Product Costing, Statement Of Cost, Statement Of Income Calculation

Methods of Product Costing and Their Benefits

Questions:

You have just been hired as an accountant by GoodStyle Furniture, a manufacturer of specialty, hand-made furniture based in South Australia. The furniture produced by Goodstyle is in two ranges, Modern and Classical. The two ranges are different in design, but both are high quality, hand-made furniture and are priced accordingly. The owner of the company, Brenton Pryce, has always believed in pricing a quality product based on how much their larger competitors are pricing theirs. His argument has been that “our product is as good, if not better, than the mass producers of furniture, so we should be charging at least as much, if not more, than what they charge”.

When you arrived at work for the first time, you learnt that the though the company has been in existence for the last twelve years, they have never had an accountant. The accounts were typically prepared by the Laura Peters , secretary of Brenton Pryce and Tom Nichols, a part-time accountant who came in once or twice a month. Tom has informed Brenton that he could no longer spare the time to come in and has suggested the need for an accountant on a full time basis, which is why you have been hired. Brenton, though, is still not convinced of the need for a full time accountant. “Look, why do I need a full-time accountant? At the end of the day, all I need to do is total up my revenues, total up my expenses and the difference is my profit. Do I really need to understand my product costs? What is the purpose of that? It’s not like I can lower my prices if my product costs are lower. I just follow the big guys like Hardly Normal and Super A-mart and price my product according to their prices. Why do I need to know what my product costs are?” asked Brenton.

Laura, who has been the secretary cum bookkeeper (of sorts) since the day the company started has prepared some information for you. Trying to be helpful, she has alphabetised the accounts. “I do not know much about accounting,” said Laura. “But Tom has said that we need a Schedule of Cost of Goods Manufactured and a Schedule of Cost of Goods Sold, whatever that means. I have last year’s accounts for you, so could you please prepare those schedules or whatever and get it to Brenton?” The alphabetised list of accounts can be found in Appendix A.
Four days into your work, there was a fire over the weekend in the main office that stored the accounts. The manufacturing facility was not affected and work could go on, however, most of the information that was for the current year’s accounts was damaged and only partial fragments were readable. Luckily your work on last year’s accounts were not affected as you had brought them home to complete and was still in process of completing them.

“You need to get me back all the information that’s now lost! My creditors want to see that information and I need you to work on it asap” said Brenton
Sifting through ashes and interviewing selected employees, you have worked up some additional information:

Step-by-Step Process to Calculate Statement of Cost

a) Laura remembers clearly that the predetermined overhead rate was based on 60,000 direct-labour hours to be worked for the year and $180,000 in overhead costs. (“Tom mentioned this before he left,” Laura said. “No idea why it is important, but if it can help you, good luck”.)

b) The work in process balance was $4,500 at 1st April . Also the production supervisor’s cost sheets showed only one job in process on 30th April. Materials of $2,600 had been added to this job, and 300 direct labour hours had been expended at $6 per hour on this job.

c) The accounts payable are for raw material purchases only, according to Laura. She clearly remembers that the balance in the account on 1st April was $6,000. Checking with Brenton for his cheque stubs, payments of $40,000 were made to suppliers during April. (All materials used were direct materials.) .The balance in the Accounts Payable account was $8,000 at 30 April .

d) A charred piece of the payroll ledger shows that 5,200 direct labour hours were recorded for the month. Laura has confirmed that there were no variations in pay rate (i.e. all employees were paid $6 per hour.)

e) Records in the warehouse indicate that the finished goods inventory totalled $11,000 on 1st April.

Also the finished goods balance was $16,000  on 30th April .

f) The balance in the Raw Materials account was $12,000 on 1st April.

g) Actual Manufacturing overhead incurred during April was $14,800.

h) From another charred piece of paper, you discerned that the cost of goods manufactured for April was $89,000.

You are now ready to and give Brenton the information he needs before you lose your job! When you went in to tell him that you can now start working on the information, Brenton tells you that he has spoken to Tom (their previous part-time accountant) and that the following information are required: “Tom says we need the following information: Work in process at the end of April, raw materials purchased in April, Overhead applied, Cost of goods sold in April, and Raw materials used in April. He also suggested that we should be looking at whether the overhead was over- or under-applied, whatever that means. “

Required:
 
Prepare a report (no more than 10-pages) for Brenton Pryce that addresses the following:

a) The purpose of a product costing system.

b) Preparation of a Schedule of Cost of Goods Manufactured and Cost of Goods Sold for last year. (The schedules may be in the appendix). Explain why some items have been excluded from the schedules.

c) An Income Statement for last year assuming that tax is charged at 30% on Income before tax

d) Determine the values for the following:

i. Work in Process at the end of April;

ii. Raw materials purchased in April;

iii. Overhead applied in April;

iv. Cost of Goods sold in April;

v. Raw materials used in April; and,

vi. Over- or under-applied overhead in April.

e) Discuss how overheads can be over- or under-applied and how the company should deal with the over- or under-application.

Step-by-Step Process to Calculate Statement of Income

Administrative salaries	$2,400
Advertising expense	1,200
Depreciation – factory building	800
Depreciation — factory equipment	1,600
Depreciation — office equipment	180
Direct labour cost	21,900
Raw materials inventory, beginning	2,100
Raw materials inventory, ending	3,200
Finished goods inventory, beginning	46,980
Finished goods inventory,. ending	44,410
General liability insurance expense	240
Indirect labour cost	11,800
Insurance on factory	1,400
Purchases of raw materials	14,600
Repairs and maintenance of factory  Sales  110,000	900
Sales salaries	2,000
Taxes on factory	450
Travel and entertainment expense	1,410
Work in process inventory, beginning	1,670
Work in process inventory, ending	1,110

(a) Product Costing is a term or methodology associated with managerial accounting. Product costing helps to determine the cost per unit of a product by studying and considering various sources used in its production. (Martin, 2012) Product Costing is defined as the process of assigning direct and indirect cost to individual branches, product and other cost items. (Brierley, 2008) Product costing help to improve the management information by helping the managers and other members of the board to take decision regarding product pricing, product design, delivery mechanism, etc. (Oracle, 2003)

Product costing also serves the following benefit:

• It helps the manager to understand the contribution of each product in generating profit and in the growth of the economy. (Scheid, 2010)

• It assists the manager in understanding the variance between the actual expenditure and the budgeted expenditure. (Hoyle, 2010)

• Product costing helps to test or examine the viability of various new products. (Fisher, 2012)

• It helps to identify various sources of profit and losses. (CO Mgbame, 2009)

There are various ways or methods involved in product costing. Each and every method have their own independent way of measuring the per unit cost of a product. Some of them are:

o Activity Based Costing (Compton, 2009)

o Marginal Costing (Per-Olov Johansson, 2010)

o Process Costing (Osmond Vitez, 2011)

o Standard Costing (Arthur, 2010)

(b) Statement of Cost

Particulars	Amount ( $)	Amount ( $)
Opening Stock of Raw Material	2,100
Add: Purchase of Raw Material	14,600
Less: Closing Stock of Raw Material	(3,200)
COST OF RAW MATERIAL CONSUMED		13,500
Add: Direct Labor Cost		21,900
PRIME COST		35,400
Add: Factory Overhead
– Depreciation on Factory Equipment	1,600
– Depreciation on Factory Building	800
– Repairs and Maintenance on Factory	900
– Insurance on Factory	1,400
-Taxes on Factory	450
– Indirect labor Cost	11,800	16,950
FACTORY COST		52,350
Add: Opening Stock of Work In Progress	1,670
Less: Closing Stock of Work In Progress	(1,110)	560
COST OF GOODS MANUFACTURED FOR SALE		52,910
Add: Opening Stock of Finished Goods	46,980
Less: Closing Stock of Finished Goods	(44,410)	2,570
COST OF GOODS SOLD		55,480

In the above schedule, Cost of Goods Manufactured is $ 52,900, whereas the Cost of Goods Sold is $ 55,480.

While calculating the Cost of Goods Manufactured and Cost of Goods Sold, some of the item such as Travel and entertainment expense has excluded from the calculation because they form the part of office and administrative expense which is included in the calculation of total cost of sale. Thus, from the above calculation we can say,

-Cost of Goods Manufactured= Factory Cost + Change in the Inventory of Work In Progress.

-Cost of Goods Sold= Cost of Goods Manufactured + Change in the Inventory of Finished Goods.

-Total Cost of Sale= Cost of Goods Sold + Office and Administrative Expense + Selling and Distribution Expense

(c) Statement of Income

Particulars	Amount ( $)	Amount ( $)
Sale		110,000
Less: Cost of Goods Sold ( Calculated in Answer b)		55,480
GROSS PROFIT (A)		54,520
B. Office and Administration Expense
– Travel and Entertainment Expense	1,410
– Depreciation on Office Equipment	180
– General liability Insurance	240
– Administrative Salary	2,400
TOTAL OF B		4,230
C. Selling and Distribution Expense
– Sales Salary	2,000
– Advertisement Expense	1,200
TOTAL OF C		3,200
Net Profit/ Income before Tax ( A-(B+C))		47,090
Amount of Tax (@30%)		14,127
Net Profit/Income after Tax		32,963

(d)

(i) Calculation of Work In Progress at the end of April

Estimated Overhead= $ 180,000
Direct Labor Hour= 60,000 hrs
Overhead Rate = Estimated Overhead/ Direct Labor Hour = 180000/60000 = 3 per hr

Particulars	Amount ( $)
Opening Stock of Work In Progress	4,500
Add: Direct Material	2,600
Add: Direct Labor Hours  (300*6)	1,800
Add: Overhead incurred (300*3)	900
Closing Stock Of Work In Progress	9,800

 
(ii) Calculation of Raw Material Purchased at the end of April

Dr.					Cr.
Date	Particulars	Amount ( $)	Date	Particulars	Amount ( $)
1st April	To Opening Payment made	6,000	During April	By Payment made	40000
During April	To Raw Material Purchased	42,000	30th April	By Closing Payment made	8,000
	(Balancing Figure)
		48,000			48,000

(iii). Calculation of Overhead Applied in the month of April

Total Labor Hrs worked in April=	5,200
Overhead Rate ( As calculated in d(i))=	3
Overhead Absorbed/Applied in April (5200*3)l=	$15,600

(iv.). Calculation of Cost of Goods Sold during the month of April

Dr.					Cr.
Date	Particulars	Amount ( $)	Date	Particulars	Amount ( $)
1st April	To Opening Stock of Finished Goods	11,000	During April	By Cost of Goods sold	84,000
				(Balancing Figure)
During April	To Cost of Goods Manufactured	89,000	30th April	By Closing Stock of Finished Goods	16,000
		100,000			100,000

(v.)  Calculation of Raw Material Used in the month of April

Dr.					Cr.
Date	Particulars	Amount ( $)	Date	Particulars	Amount ( $)
1st April	To Opening Stock of Raw Material	12,000	During April	By Raw Material Used	54,000
				(Balancing Figure)
During April	To Raw Material Purchased	42,000	30th April	By Closing Stock of Raw Material	0
		54,000			54,000

(vi.) Calculation of Over or Under Allied Overhead

Overhead Applied (As calculated in d(iii))        = $15,600
Actual Overhead                                               = $14,800

Overhead Over applied                                    = $(15600 – 14800) = $800

(e) Overhead comprise of indirect employees, indirect material cost and other indirect expenses which are not direct expense which are not directly identifiable or allocable to a cost subject economically feasible way. Overhead may be under-absorbed or over-absorbed. (Reinold, 2010)

The under-absorption or over-absorption of overhead can be disposed off in cost accounting by using any of the following method: (THAKUR, 2009)

• Under- absorption or Over- absorption is to be treated by using supplementary rate.

• Under- absorption or Over- absorption is to be written off to Costing Profit & Loss Account

• Under- absorption or Over- absorption can be carried. over to the next year’s account.

If under-absorption or over-absorption is because of the management fault then such under-absorption or over-absorption will be transferred to Costing Profit or Loss Account. (Caplan, 2011)

If under-absorption or over-absorption is because of seasonal variation then such under or over absorption of overhead shall be carried forward to the next accounting year.
 
If under-absorption or over-absorption is because of change in price level then we will calculate supplementary rate and under-absorption or over-absorption with respect to unit sold will be transferred to Profit and Loss Account and under-absorption or over-absorption with respect to units in stock will be added to the value of stock.
In the given case, in order to treat the over-absorption of overhead the company should credit the Profit and Loss Account.

References

Arthur, J. (2010). Standard Costing: A Quick Look at the Top Advantages. Bright Hub , 1.

Brierley, J. A. (2008). Understanding of the Sophistication of Product Costing . American Accounting Association , 1-3.

Caplan, D. (2011). MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES. Organ State , 1.

CO Mgbame, E. O. (2009). Product costing systems in Nigerian companies. Afrivan journal Online , 1.

Compton, T. R. (2009). Activity-Based Costing. The CPA Journal , 1.

Fisher, J. G. (2012). Product costing systems. The Jpurnal Of Corporate Accounting & Finance , 1GAS

Hoyle, K. H. (2010). Product Cost Flows in a Process Costing System. managerial Accounting , 1.

Martin, J. R. (2012). Management Accounting: Concepts. Management And Accounting Web , 1-4..

Oracle. (2003). Concept of product costing. Peoplesoft. , 3-15.

Osmond Vitez, D. M. (2011). Advantages & Disadvantages of Process Costing. Chron , 1..

Per-Olov Johansson, B. K. (2010). A note on cost-benefit analysis, the marginal cost of public funds,. Environmental Economics , 1-6.

Reinold, M. M. (2010). Concept relating to Overhead. PMC , 1-3.

Scheid, J. (2010). Pros and Cons of Product Costing. Bright Hub , 1.

Scheid, J. (2010). Standard Costing: A Quick Look at the Top Advantages. Bright Hub , 1.

THAKUR, R. (2009). How to treat the under or over absorption in cost accounting. Articles.net , 1.