Definition
Application of Funds refers to the section in the statement of changes in financial position that outlines how a company uses its available resources. This concept is fundamental in understanding the allocation of funds within a business over a specific period. There are two primary approaches to conceptualizing funds: working capital and cash.
Working Capital Concept
Using the working capital concept of funds, the applications of funds can include the following:
- Net Loss: A company’s net loss reduces the overall funds available as it deducts from the retained earnings.
- Increase in Noncurrent Assets: Purchases of long-term assets such as property, plant, and equipment (e.g., buying land for cash).
- Decrease in Noncurrent Liabilities: Paying off long-term debts, decreasing obligations from bonds, mortgages, or other long-term financings.
- Decrease in Stockholders’ Equity: Transactions like the repurchase of treasury stock, which reduces the stockholders’ equity.
Cash Concept
If the cash concept of funds is used, two additional applications include:
- Increase in Current Assets Other than Cash: Purchase of inventory or accounts receivable, which ties up cash into items that are expected to turn into cash within a short period.
- Decrease in Current Liabilities: Settling short-term obligations such as accounts payable or short-term loans, effectively reducing liabilities.
Examples
- Purchasing Equipment for Cash: If a company buys new machinery for its factory, it is an application of funds where company cash is used to acquire a noncurrent (fixed) asset.
- Paying Down Long-Term Debt: When a business makes payments towards its mortgage, this action decreases noncurrent liabilities and is considered an application of funds.
- Repurchasing Shares: If a company buys back its own shares from the stock market, it results in a decrease in stockholders’ equity and is recorded as an application of funds.
- Increasing Inventory: Utilizing cash to stock up on inventory increases current assets, representing an application of funds in the cash concept.
Frequently Asked Questions
Q1: What are the main differences between the working capital and cash concepts of funds? The working capital concept focuses on long-term uses of funds, such as net loss, changes in noncurrent assets, and liabilities, and stockholders’ equity. The cash concept also considers short-term changes, such as increases in current assets (excluding cash) and decreases in current liabilities.
Q2: Can increasing stock investments be considered an application of funds? Yes, increasing stock investments would be classified under noncurrent assets in the working capital concept and thus an application of funds.
Q3: Why is the application of funds important in financial reporting? It helps businesses and stakeholders understand how funds are allocated and used, providing insights into the company’s financial management and operational strategies.
Q4: What are noncurrent assets? Noncurrent assets include long-term investments, property, plant, and equipment, patents, and other assets that are not expected to be liquidated within one year.
Q5: How can one decrease stockholders’ equity? Through actions such as repurchasing treasury stock, issuing dividends, or incurring losses.
Related Terms
- Statement of Changes in Financial Position: A financial document showing the movement of funds in and out of the company.
- Working Capital: The difference between a company’s current assets and current liabilities.
- Noncurrent Assets: Long-term investments and resources owned by the company that are not expected to be liquidated or converted into cash within the year.
- Noncurrent Liabilities: Long-term financial obligations listed on the company’s balance sheet, such as mortgages, bonds, and leases.
Online References
Suggested Books for Further Studies
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Financial Accounting by Paul D. Kimmel, Jerry J. Weygandt, and Donald E. Kieso
- Principles of Accounting by Belverd E. Needles
Fundamentals of Application of Funds: Accounting Basics Quiz
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