Application of Funds

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.

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

### Which concept of funds includes net loss as an application? - [x] Working capital - [ ] Cash - [ ] Profit and loss - [ ] Treasury > **Explanation:** The working capital concept includes net loss as an application of funds because it directly affects the total funds available by reducing retained earnings. ### Which application of funds does not typically appear when using the working capital concept? - [ ] Increase in noncurrent assets - [ ] Decrease in noncurrent liabilities - [ ] Decrease in stockholders' equity - [x] Increase in current assets other than cash > **Explanation:** The working capital concept focuses on long-term investments and obligations, whereas increase in current assets other than cash falls under the cash concept. ### What happens when a company purchases equipment for cash? - [ ] Its liabilities increase - [ ] Its current assets increase - [x] Its noncurrent assets increase - [ ] Its stockholders' equity increases > **Explanation:** Purchasing equipment for cash decreases cash and increases noncurrent assets, reflecting an application of funds. ### Why might a company repurchase its own shares? - [ ] To increase its liabilities - [x] To decrease stockholders' equity - [ ] To increase current assets - [ ] To diversify investments > **Explanation:** Repurchasing shares reduces the stockholders' equity, as the company eliminates some of its outstanding shares, reflecting an application of funds. ### What reflects a decrease in current liabilities? - [ ] Expanding into a new market - [x] Paying off accounts payable - [ ] Accruing more short-term debt - [ ] Buying new machinery > **Explanation:** Paying off short-term obligations like accounts payable represents a decrease in current liabilities, an application of funds under the cash concept. ### In which concept of funds is an increase in inventory considered an application? - [ ] Working capital only - [x] Cash - [ ] Noncurrent - [ ] Equity > **Explanation:** An increase in inventory ties up cash into current assets and is considered an application of funds under the cash concept. ### If a business incurs a net loss, it will typically result in: - [ ] An increase in noncurrent liabilities - [x] A decrease in funds - [ ] An increase in stockholders' equity - [ ] An increase in current liabilities > **Explanation:** A net loss results in a reduction of the total available funds as it directly impacts retained earnings. ### What is considered an application of funds in both working capital and cash concepts? - [x] Payment of long-term debt - [ ] Increase in accounts receivable - [ ] Payment of short-term liabilities - [ ] Issuing dividends > **Explanation:** Payment of long-term debt is considered an application of funds under both working capital and cash concepts as it reduces noncurrent liabilities. ### Which of the following increases noncurrent assets? - [x] Purchasing a building - [ ] Issuing equity shares - [ ] Paying dividends - [ ] Selling inventory > **Explanation:** Purchasing a building increases noncurrent assets as it is a long-term investment, reflecting an application of funds. ### What term describes the overall movement of funds in a company? - [x] Statement of changes in financial position - [ ] Income statement - [ ] Balance sheet - [ ] Cash flow statement > **Explanation:** The statement of changes in financial position outlines the overall movement of funds, detailing sources and applications.

Thank you for exploring the application of funds in the accounting realm and attempting our practice quiz. Continue to deepen your understanding and enhance your financial expertise!