Question

Capstone analytical review of @ Chapters 2-4. Calculate liquidity and profitability measures and explain various financial statement relationships for an excavation contractor Gerrard Construction Co. is an excavation contractor. The following summarized data (in thousands) are taken from the December 31, 2019, financial statements: For the Year Ended December 31, 2019: Net revenues $ 96,600 Cost of services provided 34,200 Depreciation expense 19.500 Operating income $ 42.900 Interest expense 11,400 Income tax expense 9,600 Net income $ 21,900 At December 31, 2019: Assets Cash and short-term investments $ 8,400 Accounts receivable, net 29,400 Property, plant, and equipment, net 232,200 Total assets $270,000 Liabilities and Stockholders' Equity Accounts payable $ 4,500 Income taxes payable 4,800 Notes payable (long term) 142,500 Paid-in capital 30,000 Retained earnings 88,200 Total liabilities and stockholders' equity $270,000 At December 31, 2018, total assets were $246,000 and total stockholders' equity was $97,800. There were no changes in notes payable or paid-in capital during 2019.

Answer 1

Solution:

In the given case , Gerrard Construction co. is an excavation contractor and has invested substantially all of its resources in property, plant & equipment . Also, the depreciation amount is material . Therefore the company and its shareholders  might be interested in knowing the economic cost of utilization of any excavating machinery , because a substantial portion of profits will be reinvested in replacement of machinery. Including the depreciation amount in cost of providing services would not have provided this information to the shareholders. Another reason for showing depreciation amount separately is that depreciation does not result in cash outflow whereas all other expenses involve a cash outflow.

From a conceptual point of view whether depreciation should be considered as cost of providing services or not depends on the type of asset being depreciated. If the asset is involved directly in providing services to the customers then it can be included in cost of providing services, however if the asset is primarily used for administrative, general or selling purpose then it should be shown under overheads.