LEARNING OBJECTIVE 3 Prepare an income statement including calculation of the cost of goods sold.
E X H I B I T 2–2
Comparative Income Statements: Merchandising and Manufacturing Companies
}
The cost of
merchandise inventory purchased from outside suppliers during the period.
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The manufacturing costs associated with the goods that were finished during the period. (See Exhibit 2–4 for details.)
Merchandising Company Reston Bookstore
Sales . . . $1,000,000 Cost of goods sold:
Beginning merchandise inventory . . . $100,000 Add: Purchases . . . 650,000 Goods available for sale . . . 750,000
Deduct: Ending merchandise inventory . . . 150,000 600,000 Gross margin . . . 400,000 Selling and administrative expenses:
Selling expense . . . 100,000
Administrative expense . . . 200,000 300,000 Net operating income . . . $ 100,000
Manufacturing Company Graham Manufacturing
Sales . . . $1,500,000 Costs of goods sold:
Beginning finished goods inventory . . . $125,000 Add: Cost of goods manufactured . . . 850,000 Goods available for sale . . . 975,000
Deduct: Ending finished goods inventory . . . 175,000 800,000 Gross margin . . . 700,000 Selling and administrative expenses:
Selling expense . . . 250,000
Administrative expense . . . 300,000 550,000 Net operating income . . . $ 150,000
The Income Statement
Exhibit 2–2 compares the income statements of Reston Bookstore and Graham Manufactur- ing. For purposes of illustration, these statements contain more detail about cost of goods sold than you will generally fi nd in published fi nancial statements.
At fi rst glance, the income statements of merchandising and manufacturing companies like Reston Bookstore and Graham Manufacturing are very similar. The only apparent dif- ference is in the labels of some of the entries in the computation of the cost of goods sold. In the exhibit, the computation of cost of goods sold relies on the following basic equation for inventory accounts:
Basic Equation for Inventory Accounts Beginning
balance
Additions
to inventory Ending
balance Withdrawals from inventory
The logic underlying this equation, which applies to any inventory account, is illustrated in Exhibit 2–3. The beginning inventory consists of any units that are in the inventory at the beginning of the period. Additions are made to the inventory during the period. The sum of the beginning balance and the additions to the account is the total amount of inventory available. During the period, withdrawals are made from inventory. The ending balance is whatever is left at the end of the period after the withdrawals.
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These concepts are used to determine the cost of goods sold for a merchandising com- pany like Reston Bookstore as follows:
Cost of Goods Sold in a Merchandising Company Beginning
merchandise inventory
Purchases Ending merchandise
inventory
Cost of goods sold or
Cost of
goods sold Beginning merchandise
inventory
Purchases Ending merchandise
inventory
To determine the cost of goods sold in a merchandising company, we only need to know the beginning and ending balances in the Merchandise Inventory account and the purchases.
Total purchases can be easily determined in a merchandising company by simply adding together all purchases from suppliers.
The cost of goods sold for a manufacturing company like Graham Manufacturing is determined as follows:
Cost of Goods Sold in a Manufacturing Company Beginning fi nished
goods inventory Cost of goods
manufactured Ending fi nished
goods inventory Cost of goods sold or
Cost of
goods sold Beginning fi nished
goods inventory Cost of goods
manufactured Ending fi nished goods inventory
To determine the cost of goods sold in a manufacturing company, we need to know the cost of goods manufactured and the beginning and ending balances in the Finished Goods inventory account. The cost of goods manufactured consists of the manufacturing costs associated with goods that were fi nished during the period. The cost of goods manufactured for Graham Manufacturing is derived in the schedule of cost of goods manufactured shown in Exhibit 2–4 (page 48).
Schedule of Cost of Goods Manufactured
At fi rst glance, the schedule of cost of goods manufactured in Exhibit 2–4 appears com- plex and perhaps even intimidating. However, it is all quite logical. The schedule of cost of goods manufactured contains the three elements of product costs that we discussed earlier—
direct materials, direct labor, and manufacturing overhead.
LEARNING OBJECTIVE 4 Prepare a schedule of cost of goods manufactured.
E X H I B I T 2–3 Inventory Flows
Basic Study Stratiages I
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Basic Study Stratiages I
Basic Study Stratiages II
Basic Study Stratiages II
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Basic Study Stratiages I
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Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages II
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Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages I
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages II
Basic Study Stratiages I
Basic Study Stratiages I
Beginning balance ⴙ Additions ⴝ Total available ⴚ Withdrawals ⴝ Ending balance
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The direct materials cost of $410,000 is not the cost of raw materials purchased during the period—it is the cost of raw materials used during the period. The purchases of raw materials are added to the beginning balance to determine the cost of the materials available for use. The ending raw materials inventory is deducted from this amount to arrive at the cost of raw materials used in production. The sum of the three manufacturing cost elements—materials, direct labor, and manufacturing overhead—is the total manu- facturing cost of $820,000. However, you’ll notice that this is not the same thing as the cost of goods manufactured for the period of $850,000. The subtle distinction between the total manufacturing cost and the cost of goods manufactured is very easy to miss. Some of the materials, direct labor, and manufacturing overhead costs incurred during the period relate to goods that are not yet completed. As stated above, the cost of goods manufac- tured consists of the manufacturing costs associated with the goods that were fi nished during the period. Consequently, adjustments need to be made to the total manufacturing cost of the period for the partially completed goods that were in process at the beginning and at the end of the period. The costs that relate to goods that are not yet completed are shown in the work in process inventory fi gures at the bottom of the schedule. Note that the beginning work in process inventory must be added to the manufacturing costs of the E X H I B I T 2–4
Schedule of Cost of Goods Manufactured
*We assume in this example that the Raw Materials inventory account contains only direct materials and that indirect materials are carried in a separate Supplies account. Using a Supplies account for indirect materials is a common practice. In Chapter 3, we discuss the procedure to be followed if both direct and indirect materials are carried in a single account.
†In Chapter 3 we will see that the manufacturing overhead section of the Schedule of Cost of Goods Manufactured can be considerably simplifi ed by using a predetermined manufacturing overhead rate.
Direct materials:
Beginning raw materials inventory* $ 60,000 Add: Purchases of raw materials 400,000 Raw materials available for use 460,000 Deduct: Ending raw materials inventory 50,000
Raw materials used in production $410,000
Manufacturing overhead:†
Insurance, factory 6,000
Indirect labor 100,000
Machine rental 50,000 Utilities, factory 75,000 Supplies 21,000
Depreciation, factory 90,000
Property taxes, factory 8,000
Total manufacturing overhead cost 350,000
Total manufacturing cost 820,000
Add: Beginning work in process inventory 90,000
910,000
Deduct: Ending work in process inventory 60,000 Cost of goods manufactured (see Exhibit 2–2) $850,000
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. . . . . . . . . . . . .
Direct labor 60,000
Manufacturing overhead
Direct labor Direct materials
Cost of goods manufactured . . . .
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period, and the ending work in process inventory must be deducted, to arrive at the cost of goods manufactured. Since the Work in Process account declined by $30,000 during the year ($90,000 $60,000), this explains the $30,000 difference between the total manu- facturing cost and the cost of goods manufactured.