Page 61 - DCOM409_CONTEMPORARY_ACCOUNTING

Contemporary Accounting

Notes
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Caution EVA is always expressed as a rupee amount.
While calculating of NOPAT, the non-operating items like dividend/interest on securities invested
outside the business, non-operating expenses, etc., will not be considered. The total capital
employed is the sum of shareholders funds as well as loan funds. But this does not include
investments outside the business. In determining WACC, cost of debt is taken as cost after tax
and the cost of equity is measured on the basis of Capital Asset Pricing Method (CAPM). CAPM
is traditionally used by the founders of EVA. Under CAPM, Cost of Equity (Ke) is given by the
following:
K =R + b (Rm - R )
e f i f
Where,
R = Risk free return
f
R = Expected market rate of return
m
b = Risk coefficient of particular investment
i
EVA is expressed in terms of rupee figure and not as a percentage i.e., EVA measures the
absolute rupee value of wealth created. EVA calculation removes the distinction between the
providers of capital because the total capital employed in the business is taken, whether provided
by shareholders or creditors. The EVA figure measures the value added after the claims or
expectations of each of the group of capital providers have been met.
EVA calculation involves calculating the three figures NOPAT, TCE and WACC; EVA requires
some of the following adjustments for the accounting figures:
4.2.1 Adjustments to ‘Net Operating Profit after Tax’

The adjustments suggested for Net Operating Profit after Tax (NOPAT) are as follows:
The depreciation charge, if excessive, needs adjustments.
Certain marketing expenses like advertising or sales promotion for a new brand launch
are capitalized and amortised over the period during which benefits will be reaped.
Goodwill of an acquired business, if written off, is capitalized and adjusted in NOPAT and
equity.

Expenses incurred on employee training will provide benefits over a period, so these
expenses are to be capitalized.

Accounting principles allow companies to write-off research and development expenses,
but these expenses may not be truly revenue in nature. For successful R&D projects, EVA
calculations writes back the R&D expenses and amortises them over a period during
which benefits of the successful R&D projects will be reaped. The NOPAT figure calculated
from Profit and Loss account is adjusted by adding back the R&D expenses and capitalizing
them in the balance sheet. Only these R&D expenses that have no future value are charged
to the Income statement.

During periods of rising prices companies save taxes by adopting the LIFO system of
inventory valuation. Under the LIFO method, costs of the recently acquired raw material
are charged to the production while the costs of earlier purchases are accumulated in
inventory thereby understanding the inventory and the profits. For calculating EVA the
LIFO system of valuation is changed to FIFO basis, which is a better basis for estimating

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