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Keeping track of the money

By TOM W. GLASER

© St. Petersburg Times, published May 17, 2001


art
[Times art: Teresanne Cossetta]
In the Broadway hit The Producers, Nathan Lane plays a small-time Broadway producer who finances his shows any way he can. Matthew Broderick plays an accountant who is hired by a potential investor to check the producer's books. Broderick discovers that Lane sometimes engages in "creative accounting" -- by recruiting investors for more than 100 percent of the cost to produce a show. No investor has ever complained because the shows were always flops, so that put extra money in the producer's pocket. As long as the shows never made any money, investors never expected to get any profits in return for their investments.

Broderick then speculates that one could make more money from a flop than from a success. If you could guarantee that the show would be a disaster, why not get investors for 25,000 percent of the production costs, and never have to pay anything back? The glitch comes, of course, when a show is a big hit and the producer can't pay more than 100 percent of profit but has investors who expect much more because they don't realize the investments were oversold. Needless to say, the story ends with them producing another play -- in prison.

In business, recordkeeping is accounting, but it is a great deal more than just an end-of-the-year statement. If accounts are properly kept and properly used, they provide a snapshot of the company's economic health at any given moment. The key for the entrepreneur is to understand the figures he or she gets from the accountant and how to use them.

The basic structure of accounting is what is called a T-account. It's called that because it's shaped like a giant capital letter T. Liabilities, or debts, go on the left side of the T, and assets, or credits, go on the right side of the T. One of the more difficult concepts to understand is that the accounts must always balance. That is to say, your assets must equal liabilities. For example, when someone buys a bond from you, you get the cash, which is an asset. However, you now owe them that money for the loan. That's a liability. If someone buys goods from you on credit, those unpaid-for goods are a liability for you. However, that unpaid account is also an asset for you because you will get paid for it in the future. That asset is often bought up quickly when a company goes out of business because the money can be collected to provide a profit to the new owner of the account.

There are many kinds of accounting. Some track sales, some track expense accounts, some track investments and some track production. This last part is particularly complex because seldom is everything in a production process completed at once. Instead, when you perform an inventory, (a counting of all the things you have in your operation at one point in time), you find things half-done, one-quarter done, one-third done and so on. So, although you know what something cost and what it's worth when it's complete, what is a thing worth and what does it cost when it's only 48 percent finished? This is called the cost of goods in process, and the accountant has to take many things into consideration when coming up with such a value.

You could just say, "It's worth 48 percent of the finished product," but not all contributions to the final product have the same value. Say an automobile engine represents 30 percent of the overall cost of the car. Is the car without an engine therefore worth 70 percent of the finished price? Obviously, a car without an engine is not worth very much at all. The last component, if it is as essential as the engine, could be the most important -- far more important than an ashtray or carpet protector.

Further, each component part has value, as do all the spare parts in the warehouse. To determine the component price, the accountant has to figure what has already gone into making that component, such as other parts (screws, for instance), raw materials and labor. Whenever anyone does anything to a product, it adds costs but does not necessarily add value. If a person damages a product, which then has to be repaired, that repair obviously adds costs but does not add any value to the product.

Other things must be factored in as well that can't be connected to any specific product. This would include marketing costs, non-production payroll costs, rent, maintenance, payments on debts, government compliance, depreciation and taxes. Each part has to bear its share of the total expenses of the company, as well as contribute to the profits of the company.

Depreciation and taxes are of vital concern to a business. Depreciation is the wear and tear that happens to things as they are used until they are too worn out to use anymore. Machinery and buildings, just like people, get old and then don't work as well. In general, you can't just trade in people for new models when they get old, but in a business you have to do exactly that. You can't hang on to an outdated and inefficient machine out of nostalgia and affection. It has to go to make room for newer, faster, more efficient machines.

In the workplace, many kinds of records go into the accounting process. Time sheets, drivers' logs, scrap and waste reports from the production line, injury and incident reports, sales figures, expense accounts, leases, accounts receivable, all go into making up the financial status of the company, tracking both its assets and its liabilities. Without all those records, the entrepreneur would never know until it was too late the status of the enterprise. They might miss business opportunities if they think they have less money than they actually do, and they may go out of business if they spend more than they actually have coming in.

It is also important for both the entrepreneur and the investor to know what methods of accounting are being used. There are many approved ways of accounting, but to change from one method to another can make the figures quite misleading. In inventory control, for example, there are two main methods of accounting -- FIFO (First In -- First Out) and LIFO (Last In -- First Out). In FIFO, you ship your oldest merchandise to your customer, so you are constantly rotating your inventory. This is what grocery stores do with foods to make sure goods on the shelf are the freshest. It also means your inventory costs will increase, as it is valued at the costs of the most recent invoices.

LIFO means that you send out the newest things you get in, the ones with the highest costs, keeping in inventory the older and usually cheaper goods. As you keep the older goods in inventory, you can also depreciate them. This can be done with things that don't spoil or change fashion, such as nails or screws. This can make the inventory costs appear quite low. Moreover, changing from one to the other can drastically affect the annual statement without making drastic changes in the company. A good business person must know how to read those financial statements.

Someone once said that an economist is someone who was pretty good with numbers as a kid but didn't have the personality to be an accountant. There are lots of accountant jokes, but accountants perform a service without which businesses could not function.

Classroom activities

If your class is continuing with the project, you certainly need to know how much your goods or services are going to cost. Make sure you understand that your time has value, that if you weren't doing this you could be doing something else, like going to a movie or a concert. If those things have value, then giving them up costs that value. This is also a good time to talk about the concept of opportunity cost. You also will be able to keep track of your profits to repay your Student Free Enterprise bank loan.

You can create T accounts for making your products. Have an accountant come in and explain in more detail how the process works and how you can use it to identify areas of profit and loss within your operation. You might also get that person to be a volunteer auditor to go over the class books and show what the numbers mean.

If your class is not continuing with the project (or even if it is), create T accounts for your own budgets. You all have income and expenses, so track them and take ownership of them. Two excellent sources for this kind of exercise are the Florida Council on Economic Education (http://www.fcee.org) and the National Endowment for Financial Education (http://www.nefe.org). The council offers a new program, Financial Freedom, a 100-page student workbook that deals with the real-world financial and economic decisions students will have to make. The national endowment offers a High School Financial Planning Program with student workbooks, a teacher's manual, overhead masters, quizzes and tests. The best part is, both of these programs are free for the asking.

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-- Tom W. Glaser is a high school teacher at the School for Advanced Studies at the Wolfson campus in Miami. He has won numerous national teaching awards for economics and was named Florida Council on Economic Education Economic Educator of the Year in 1997.

About the Florida Council on Economic Education

Money Stuff: Get it! Spend it! Keep It!

Introduction and previous chapters

Money Stuff was developed by the Florida Council on Economic Education and project director Fonda Anderson. The council is a statewide non-profit organization founded in 1975 to educate K-12 teachers and students about the free enterprise system and to instill in them an appreciation for a market economy. For more information on the council's programs for teachers and students, please call (813) 289-8489.

About Newspaper in Education

The St. Petersburg Times devotes news space to NIE features throughout the year, including this classroom series. The Times' NIE department works with local businesses and individuals to enrich the classroom experience by providing newspapers, supplemental guides and educational services to schools in the Tampa Bay area. To find out how you can become involved in NIE, please call (727) 893-8138 or (800) 333-7505, ext. 8138. For past chapters check out http://www.sptimes.com/nie and click on Money Stuff.

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