Delta Cargo Capital Asset -

Delta Cargo

Capital Asset - Purchase Analysis

Our Commitment

Purchase Opportunity

Purchase Analysis

Capitalization vs. Expense

Depreciation Method

Disposal of Assets

Bonus Calculation

Exhibits

Capitalization/Expense Schedule

Depreciation - Method Comparisons

Bonus Plan Calculation

Our Commitment

The logistics department is entrusted with the responsibilities of ensuring that the entire Delta Cargo process is maintained and developed in accordance with the goals of our business at an economical cost. The tasks of the logistics department involve storage, distribution, warehousing, movement of goods from one place to another (internally or externally), tracking and delivery of goods. It includes a complete process of planning, managing, controlling and coordination to make sure that the goods reach the right place, at the right time, for the right cost and in a right condition. Currently, the various tasks performed by the department may be summarized as follows:

1. Ensuring all the requirements of the customers are met efficiently and safely.

2. To coordinate with third party logistics (3PLs).

3. To ensure that there is a safe and timely dispatch of goods.

4. To draft plans and policies and procedures for successful implementation

5. To ensure that the business goals are in synchronization with logistics system.

6. To create and maintain customer support.

7. To coordinate with vendors, service providers, and transport carriers.

8. To ensure that no fraud is committed.

9. To ensure timely supply and payment of goods and reduce inventories.

(Cited at Best Logics. "The Logistics Department - Supporting the Entire Operation")

Purchase Opportunity

The Logistics Department at Delta Cargo is proposing the purchase of a capital asset that with improve the efficiency of our organization and deliver long-term savings to the entire company. We have the opportunity to purchase a new crane to replace labor currently being performed with 10 forklifts. This proposal will present financial justification to support this purchase as well as provide several exhibits that address Depreciation, Capitalization/Expense issues, and impact on profitability and Bonus structure. Before presenting our financial support, we would like to provide the following benefits associated with the Crane capital purchase vs. our existing forklifts:

More Cost Effective Use of Space

Fewer Expenses

More Durability

Greater Efficiency

More Cost Effective Use of Space

Forklifts can only stack product as high as the mast will elevate. As a result, product is often stored over a wide area on the floor or yard. As the business expands, a larger factory or yard is needed in order to accommodate the product. The facility then must be maintained with greater costs and other management resources.

Fewer Expenses, More Durability

Heavy use and a large number of forklifts in operation translates into high maintenance costs. Typically, forklifts need replacing after several years of this type of wear.

Class "D" cranes from North American Industries require very little maintenance and are rated for heavy duty usage. Cranes from North American Industries are also guaranteed for two years and will endure for decades.

Greater Efficiency

Frequent use of multiple forklifts requires many operators and maintenance technicians. One crane system with one operator can replace multiple forklifts; therefore proving more efficient.

(Cited at Forklifts and Cranes. "What is the Best Material Handling Equipment for You?")

III. Purchase Analysis

Capitalization vs. Expense

To classify a cost as a long-term investment, rather than charging it to current operations. A capitalized cost does not appear on the income statement, but instead appears as a debit on the long-term assets account and a credit on the cash account of the balance sheet. However, the depreciation expense related to the capitalized cost will appear as an expense on the income statement. Since the long-term assets account is larger due to the effect of capitalization, the depreciation costs are also proportionately larger. Thus, the timing of expense recognition is changed, but eventually all expenses do get recognized on the income statement.

The General Principles of the Governmental Accounting and Financial Reporting Standards established by the Governmental Accounting Standards Board (GASB) include the following requirements for the valuation and reporting of capital assets.

Capital assets should be reported at historical cost. The cost of a capital asset should include ancillary charges necessary to place the asset into its intended location and condition for use. Ancillary charges include costs that are directly related to asset acquisition -- such as freight and transportation charges, site preparation costs, and professional fees. Donated capital assets should be reported at their estimated fair value at the time of acquisition plus ancillary charges, if any. The proper and consistent capitalization of expenditures is required to comply with the periodicity and matching principles of GAAP.

We would like to offer additional insight on how costs and expenses are treated in our department. The cost of the direct labor used to manufacture a product is a cost of the product. If the product is not sold, the entire cost of the product (including the direct labor component) is reported as an asset. When the product is sold, the cost of the product that is sold will be reported as the expense known as the cost of goods sold (which is matched with sales) on the income statement. The wages paid to the driver of our delivery trucks are reported immediately as an expense, since this cost is not part of a product's cost -- it is part of selling the product. Electricity in the facility is part of the products' cost and will not become an expense until the products are sold. Electricity our offices are reported immediately as expenses in the accounting period that they are used.

Below is a summary of all costs related to the capital purchase of a new crane. Cumulative maximus costs for this project are $2,288,000. Initially, our department identified line items that may qualify as expenses: Operator Training, Consultant Operator, and Severance for Forklift Operators. These items are related to Salaries and Wages and are not necessary to prepare the new asset for use.

However, we have made the decision to allocate these costs to the product, given the value that the new asset would retain.

Depreciation Method - Straight Line vs. Double Declining

The benefits of using the straight-line method for book purposes are that it is simple and easy to use, and is a fairly reasonable transfer of costs for financial reporting purposes. A simple spreadsheet is all that is required to use this method. Our accountants simply calculate the depreciable cost of assets, and divides this amount by the estimated useful life. This entry is recorded monthly on the books for financial reporting purposes by debiting depreciation expense and crediting accumulated depreciation. We employ the Straight Line method for 3 main reasons: (1) Consistency, (2) Ease, and (3) Salvage Value.

Consistency and Control. The straight-line depreciation formula does not have any variables that are outside of our company's control. If we use MACRS (modified accelerated cost recovery system), the IRS has a say in the recovery period of our company's specific property.

Ease. Straight-line depreciation is a relatively easy formula to understand, and it is also easy to account for in our books. The depreciation value is the same each year; and we do not have to figure a new rate as we do when the IRS publishes changes.

Salvage Value. Straight-line depreciation predetermines re-sale value. After an asset is used for five years, it is usually still worth something. Straight-line depreciation accounts for that and provides a more accurate depiction of the asset's true worth. We are inclined to use it to provide a true value of the worth of the new crane. Our decision is to implement the Straight Line method of depreciation. Based on a lower expense profile, a more favorable revenue profile, and overall consistency on the Income Statement and Balance Sheet, we strongly support this method.

The double declining balance depreciation method is like the straight-line method except that the total percentage of the asset that is depreciated the first year is doubled. While the Double Declining method would account for more value for the asset at the beginning of its useful life, we have chosen to capitalize training expenses for employees to extend the useful life of this asset. Appropriate operation of the machine will reduce the likelihood of breakdowns and maintenance. Therefore, our depreciation expense would be more consistent over a 10-15-year period.

Disposal of Old Assets

We currently have 2 options available for disposing the 10 forklifts that would be replaced by the new asset:

Option a = Sell to Firm Buyer now for $80,000 cash

Option B = Sell to Buyer with contingency clause for refurbishment which

Buyer will pay back at time of sale

Refurbishment Cost = $60,000

Sale Price

= $140,000

Total Cash

= $200,000

Our proposal is to sell the forklifts immediately to our firm buyer. While we have the opportunity to realize a larger gain from the second buyer, this is not a firm commitment. In addition, we do not want operations to be impacted by the storage the old equipment or logistics of the refurbishment process over the next 12 months.

Bonus Calculation

The purpose of our profit sharing bonus is to encourage employees to understand how their work affects the company's performance and to improve the company's profitability. But it does not end there. Our incentive program also paves the way for employees to exceed their current status of "just another hired employee." This continues to be a useful tool to make our business work and our employees happy. Here are some of the benefits of our employee incentive program.