Product Costing in Service and Manufacturing Entities

The cost of materials put into production is then transferred from the Raw Material Inventory account to the Work in Process Inventory account. The cost of the goods completed during the period is transferred from the Work in Process inventory account to the Finished Goods inventory account. The amount of the product cost transferred to the Cost of Goods Sold account is expensed on the income statement.

For example, the amount of the allocation between the Finished Goods Inventory and the Cost of Goods Sold accounts is required for the financial statements.

CHECK YOURSELF 11.1

Assigning the total cost of these resources to December alone would overestimate the cost of December production and underestimate the cost of production in other months. By using estimated overhead costs during the accounting period, management reduces the distortions that using actual monthly costs would create.

Summary of January Events

The merchandise inventory and cost of goods sold accounts include the cost of materials, labor, and an estimated amount of overhead. Accounts are adjusted at the end of the year to equalize the difference between estimated and actual overhead costs.

Manufacturing Cost Flow Events for February through December

The year-end manufacturing supplies inventory indicated that $300 of supplies were on hand on December 31. A year-end closing of the manufacturing overhead account revealed that overhead costs were underutilized by $3,752. Because estimated fixed costs pass through the general ledger accounts from work-in-process inventory to finished goods inventory and ultimately to cost of goods sold, the balance in the cost of goods sold account is understated.

Ventra recorded an adjusting entry to close the Manufacturing Overhead account and increase the balance in the Cost of Goods Sold account.

Analyzing Underapplied Overhead

Ventra recognized supplies on hand 2 $300 ending balance) of indirect materials costs for supplies used during the year. The January entries are shown in blue to distinguish them from the entries for the rest of the year. Cash Raw material inventory Work in progress inventory Finished goods inventory Cost of goods inventory Common inventory Bal.

CHECK YOURSELF 11.2

VENTRA MANUFACTURING COMPANY

PREPARING THE SCHEDULE OF COST OF GOODS MANUFACTURED AND SOLD

Confirm this relationship by comparing the information in the raw materials inventory account in Exhibit 11.5 with the calculation of the cost of direct raw materials used in the table in Exhibit 11.6. Beginning raw material inventory, purchases, and ending raw material inventory in the ledger account are consistent with the schedule. In practice, one figure in the chart can represent thousands of individual events recorded in the financial accounts.

The cost statement of goods produced and sold includes the actual amount of overhead costs.

FINANCIAL STATEMENTS

Data for financial statement reports is summarized at the end of the year when actual cost data is available. Although companies use estimated costs for internal administration and decision making during the year, they use actual historical cost data in this schedule that is prepared at the end of the year.

MOTIVE TO OVERPRODUCE

Absorption Costing versus Variable Costing

Inventory is subject to obsolescence, damage, theft or destruction by fire, weather or other calamities. To motivate managers to increase profitability without tempting them to overproduce, many companies use variable costing for internal reporting.

Variable Costing

The Raw Materials Inventory account is used to accumulate the cost of direct raw materials purchased for use in production. The costs of materials used in production are transferred from raw material inventories to work-in-progress inventories. When goods are completed, their costs are transferred from work-in-progress inventory to finished goods inventory.

When goods are sold, their cost is transferred from finished goods inventory to cost of goods sold. The ending balances in the Raw Materials, Work in Process and Finished Goods inventory accounts are reported in the balance sheet. The product cost in the Cost of Goods Sold account is subtracted from sales revenue on the income statement to determine the gross margin.

Examples of such costs include the cost of rent, supplies, utilities, indirect materials, and indirect labor. Differences between actual and applied overhead result in a balance in the Manufacturing Overhead account at the end of the accounting period. If the amount of over- or under-applied overhead is insignificant, it is closed directly to the cost of goods sold through a year-end adjusting entry.

Information about production costs is summarized in a report known as a schedule of costs of goods manufactured and sold. This schedule shows how the amount of cost of goods reported on the income statement was determined.

CHECK YOURSELF 11.3

Finally, the Finished Goods Inventory account contains the cost of fully completed products that are ready for sale. When purchasing direct materials, their costs are first recorded in raw materials inventory. The actual amounts of many indirect overhead costs incurred in the manufacture of products are not known until the end of the accounting period.

Because many management decisions require product cost information before the end of the year, companies often estimate the total cost amount. Generally accepted accounting principles require that all product costs (fixed and variable) be included in inventory until the products are sold. Overproduction spreads fixed costs over more units, reducing the cost per unit and the amount charged to cost of goods sold.

Overproduction has the adverse effect of reducing long-term profitability by increasing the risks and costs of stockpiling. To eliminate the temptation to overproduce, for internal reporting many companies determine product costs using variable costing. Fixed product costs are accounted for as an expense in the period they are incurred, regardless of when products are sold.

As a result, overproduction does not reduce the unit cost of the product, and managers are not tempted to overproduce to increase profitability.

A Look Forward >>

Product cost flow and financial statements
Recording events in T-accounts and preparing financial statements Pruitt Manufacturing Company was started on January 1, 2011, when it acquired $2,000 cash
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Missing information in a schedule of cost of goods manufactured Required

14 Cost of goods sold 1 Finished goods inventory 2 15 Manufacturing overhead 1 Accumulated depreciation 1 16 Depreciation expense 1 Accumulated depreciation 1 17 Manufacturing overhead 1 Manufacturing supplies 2 18 Accumulated cost of goods sold 2 direct purchased materials. , and the costs were then transferred to work in process inventory. At the end of the accounting period, an adjusting entry is made for the accrued wages of production workers.

How does the entry to close an insignificant amount of overadjusted overhead on the Cost of Goods Sold account affect net income. Due to seasonal fluctuations, Buresch Corporation has a problem in determining the unit cost of its products. During the first year of operation, $800 of direct raw materials were purchased with cash, and $600 of the materials were used to make products.

Prepare a schedule of costs of goods manufactured and sold, an income statement and a balance sheet. Use a horizontal statement model to indicate how each of the following independent accounting events affects the elements of the balance sheet and the income statement. Indicate whether the event increases (I), decreases (D), or does not affect (NA) each element of the statements.

During the accounting period, Cooper purchased $240,000 of raw materials and issued $248,000 of materials to the production department. Determine the ending balance of each of the three inventory accounts that will appear on the year-end balance sheet.

DEWBERRY CORPORATION

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Prepare a schedule of the cost of goods manufactured and sold, an income statement and a balance sheet as of the close of business on December 31, 2010. Prepare a schedule of the cost of goods manufactured and sold, an income statement, and A balance sheet for 2011. Prepare a schedule of costs of goods manufactured and sold, an income statement and a balance sheet.

The company completed work in inventory that began between February 1 and December 31, and the cost of finished goods inventory was transferred to the Finished Goods Inventory account. Employees completed work on all inventory items that began in February; the cost of this production was transferred to the Finished Goods Inventory account. Assume that the company uses the FIFO inventory cost flow method to determine cost of goods sold.

Prepare a cost of goods manufactured and sold schedule, an income statement, and a balance sheet for each year. Fill in the missing information on the following summary of costs of goods manufactured and sold.

TORBERT CORPORATION

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Smoothing unit cost
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Manufacturing cost for one accounting cycle
Manufacturing cost flow for one-year period Burnside Manufacturing started 2011 with the following account balances
Manufacturing cost flow for monthly and annual accounting periods York Manufacturing Company manufactures puzzles that depict the works of famous artists
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Determine the amount of cost of goods manufactured (amount transferred from inventory in the process of production to inventory of finished goods). By the end of the accounting period, $3,500 of the liability had been paid in cash. By the end of the accounting period, $6,500 of the payroll bill had been paid in cash.

At the beginning of the accounting period, the company expected overhead for the period to be $5,500 and 1,250 direct labor hours to be worked. A count of the production inventories revealed a balance on hand of $150 at the end of the accounting period. Determine that $3,200 of manufacturing supplies were on hand at the end of the accounting period.

The company completed work in inventory begun between February 1 and December 31, and the cost of finished goods inventory was transferred to the Finished Goods Inventory account. The company produces stereo CD players for cars and sells them to some of the largest car manufacturers in the country. Rowley expects to devote his time to the administrative aspects of the business and to provide back-up support in production work.

Your answer should include the amount of inventory balance that would exist under the two costing approaches. The spokesperson of the first section must provide information for the calculation of the starting balance on the raw materials account. The spokesperson for the second department must provide data to determine the starting balance on the Work in Progress Inventory account.

The spokesperson for the third division must provide information for determining the beginning balance in the Finished Goods inventory account.