Self-built assets and value added

Dealing with capitalised costs

Instead of purchasing non-current assets from third party suppliers, a firm may choose to itself construct or erect an asset for use in its own business. In these cases, costs and expenses which would otherwise be revenue in nature should be capitalised. Capitalised costs will not appear in a firm’s statement of profit or loss and hence materials and labour costs will be understated in this account, notwithstanding disclosure by way of a note.

Example

ca[italised costs profit or loss

During the period, a new warehouse was constructed by the firm’s workforce for the firm’s own use at a cost of £4m. The materials cost of the construction was £1m and the labour cost assigned to the construction came to £3m. These costs were capitalised and hence do not appear in the above statement of profit or loss. A value added statement brings these costs in to view because the construction is part of the value created by the firm during the period.

Capitalisation of costs value added statement

Workings and notes

Bought in materials, goods, and services

Purchases of all materials, goods, and services whether or not capital or revenue but excluding depreciation.

To pay employees

All wages and employment on-costs including labour costs assigned to the construction of the new warehouse.

Investment adjustment

The capitalised cost of materials (£1m) and labour (£3m)

Inventory adjustment

Closing inventory minus opening inventory. This represents additional investment in inventory if positive or disinvestment in inventory if negative.

Depreciation adjustment

The total of the depreciation charges shown in the profit or loss statement. This is a measure of capital consumption during the period. In the national accounts, the government may substitute its own figure for a firm’s measure of capital consumption.

Link to the national income accounts

The total of the adjustments will be shown as an investment activity in the national income accounts where it will be denoted as I

 

I is for investment

How is the investment component, denoted by I, of national income determined? An explanation is proffered here by converting the following simple statement of profit or loss into a value added statement.

Investment and VAS

Additional information

During the period, the firm replaced some plant and machinery at a cost of £10m.

Points to note

A statement of profit or loss does not record purchases of a capital nature. Hence the purchase of plant and machinery for £10m is not reported in the statement of profit or loss.

A value added statement does report purchases of a capital nature.

Example

Investment and VAS 2

Working

Working for investment and VAS

National Income Accounts

If every firm prepared a value added statement the total of the net investment adjustments would represent the nation’s periodic investment activity shown in the national accounts prepared by the government. This figure for the periodic investment activity is shown as I in the national accounts.  

NB. The government may substitute its own standard calculation of the depreciation adjustment so as to achieve consistency.

 

Value Added Statements for Dummies

This is a short presentation to demonstrate how value added statements are prepared and to explain how they differ from the accountant’s traditional profit or loss account. A single example will be used which will capture the essential differences.

Example

Below is shown a firm’s statement of profit or loss and value added statement. The two statements are shown side-by-side for ease of comparison.

During the period, the firm purchased plant and machinery for use within the business at a cost of £30m. Because this is capital expenditure, there is no entry in the statement of profit or loss to record this purchase. In the value added statement, the £30m cost appears against “bought-in materials, goods, and services” to obtain the “net value of output” figure. The firm’s investment activity is then shown by the investment adjustment to arrive at “net value added.”

VAS for dummies

Derivation of value produced figures

Bought-in materials, goods and services is equal to the purchases figure taken from the profit or loss statement (£80m) plus the capital expenditure (£30m).

The inventory adjustment is equal to the closing inventory minus the opening inventory. If this figure is positive then it represents additional investment in inventory. If negative then it represents disinvestment in inventory.

The depreciation adjustment is the total depreciation charged to the profit or loss account. This will usually be shown as a negative figure in the value added statement and represents consumption of capital in the period.

The investment adjustment is equal to the capital expenditure during the period. If this adjustment is positive then investment in new productive capacity has occurred. If negative, then disinvestment in productive capacity has occurred. The new productive capacity may consist of either tangible or intangible assets or some mixture.

Derivation of value distributed figures

To pay employees is the wages figure taken from the profit or loss account. The figure should include employer’s on costs, including employer’s National Insurance Contributions, and other employment taxes where they exist

To pay government is the sum of business rates and corporation tax charged to the profit or loss account. The figure represents the contribution the firm makes to the upkeep of the nation’s infrastructure and public services that enable firms to flourish.

To pay rentiers is the sum of property rents, licence fees, patent and copyright charges and the like. Payments to parties who derive income from ownership rather than from provision of a service or goods are recorded under this heading.

To pay financiers is the sum of interest charges in the profit and loss account plus dividends paid in the year. Payments of interest and dividends paid should be offset by interest and dividends received. Interest and dividends received are distributions of  value added produced by other firms. 

Undistributed value is equal to the retained profits shown in the profit or loss statement.

Labour Force Statistics: How good are they?

Acknowledgement

I am grateful to ONS for providing me with the numbers that populate the table. ONS warns the numbers are experimental. I have assumed this is why the table’s quarter-end counts may not reconcile to the statistics separately released by ONS at the end of the Sept 2012 quarter.

 A 3-state workforce

The table shows that ONS uses a 3-state model – that is workers are shown in the table as being in one of three states:  in work, unemployed or inactive. Workers are individuals between the ages of 16 and 64.

People classed as in-work is the sum of those in employment, those in self-employment, and those on government workfare schemes. People classed as unemployed are those actively seeking work, even if they are not claiming out-of-work benefits.  People classed as inactive are those of working age who are not employed/self-employed and who are not seeking work.

Transitions

The table shows the transitions workers have made from one state to another during the quarter.

For example, the In-work row indicates that 28.467 million were in work at the start of the quarter (ie on 1 July 2012). Reading the figures in this row, we can determine that 27.596 million of those in work at the start of the quarter were still in work at the end of the quarter (ie on 30 Sept 2012). We can also see that 395,000 of those in work at the start of the quarter became unemployed and 476,000 became economically inactive.

Similarly, with the next row down, we can see that of the 2.545 million unemployed workers at the start of the quarter 591,000 found work, 1.564 million remained unemployed, and 390,000 became inactive.

The next row down shows that of those inactive workers at the start of the quarter, 437,000 found work, 508,000 declared themselves to be looking for work, whilst 8.017 million continued to be economically inactive.

A 4-state model

The inclusion of workfare participants in the In-work state adds to the controversy that surrounds workfare schemes. Including workfare participants in the in-work count does not assist the public or decision-makers to evaluate how well these schemes help the participants into work.  For this to happen, I suggest ONS should adopt a 4-state model with the workfare count as the fourth state. Transitions to and from this state could then be measured and published.

Conclusions

It appears that transitions between states for the UK labour force have not historically been routinely published.  ONS now appears to be investing effort to address this issue. So far the transitions data it has collated are experimental. ONS appears currently to be developing its methodology, presumably so that transitional flows reconcile to the separately determined end-point statistics. I suggest a further improvement would be for ONS to adopt and publish a 4-state transition analysis which includes workfare as the fourth state. The improved accountability will assist taxpayers to assess whether DWP is effective in helping people into work. Historically, this task may have not been easy for analysts and taxpayers.