Chapter 12 - Capital investment, leasing, and taxation. In this chapter, you will learn how owners and investors determine which businesses are worthy of their capital investment. While it may not be possible to predict with 100% accuracy the chances of a specific business becoming a financial success, it is true that knowledge is power.
Chapter 12 Capital Investment, Leasing, and Taxation © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Chapter Outline Capital Budgeting Capital Investment Financing Alternatives Taxation © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Learning Outcomes Identify the purpose of capital budgeting Compute business owners’ investment rates of return Identify advantages and disadvantages of capital financing alternatives such as debt versus equity financing and lease versus buy decisions Determine the effects of taxation on a hospitality business © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Capital Budgeting In business, capital simply refers to money Those who invest their capital are, not surprisingly, called capitalists, and the economic system that allows for the private ownership of property is called capitalism As is the case in most industries, investing money in hospitality businesses can be risky Capital budgets are used to plan and evaluate purchases of fixed assets such land, property, and equipment © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Capital Budgeting Purchases of this type are called capital expenditures and, as you learned previously, are recorded on a business’s balance sheet Capital budgeting is the essential process by which those in business evaluate which hospitality operations will be started, which will be expanded, and which will be closed In nearly all cases, business owners seek returns on their investments which are large enough to justify the continued investment of their capital © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Capital Budgeting In general, capital budgeting techniques can be classified as those that are directed toward one or more of the following business activities: Establish a business (new venture, sometimes funded by venture capitalists) Expand a business (increase revenues) Increase efficiency (reduce expenses) Comply with the law (mandated change) © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Capital Investment Investors seek to balance the concepts of risk, with that of reward (increase vs decrease in value) In most cases, as the amount of risk involved in an investment increases, the return on that investment also increases As an investor you would ultimately seek to compare the cost of making an investment today against the stream of income that the investment will generate in the future To best make this “in the future” value comparison, or time value of money, which is the concept that money has different values at difference points in time © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Time Value of Money To illustrate the time value of money concept, assume that you have won $10,000 in the state lottery Your options for collecting payment are: Receive $10,000 now, or Receive $10,000 in four years If you are like most people, you would choose to receive the $10,000 now It makes little sense to defer (delay) a cash flow into the future when you could have the exact same amount of money now © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Time Value of Money From an investment perspective, those in business know you can much more with money if you have it now because you can earn even more money through wise investments The value of the money that is invested now at a given rate of interest and grows over time is called the future value of money The process of money earning interest and growing to a future value is called compounding See Go Figure! for an illustration of this © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To see why this is so, consider Rhonda and Ron Both are owed $1,000 Rhonda collects the money owed to her on January 1st while Ron collects the $1,000 owed to him on December 31st of the same year After thoroughly evaluating her investment opportunities, Rhonda takes her money on January 1st and invests it in a company that will pay her a 10% annual rate of return As a result, on December 31st Rhonda would have $1,100 as shown using the total investment value formula as follows: Investment + Return on Investment = Total Investment Value or $1,000 + ($1,000 X 0.10) = $1,100 As a result of her investment, at the end of the year, Rhonda’s $1000 is now worth $1,100, while Ron’s $1000 is, of course, still worth only $1,000 Now, assume that Rhonda elects to re-invest her original $1,000 and all of her investment earnings If she does so, Rhonda is poised to increase the future value of her money even further by earning investment returns over an even longer period of time The value of the money that is invested now at a given rate of interest and grows over time is called the future value of money The process of money earning interest and growing to a future value is called compounding If Rhonda maintained her investment for four years, it would grow as follows: © 2009 John Wiley & Sons Hoboken, NJ 07030 Year $1,000 + ($1,000 X 0.10) = $1,100 Year $1,100 + ($1,100 X 0.10) = $1,210 Year $1,210 + ($1,210 X 0.10) = $1,331 Year $1,331 + ($1,331 X 0.10) = $1,464 10 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 12.9 Federal Corporate Income Tax Rates Taxable Income Over $0 But Not Over Tax rate 50,000 15% 50,000 75,000 25% 75,000 100,000 34% 100,000 335,000 39% 335,000 10,000,000 34% 10,000,000 15,000,000 35% 15,000,000 18,333,333 38% 18,333,333+ © 2009 John Wiley & Sons Hoboken, NJ 07030 43 35% Managerial Accounting for the Hospitality Industry Dopson & Hayes Capital Gains Taxes A capital gain is the surplus that results from the sale of an asset over its original purchase price adjusted for depreciation (asset basis) A capital loss occurs when the price of the asset sold is less than the original purchase price adjusted for depreciation Capital gains and losses occur with the sale of real assets, such as property, as well as financial assets, such as stocks and bonds The federal government (and some states) imposes a tax on gains from the sale of assets © 2009 John Wiley & Sons Hoboken, NJ 07030 44 Managerial Accounting for the Hospitality Industry Dopson & Hayes Property Taxes In addition to income and capital gains taxes, most hospitality businesses will be responsible for paying property taxes on the property owned by their businesses These assessments are determined through a real estate appraisal, which is an opinion of the value of a property, usually its market value, performed by a licensed appraiser Market value is the price at which an asset would trade in a competitive setting © 2009 John Wiley & Sons Hoboken, NJ 07030 45 Managerial Accounting for the Hospitality Industry Dopson & Hayes Other Hospitality Industry Taxes Hospitality businesses are responsible for reporting and paying a variety of hospitality industry taxes Sales Tax In most cases, sales taxes are collected from guests by hospitality businesses for taxes assessed on the sale of food, beverages, rooms, and other hospitality services Typically, the funds collected are then transferred (forwarded) to the appropriate taxing authority on a monthly or quarterly basis © 2009 John Wiley & Sons Hoboken, NJ 07030 46 Managerial Accounting for the Hospitality Industry Dopson & Hayes Other Hospitality Industry Taxes Occupancy (Bed) Tax Occupancy (bed) taxes are a special assessment collected from guests and paid to a local taxing authority based upon the amount of revenue a hotel achieves when selling its guest rooms Tipped Employee Tax Tipped employee taxes are assessed on tips and gratuities given to employees by guests or the business as taxable income for those employees As such, this income must be reported to the IRS, and taxes, if due, must be paid on that income © 2009 John Wiley & Sons Hoboken, NJ 07030 47 Managerial Accounting for the Hospitality Industry Dopson & Hayes Modified Accelerated Cost Recovery System (MACRS) Depreciation is a method of allocating the cost of a fixed asset over the useful life of the asset Depreciation is subtracted on the income statement primarily to lower income, thus lower taxes The portion of assets depreciated each year is considered “tax deductible” because it is subtracted on the income statement before taxes are calculated The Modified Accelerated Cost Recovery System (MACRS) is the depreciation method required for equipment in the hospitality industry (and all industries) © 2009 John Wiley & Sons Hoboken, NJ 07030 48 Managerial Accounting for the Hospitality Industry Dopson & Hayes Modified Accelerated Cost Recovery System (MACRS) MACRS was designed to accelerate depreciation in the first years of depreciating an asset in order to reduce the amount of taxes paid in those years This is especially good for new businesses whose net income may be small in the first few years of operations Depreciation for real estate, however, follows straightline depreciation, which is the cost of the asset divided evenly over the life of the asset MACRS establishes shorter recovery periods than in straight-line depreciation © 2009 John Wiley & Sons Hoboken, NJ 07030 49 Managerial Accounting for the Hospitality Industry Dopson & Hayes Modified Accelerated Cost Recovery System (MACRS) MACRS calculations are based on property class lives and an estimated salvage value (the estimated value of an asset at the end of its useful life) of zero Property class lives as they are applied to hospitality businesses are shown in Figure 12.11 Depreciation using MACRS is calculated using stated percentages for varying property classes (see Figure 12.12) © 2009 John Wiley & Sons Hoboken, NJ 07030 50 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 12.11 MACRS Property Classes Table as Applied to Hospitality Businesses Property Class All Property Except Real Estate 3-Year Property Special handling devices for food and beverage manufacture 5-Year Property Computers and peripherals; automobiles 7-Year Property All other property not assigned to another class including furniture, fixtures, and equipment Figure 12.12 MACRS Percentages for Property Classes Recovery Year 3-Year Property % 5-Year Property % 7-Year Property % 33.33 20.00 14.29 44.45 32.00 24.49 14.81 19.20 17.49 7.41 11.52 12.49 11.52 8.93 5.76 8.92 8.93 4.46 © 2009 John Wiley & Sons Hoboken, NJ 07030 51 Managerial Accounting for the Hospitality Industry Dopson & Hayes Modified Accelerated Cost Recovery System (MACRS) The number of recovery years (years of depreciation for the asset) include one more year than the years of the property class life This is because of the half-year convention The half-year convention allows for one-half of a year’s depreciation to be taken in the year of purchase and one-half in the year following the end of the class life In effect, this allows for one more year of depreciation The salvage value is subtracted from the original cost of the asset before depreciation is calculated See Go Figure! for an illustration of MACRS © 2009 John Wiley & Sons Hoboken, NJ 07030 52 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To illustrate, consider again Joshua Richards, the owner of Joshua’s Restaurant located across the street from the Blue Lagoon Water Park Resort Assume that he wants to depreciate a fryer that he just purchased for $7,000 Using a 7-year property class life from Figure 12.11 and the 7-year property MACRS percentages in Figure 12.12, Joshua can calculate his annual depreciation for the fryer by multiplying the cost of the fryer, $7,000, by the percentages for recovery years to fully depreciate his fryer For example, Joshua’s depreciation in recovery year would be $1,000.30 ($7,000 X 14.29% = $1,000.30) Joshua’s calculations for all years of depreciation are as follows: Recovery Year Total © 2009 John Wiley & Sons Hoboken, NJ 07030 53 7-Year Property % 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 4.46% 100.00% Depreciation $ $1,000.30 1,714.30 1,224.30 874.30 625.10 624.40 625.10 312.20 $7,000.00 Managerial Accounting for the Hospitality Industry Dopson & Hayes Role of Hospitality Managers While it is not reasonable for most hospitality managers to become tax experts, it is possible for them to: Be aware of the major entities responsible for tax collection and enforcement Be aware of the specific tax deadlines for which they are responsible Stay abreast, to the greatest degree possible, of changes in tax laws that may directly affect their business © 2009 John Wiley & Sons Hoboken, NJ 07030 54 Managerial Accounting for the Hospitality Industry Dopson & Hayes Role of Hospitality Managers The Internal Revenue Service (IRS) is the taxing authority with which hospitality managers are likely most familiar Among other things, the IRS requires businesses to the following: File quarterly income tax returns and make payments on the profits earned from business operations File an Income and Tax Statement with the Social Security Administration Withhold income taxes from the wages of all employees and deposit these with the IRS at regular intervals © 2009 John Wiley & Sons Hoboken, NJ 07030 55 Managerial Accounting for the Hospitality Industry Dopson & Hayes Role of Hospitality Managers Report all employee income earned as tips and withhold taxes on the tipped income Record the value of meals charged to employees when the meals are considered a portion of an employee’s income Furnish a record of withheld taxes to all employees on or before January 31 of each year (Form W-2) It is the role of hospitality managers to stay abreast of significant changes in tax laws and follow them to the letter © 2009 John Wiley & Sons Hoboken, NJ 07030 56 Managerial Accounting for the Hospitality Industry Dopson & Hayes Review of Learning Outcomes Identify the purpose of capital budgeting Compute business owners’ investment rates of return Identify advantages and disadvantages of capital financing alternatives such as debt versus equity financing and lease versus buy decisions Determine the effects of taxation on a hospitality business © 2009 John Wiley & Sons Hoboken, NJ 07030 57 Managerial Accounting for the Hospitality Industry Dopson & Hayes ... 5,145 ,123 - 1,080,000 4,065 ,123 4.8 8.0% 35.6% 5,145 ,123 - 1,296,000 3,849 ,123 4.0 8.0% 44.9% 5,145 ,123 - 1, 512, 000 3,633 ,123 3.4 8.0% 63.3% 5,145 ,123 - 1,728,000 3,417 ,123 3.0 Managerial Accounting for the Hospitality Industry... Hoboken, NJ 07030 15 Managerial Accounting for the Hospitality Industry Dopson & Hayes Rates of Return Before closely examining rates of return, it is very important for those in the hospitality industry... Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! To illustrate, consider the High Hills Hotel, which was offered for sale for $16,000,000 The