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Introduction To Management Accounting: Producing Costing System Add in library

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Question:

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:

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 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. 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:
1. The purpose of a product costing system.
2. 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.
3. An Income Statement for last year assuming that tax is charged at 30% on Income before tax
4. Determine the values for the following:
(a)Work in Process at the end of April;
(b) Raw materials purchased in April;
(c) Overhead applied in April;
(d) Raw materials used in April; and,
(e) Over- or under-applied overhead in April.
(f) Cost of Goods sold in April;
5. Discuss how overheads can be over- or under-applied and how the company should deal with the over- or under-application.

SCHEDULE  A
Last years accounts

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

 

 

Answer:  

(1)

There is a great importance of Producing Costing system in a Manufacturing Industry. Product Costing is basically to identify the Cost of the Product to the company. There are various method through which product cost can be identified some of them are standard cost, Marginal Costing Method or Actual Cost Method. (Thomas, 2012)

 

To Identify the Product Cost first of all we have to identify the direct cost, overhead cost, basis of cost allocation and then we have to calculate the Overhead Cost. This production manager wants per unit cost of the product in order to identify the performance and product sourcing. This helps the manager in identifying the wastage made by the worker if the cost per product is higher than the industry average. (Calpan, 2012) 

 

Further, if the Management knows the cost of his product than h is in better position to negotiate the price of its product with the buyer of the goods and increase its sale volume. Product Costing also helps the top management in evaluating the performance of the production Manager. It also help them to give focus on such factory which costing is high and also necessitate the top management to identify the reason for such high cost and take measures to reduce the wastages to reduce the product cost.

(2)

Particulars

 Amount

 Amount

Raw Material at the Beginning

                   2,100

 

Add: Purchase of Raw Material

                 14,600

 

Less: Raw material at the end

                 (3,200)

 

Cost of Material Consumed

 

         13,500

Add: Direct Labour Cost

 

         21,900

Add: Factory Overhead

 

 

Depreciation - Factory Building

                       800

 

Depreciation - Factory Equipment

                   1,600

 

Indirect Labour Cost

                 11,800

 

Insurance on Factory

                   1,400

 

Repairs and Maintenance Factory

                       900

 

Taxes on Factory

                       450

         16,950

Factory Cost

 

         52,350

Add: Opening stock of WIP

 

           1,670

Less: Closing Stock of WIp

 

         (1,110)

Cost of Goods Manufactured

 

         52,910

Add: Opening stock of Finished Goods

                 46,980

 

Less: Closing Stock of Finished Goods

              (44,410)

           2,570

Cost of Good Sold

 

         55,480

While calculating Cost of Goods Manufactured we will consider all the direct and indirect cost which has been incurred in the factory for manufacturing the goods along with the portion of deprecation. This is mainly the Factory Cost

 

However if we calculate the cost of goods sold, then we will have to also consider the opening and closing inventory of goods. All the other expenses will be consider as operating Expenses and we will form Part of Income Statement.

 (3)
Income Statement is as follows:

Particulars

 Amount

 Amount

Sales

 

110000

Less: Cost of Goods Sold (As In Answer2)

 

      (55,480)

Gross Profit

 

         54,520

Less: Operating Expenses

 

 

Administrative Expenses

 

 

Administrative Salary

                   2,400

 

Travel and Entertainment Expenses

                   1,410

 

Depreciation - Office Equipment

180

 

General Liability Insurance

240

         (4,230)

Selling & Distribution Expenses

 

 

Advertisement Expenses

1200

 

Sales Salary

2000

         (3,200)

Income from Operation / Income before Tax

 

         47,090

Tax Expenses @ 30%

 

      (14,127)

Net Income

 

         32,963

 

(4)
(a) Work in Progress at the End of April

Overhead Cost                 =          180,000

Direct Labour                    =          60,000

Overhead Rate                  =          180,000/60,000           =          3 per hour

Particulars

 Amount

Opening Stock of WIP

                   4,500

Add: Material

                   2,600

Add: Direct Labour Hour (300*6)

                   1,800

Add: Overhead (300*3)

                       900

Closing Stock of WIP

                   9,800

 

(b) Raw Material Purchased in April

Particulars

 Amount

Account Payable as on 30th April

                   8,000

Add: Payment mad during April

                 40,000

Less: Opening Account Payable on 1st April

                 (6,000)

Purchase Made during the Month

                 42,000

 

(c) Overhead Applied in April 
Labour Hours Worked in April    =          5,200
Overhead Rate                              =          3 per hour
Total Overhead Expenses           =          5200 * 3          =          15,600 

(d) Cost of Goods Sold in April

Particulars

 Amount

 Amount

Cost of Goods Manufactured (Given)

 

         89,000

Add: Opening stock of Finished Goods

                 11,000

 

Less: Closing Stock of Finished Goods

              (16,000)

         (5,000)

Cost of Good Sold

 

         84,000

 
 (e) Raw Material Used in April
 

Particulars

 Amount

 Amount

Raw Material at the Beginning

                 12,000

 

Add: Purchase of Raw Material

                 42,000

 

Less: Raw material at the end

 NIL

 

Cost of Material Consumed

 

         54,000

 

(f) Over or Under Allied Overhead
Overhead Applied                  =          15,600
Actual Overhead                     =         14,800 
Overhead Over applied          =          (15600 – 14800) = 800 

(5) All the cost incurred in the factory other than Direct Material and Direct Labour is called overhead. In Standard / Marginal Costing we will predetermined the Overhead Expenses that would likely to be incurred in the given period of time. Then we will determine the appropriate cost driver to determine the recovery rate of the overhead. After determining the appropriate cost driver we will divide the overhead expenditure with the cost pool to get the recovery rate.

Overhead recovery rate is just estimation. This may differ from the Actual Expenditure. If the actual expenditure is more than the overhead applied than this is the situation of under recovery of overhead. However, if the actual expenditure is less than it is case of over recovery.

 

In case of Over / Under recovery of the overhead the same should be debited / credited in the profit & loss a/c so that it impact will reflect on the company balance sheet. 

 

Reference:

Calpan, D. (2012). Management Accounting: Concept & Technique. 10.

Thomas, J. (2012). Overview to Product Costing and Manufacturing Accounting. 8. 

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