 credit from a bank and a P450,000.00 loan mortgage on its property. The owners of the business invested P1.8 million. The debt to equity ratio is computed as:

22. Measurement levels: Solvency Debt to Equity computation is: Interpretation: A debt ratio of 0.39 means that there is still more equities than liabilities.  

23. Measurement levels: Solvency 2. Solvency – pertains to the company’s capacity to pay long term debts or liabilities. c. Equity Ratio – it pertains to the ratio of the business assets that are financed by capital. A high ratio shows a high level of capital.  

24. Measurement levels: Solvency Example: John Dale’s Infotech has just started its business with some investors. It is looking for additional investors to finance its future expansion. It had reported its total assets to P350,000.00, total liabilities of P80,000.00 and total equity of P 270,000.00. The equity ratio is computed as:

25. Measurement levels: Solvency Equity Ratio computation is: Interpretation: John Dale’s showed a healthy ratio because 77 percent of its total assets are owned by the owners and not creditors. It means that investors/owners rather than creditors are funding more assets.  

26. Measurement levels: stability 3. Stability – It is the long- term counter part of liquidity or the company’s ability to be structurally firm and can support its long-term debts by its equity. a. Debt to Equity Ratio – it pertains to the ratio of total debt to owner’s equity/shareholders equity (Asset – Liabilities = Equity).  

27. Measurement levels: stability 3. Stability – It is the long- term counter part of liquidity or the company’s ability to be structurally firm and can support its long-term debts by its equity. b. Interest Cover Ratio – it shows how many times a business’s interest expense on its loans/ credits are covered by its operating profit. The higher multiple the better.  

28. Measurement levels: stability Example: Arlene’s Flower Shop has generated P 95,000.00 operating profit for the year and spent P 13,800 on its Interest expense. Interest Cover ratio is computed as follows:

29. Measurement levels: stability Interest Cover Ratio computation is: Interpretation: The interest cover ratio of 6.88 shows that the Shop’s operating profit can cover up its interest expense 6.88 times.  

30. Measurement levels: profitability 4. Profitability – the company’s ability to convert its sales into cash flow and profit. a. Gross Margin Ratio – it is the ratio of gross profit to sales (Gross profit = Sales – Cost of goods sold).    

31. Buchakay’s Merchandising Enterprise Statement of Comprehensive Income For the period ended 31 December 2020 Gross Sales P450,000.00 Less : Sales Discount P10,000.00 Sales Returns and Allowances 12,500.00 22,500.00 Net Sales P427,500.00 Less : Cost of Sales (See schedule 1) 265,450.00 Gross Profit 162,050.00 Less: Operating Expenses Administrative Expenses (See schedule 2) P95,500.00 Selling Expenses (See schedule 2) 56,575.00 152,075.00 Operating Income P9,975.00 Add (or Deduct) Other Income (or Expense) Interest Income 3,275.00 Interest Expense (1,450.00) Net Income P11,800.00

32. Measurement levels: profitability Example: Assume Dale’s Apparel Store showed Inventory of P250,000.00 for the year. They were able to made a sale of P840,000.00. Some of it were returned and refunded amounting to P35,000.00. Dale’s gross margin ratio is computed as follows:

33. Measurement levels: profitability Gross Margin Ratio computation is: Interpretation: Dale’s gross margin ratio of 69 percent shows a high ratio in the apparel industry. It means that after Dale pays off its inventory costs, it still has 69 percent of the sales revenue to cover its operating costs.  

34. Measurement levels: profitability 4. Profitability – the company’s ability to convert its sales into cash flow and profit. b. Operating Margin Ratio – it is the ratio of operating profits to sales (Operating profit = Gross profit- Operating expenses).  

35. Measurement levels: profitability Example: Josefina’s Café reported Gross Profit of P500,000.00, Operating Expenses of P 115,000.00 and Net Sales of P 785,000.00 on its Statement of Comprehensive Income. Operating Margin Profit is computed as:

36. Measurement levels: profitability Operating Margin Ratio computation is: Interpretation: Josefina’s operating margin ratio shows that after paying off operating expenses it still has 49 percent remaining portion of net sales that could cover other expenses.  

37. Measurement levels: profitability 4. Profitability – the company’s ability to convert its sales into cash flow and profit. c. Net Income Margin Ratio – it is the ratio of net income margin to sales (Net income = Operating profit – interest and taxes). Also referred to as Profit Margin Ratio. It measures how much net profit is produced at a certain level of sales.  

38. Measurement levels: profitability Example: Josefina’s Café reported Net Sales of P910,000.00 and Net Income of P 315,000.00 on its Statement of Comprehensive Income. Net Income Margin ratio is computed as:

39. Measurement levels: profitability Profit Margin Ratio computation is: Interpretation: It shows that Josefina’s converted 35 percent of her sales into profits.  

40. Measurement levels: profitability 4. Profitability – the company’s ability to convert its sales into cash flow and profit. d. Return on Asset (ROA) – it is the ratio that measures the peso value of income generated by using the business assets. Note: Average assets are computed by adding the beginning balance and ending balance and then divide it by 2. It may be only ending of total assets if beginning balance is not given.  

41. Measurement levels: profitability Example: Kiko’s Trading and Construction is a fast- growing construction business that caters building construction and real estate development in Puerto Princesa City. Its Statement of Financial Position showed beginning assets of PhP 2, 500,000.00 and an ending balance of PhP 3,800,000.00. During the year, it had made a net income of PhP 15,825,000.00. Kiko’s return on assets ratio will be:

42. Measurement levels: profitability Return on Asset Ratio computation is: Interpretation: The ROA of 502.38 percent means that for every peso that Kiko invested in assets during the year produced PhP 5.02 of net income.  

43. Measurement levels: profitability 4. Profitability – the company’s ability to convert its sales into cash flow and profit. e. Return on Equity (ROE) – measures the return (net income) generated by the owner’s capital invested in the business. Similar to ROA, the denominator of ROE may also be total equity or average equity. Note: Average equity are computed by adding the beginning balance and ending balance and then divide it by 2. It may be only ending of total equity if beginning balance is not given.  

44. Measurement levels: profitability Example: John’s Trading is engaged in retail business. It had reported a Net Income for the year of PhP 235,000.00 and Owner’s Capital of PhP 580,000.00 ending balance.

45. Measurement levels: profitability Return on Equity Ratio computation is: Interpretation: ROE of 41 percent shows that for every peso of investment there is a P0.41 return on the owner’s investment.