In this appendix, we use Microsoft Excel to depict how the transactions in a job-order costing system impact a company’s balance sheet. While the main body of the chapter focused on using journal entries to record transactions, the approach demonstrated in this appendix will help you develop a new and valuable managerial skill—analyzing how transactions affect the balance sheet without having to prepare formal journal entries.
To set the stage for the forthcoming example, we need to review your understanding of two fundamental accounting equations and we need to specify three important assumptions.
Fundamental Accounting Equations
A company’s balance sheet is based on the following accounting equation that is the bed- rock of double-entry bookkeeping:
LO3–5
Use Microsoft Excel to summarize the flow of costs in a job-order costing system.
Assets = Liabilities + Stockholders’ Equity
In the Excel spreadsheets that we’ll be using in this appendix, one column will always be populated with an “=” sign. The accounts on the left-hand side of the “=” sign will be asset accounts and the accounts on the right-hand side will be liability and stockholders’
equity accounts. After we record every transaction, the amounts on the left-hand side of the “=” sign must equal the amounts on the right-hand side.
The second foundational equation relates to the Retained Earnings account on a com- pany’s balance sheet. The ending balance in retained earnings is computed using the following equation:
Ending balance in retained earnings = Beginning balance in retained earnings +
Net operating
income − Dividends This equation highlights the connection between the balance sheet and the income statement. It recognizes the fact that net operating income from the income statement is embedded within retained earnings on the balance sheet. Thus, in our Microsoft Excel- based approach, any transactions involving sales or expenses will be recorded in the Retained Earnings column of the balance sheet.
Three Key Assumptions
The first assumption in the appendix is that we will always use only one predetermined overhead rate. In other words, we are going to use the same approach that was demon- strated in the main body of this chapter. This requires using an account titled Manufacturing Overhead within our Microsoft Excel spreadsheets that will serve the same purpose as the Manufacturing Overhead clearing account discussed earlier in the chapter.
The second assumption is that any underapplied or overapplied manufacturing overhead will always be closed to Cost of Goods Sold as reported in the income statement. Because the income statement is embedded in the Retained Earnings account on the balance sheet, we will always close underapplied or overapplied overhead to Retained Earnings.
Our third assumption is that we’ll record transactions within Microsoft Excel by using positive numbers to increase balance sheet accounts and negative numbers (shown in parentheses) to decrease balance sheet accounts. This is a slightly different approach than we used in the main body of the chapter where all transactions were depicted using the language of debits and credits—in journal entry form and in T-account form. This appendix replaces the language of debits and credits with an equivalent alternative.
Instead, it identifies the balance sheet accounts affected by each transaction and it deter- mines if those account balances should increase or decrease.
Sapphire Company −Setting the Stage
Sapphire Company uses a job-order costing system to assign manufacturing costs to jobs.
Its balance sheet on January 1 is as follows:
Sapphire Company Balance Sheet
January 1 Assets
Cash. . . $ 15,000 Raw materials. . . $ 8,000
Work in process. . . 5,000
Finished goods . . . 13,000 26,000 Prepaid expenses . . . 3,000 Property, plant, and equipment (net) . . . 240,000 Total assets. . . $ 284,000 Liabilities and Stockholders’ Equity
Accounts payable . . . $ 4,000 Retained earnings . . . 280,000 Total liabilities and stockholders’ equity . . . $ 284,000
Exhibit 3A–1 contains a Microsoft Excel spreadsheet that includes the beginning balances shown in the balance sheet above. Notice that column “J” of the spreadsheet contains “=” signs (see cells J1 and J2). This means that after we record each of the forth- coming transactions, the amounts on the left-hand side of column “J” will always need to equal the amounts on the right-hand side of column “J.”
Also, notice that the spreadsheet contains all of the accounts shown in the January 1 balance sheet plus an account called Manufacturing Overhead. As discussed earlier in the chapter, Manufacturing Overhead is a clearing account that always has a beginning and ending balance of zero. This account is used to record two things—all actual overhead costs and the amount of manufacturing overhead applied to production using the prede- termined overhead rate. The difference between the actual overhead cost and the amount of overhead applied to production is the underapplied or overapplied overhead.
Finally, to conserve space, the Excel spreadsheet abbreviates Property, Plant, and Equipment (net) as PP&E (net). The term net implies that the acquisition cost of property, plant, and equipment is being reported net of accumulated depreciation.
Sapphire Company −Transaction Analysis
The remainder of the appendix proceeds in three steps. First, it lists Sapphire Company’s transactions for the month of January. Second, it explains how each of these transac- tions is recorded in the Microsoft Excel spreadsheet. Finally, it explains how to use the
E X H I B I T 3 A – 1
Sapphire Company: Transaction Analysis
information depicted in the spreadsheet to prepare a schedule of cost of goods manufac- tured, a schedule of cost of goods sold, and an income statement for the month of January.
To begin our illustration, let’s assume that Sapphire Company has a predetermined overhead rate of $25 per direct labor-hour that was based on a cost formula that estimated
$100,000 in manufacturing overhead cost for an estimated allocation base of 4,000 direct labor-hours. During January, the company completed the following transactions:
a. Purchased raw materials on account, $80,000.
b. Raw materials used in production, $78,000 ($70,000 was direct materials and $8,000 was indirect materials).
c. Paid $135,000 of salaries and wages in cash ($68,000 was direct labor, $45,000 was indirect labor, and $22,000 was related to employees responsible for selling and administration).
d. Utility costs incurred (on account) to support production, $15,000.
e. Depreciation recorded on property, plant, and equipment, $40,000 (70% related to man- ufacturing equipment and 30% related to assets that support selling and administration).
f. Advertising expenses paid in cash, $18,000.
g. Prepaid insurance expired during the month, $1,000 (80% related to production, and 20% related to selling and administration).
h. Manufacturing overhead applied to production, $102,500. This amount was com- puted by multiplying 4,100 direct labor-hours worked in January by the predeter- mined overhead rate of $25 per direct labor-hour.
i. Cost of goods manufactured, $235,000.
j. Cash sales, $320,000.
k. Cost of goods sold, $245,000.
l. Cash payments to creditors, $92,000.
m. Close overapplied overhead of $5,700 to cost of goods sold.
Exhibit 3A–2 summarizes how each of the transactions just described would be recorded in the Microsoft Excel spreadsheet. The underlying explanations for each trans- action are as follows (each transaction includes a parenthetical reference to its row within the Microsoft Excel spreadsheet):
a. (row 7) Purchasing raw materials on account for $80,000 will increase Raw Materi- als and Accounts Payable by $80,000.
b. (row 8) When raw materials are used in production, it decreases Raw Materials by
$78,000. The direct materials of $70,000 are added to Work in Process, whereas the E X H I B I T 3 A – 2
Sapphire Company: Completed Transaction Analysis
indirect materials of $8,000 are added to Manufacturing Overhead. Notice that actual manufacturing overhead costs, such as the $8,000 of indirect materials, are not added to Work in Process. As you will see in a later transaction, manufacturing overhead is applied to Work in Process using the predetermined overhead rate.
c. (row 9) The salaries and wages decrease Cash by $135,000. The direct labor cost of $68,000 increases Work in Process, whereas the indirect labor cost of $45,000 increases Manufacturing Overhead. The $22,000 paid to employees working in sell- ing and administrative roles is a period cost that should be recorded on January’s income statement. Because the income statement is embedded in Retained Earnings, we decrease Retained Earnings by $22,000.
d. (row 10) The utility costs support production, so they are treated as a product cost rather than a period cost. Thus, Manufacturing Overhead increases by $15,000 and Accounts Payable increases by the same amount.
e. (row 11) The depreciation reduces Property, Plant, and Equipment (net) by $40,000.
This is equivalent to recording accumulated depreciation of $40,000. The deprecia- tion on manufacturing equipment of $28,000 (a product cost) increases Manufac- turing Overhead, whereas the depreciation on selling and administrative assets of
$12,000 (a period cost) decreases Retained Earnings.
f. (row 12) Advertising is a period cost so Cash and Retained Earnings decrease by $18,000.
g. (row 13) The expired insurance coverage decreases Prepaid Expenses by $1,000. The insurance related to production (a product cost) increases Manufacturing Overhead by $800. The insurance related to selling and administration of $200 (a period cost) decreases Retained Earnings by $200.
h. (row 14) The manufacturing overhead applied increases Work in Process and decreases Manufacturing Overhead by $102,500. Notice that manufacturing over- head is applied to Work in Process using the predetermined overhead rate. Actual manufacturing overhead costs are not recorded in Work in Process. In a later transac- tion, the actual overhead costs will be compared to the applied overhead to determine the amount of underapplied or overapplied overhead for the month.
i. (row 15) The cost of goods manufactured refers to the cost of the goods that were trans- ferred from work in process to finished goods during the period. This transaction decreases Work in Process by $235,000 and increases Finished Goods by the same amount.
j. (row 16) The sales will increase Cash by $320,000, and given that sales appear on the income statement, Retained Earnings will increase by the same amount.
k. (row 17) The cost of goods sold must be removed from finished goods; therefore, Finished Goods decreases by $245,000. Because cost of goods sold appears on the income statement, Retained Earnings decreases by the same amount.
l. (row 18) The cash payments to creditors decrease Cash and Accounts Payable by
$92,000.
m. (row 19) The manufacturing overhead applied of $102,500 is $5,700 greater than the actual overhead costs incurred during the month of $96,800 (= $8,000 + $45,000 +
$15,000 + $28,000 + $800). Therefore, manufacturing overhead is overapplied by
$5,700. We record this transaction by increasing Manufacturing Overhead by $5,700 and increasing Retained Earnings by the same amount. The increase in Retained Earnings reflects the fact that we are decreasing Cost of Goods Sold (which increases net operating income).
Once we have recorded all transactions, the company’s balance sheet at January 31 can be derived by summing each column in the spreadsheet (see row 20 for the ending balances that would be reported on Sapphire Company’s balance sheet at January 31).
Sapphire Company −Schedules of Cost of Goods Manufactured and Cost of Goods Sold
The transactions recorded in Exhibit 3A–2 can be used to create schedules of cost of goods manufactured and cost of goods sold. Exhibit 3A–3 shows Sapphire Company’s schedule of cost of goods manufactured. Each row heading in this exhibit contains a cell reference that indicates where the number appears in Exhibit 3A–2.
E X H I B I T 3 A – 3
Sapphire Company: Schedule of Cost of Goods Manufactured
E X H I B I T 3 A – 4
Sapphire Company: Schedule of Cost of Goods Sold
Notice that the cost of goods manufactured of $235,000 as shown in Exhibit 3A–3 equals the cost of goods manufactured mentioned in transaction “i” and recorded in row 15 of Exhibit 3A–2.
Exhibit 3A–4 shows Sapphire Company’s schedule of cost of goods sold. Each row heading in this exhibit contains a cell reference that indicates where the number appears in Exhibit 3A–2.
In the schedule of cost of goods sold, we subtract overapplied overhead of $5,700 from unadjusted cost of good sold because overapplied overhead means that too much overhead was added to production during the period, and hence, the cost of goods sold was overstated. In Exhibit 3A–2, we add overapplied overhead to retained earnings (see row 19) because lowering cost of goods sold increases net operating income, which in turn increases retained earnings.
Sapphire Company −Income Statement
Exhibit 3A–5 shows Sapphire Company’s income statement for the month of January.
The sales and selling and administrative expenses come from the transaction analysis in Exhibit 3A–2 and they each contain a corresponding parenthetical cell reference. The cost of goods sold ($239,300) is carried over from the schedule of cost of goods sold in Exhibit 3A–4.
E X H I B I T 3 A – 5 Sapphire Company: Income Statement