Question

As a financial analyst of the company, you have gathered relevant purchase prices and operating costs of the two chip crushers from the supplier of the chip crushers and the marketing and production staff. The key estimates of financial data for the two machines are given below:

	LCC	HCC
Purchase Price	$400,000	$480,000
Useful Life (years)	4	6
Depreciation (reducing balance method)	40% p.a.	30% p.a.
Salvage value at the end of useful life	$80,000	$48,000
Annual interest expense	$48,000	$48,000
Annual scrap revenue	$450,000	$600,000
Annual operating costs:
– Variable overheads	$50,000	$150,000
– Salaries	$80,000	$110,000
– Marketing	$45,000	$60,000

The calculation for annual operating costs includes the following items:

a) Variable overheads are direct operating expenses incurred in the production of the fine or
rough scrap.
b) Salaries represent the costs of employing two new machine operators at a salary of $40,000
per annum each. For the HCC machine, the company will only need to employ a new machine
operator and the second, who earns $70,000 per annum, will be transferred from the axle
assembly plant. The second operator from the main plant would otherwise have been made
redundant with a redundancy payment of $50,000.
c) The marketing cost is based on the standard allocation of the new investment towards group
advertising expenses, which is 10% of annual revenue. It has been estimated that the additional
group advertising required to promote the sales of fine or rough scrap is only $40,000 per year.
The accountant, Mr. Smith pointed out to you that the revenue figures do not take into
consideration the scrap sales that XYZ would generate regardless of whether the company
bought either machine. He has estimated that the current unprocessed scrap would generate a
net income of $50,000 per year.
Production facilities for the steel scrap would be set up in an unused section of XYZ Limited
main plant. The section of the plant where the steel scrap production would occur has been
unused for several years and consequently had suffered some deterioration. Last year, as part
of a routine facilities improvement program, XYZ Limited spent $80,000 to rehabilitate that
section of the main plant. Mr. Smith believes this outlay, which has already been paid and
expensed for tax purposes, should be charged to the steel scrap project. His contention is that
if the rehabilitation had not taken place, the firm would have to spend $50,000 to make the site
suitable for the steel scrap project. As the section of the plant has been rehabilitated, it could
fetch a rental income of $40,000 per year.
The company’s nominal cost of capital is 15 percent per annum. Assume that the company is
subject to 30% corporate tax and that the tax is paid at end of the same year (i.e. not the
following year).

How do we treat for the redundancy payment of $50,000? It can be considered as cash flow? If yes what is the text effect and which years should we consider it?

And how to affect tax on it?

Answer 1

Ans :

When a person( Employee) become redundant (actually it is your job that becomes redundant) his employer may make a payment to him, called a redundancy payment. This is to compensate him for being made redundant.

Any redundancy payment that an employer makes to an employee is part of pay and hence is an expense accounted for on the employer's profit and loss account, taken in the month in which the redundancy occurs.

As a cost, a redundancy payment reduces the profits reported from the profit and loss account to the balance sheet. The payment therefore reduces the net worth of the company as reported on the foot of the balance sheet for that year.

a) So , redundancy payment will be treated as expense in Statement of P/L

b) Yes , it is a Cash outflow for the employer

c) It will be recorded in the month / year of payment

And it is a tax deductible item , so the employer can save 30 % tax on it , just like any other expense .