Chapter 1, Problem 3PSB

Using the information from Problem 1-2B and the inventory information for the Best Bikes below, complete the requirements below. Assume income tax expense in $136,700 for the year.

Required

1. Prepare the company’s 2015 schedule of cost of goods manufactured.
2. Prepare the company’s 2015 income statement that reports separate categories for (a) selling expenses and (b) general administrative expenses.

Analysis Component

2. Compute the (a) inventory turnover, defined as cost of goods sold divided by average inventory, and (b) days' sales in inventory, defined as 365 times ending inventory divided by cost of goods sold, for both its raw materials inventory and its finished goods inventory. (To compute turnover and days' sales in inventory for raw materials, use raw materials used rather than cost of goods sold.) Discuss some possible reasons for differences ratios for the two of inventories. Round answers to one decimal place.

To determine

Concept introduction:

Cost of goods manufactured:

Cost of goods manufactured, also known as cost of goods completed calculates the total value of inventory that was produced during the period and is ready for sale. It is the total amount of expenses incurred to turn work in process into finished goods. It includes total manufacturing costs including all direct materials, direct labor, factory overheads to the beginning work in process inventory and subtracting ending work in process inventory which can be seen below:

$Costofgoodsmanufactured=Directmaterials+Directlabor+Factoryoverheads+Beginningworkinprocessinventory-Endingworkinprocessinventory$

Requirement 1:

To calculate:

Schedule of Cost of goods manufactured for 2015.

Answer to Problem 3PSB

Cost of goods manufactured = $18, 16, 995

Explanation of Solution

To calculate cost of goods manufactured, following formula would be used:

$Costofgoodsmanufactured=Directmaterials+Directlabor+Factoryoverheads+Beginningworkinprocessinventory-Endingworkinprocessinventory$

To calculate Direct materials used, following formula would be used:

$Directmaterialsused=Beginningrawmaterial+Rawmaterialpurchases-Endingrawmaterials$ In the given problem, following information is given:

Beginning raw material = $40, 375

Raw material purchases = $8, 94, 375

Ending raw material = $70, 430

$Thus,Directmaterialsused=\$40,375+\$8,94,375-\$70,430=\$8,64,320$

Direct labor is given as $5, 62, 500 in the given problem. Factory overheads would include the following:

Depreciation charged on factory equipment = $35, 400

Cost of factory supervision = $1, 21, 500

Utilization of factory utilities = $6, 060

Expenses for utilities of factory = $37, 500

Indirect labor = $59, 000

Miscellaneous cost of production = $8, 440

Expense pertaining to rent on factory building = $93, 500

Expense pertaining to maintenance of factory = $30, 375

$Thus,Factoryoverheads=\$35,400+\$1,21,500+\$6,060+\$37,500+\$59,000+\$8,440+\$93,500+\$30,375=\$3,91,775$

Also, beginning work in process inventory is given as $12, 500 and Ending work in process inventory as $14, 100 in the given problem. Therefore, schedule of cost of goods manufactured as asked in the given problem is given below:

Schedule of cost of goods manufactured of company (Amount in $):

Particulars	(Amount in $)	(Amount in $)
Direct materials used	8, 64, 320
Add: Direct labor	5, 62, 500
Add: Factory overheads	3, 91, 775
Total manufacturing costs		18, 18, 595
Add: Beginning work in process inventory	12, 500
Less: Ending work in process inventory	(14, 100)
Cost of goods manufactured		18, 16, 995

Thus, cost of goods manufactured is coming out to be $18, 16, 995.

To determine

Concept introduction:

Income statement:

Income statement, also known as Statement of revenue and expense measures company’s financial performance over an accounting period (say for a year, a quarter). In this statement, total expenses are deducted from total revenues to arrive at net income or loss for the period.

Selling expenses:

These are the expenses incurred for making sales. These include direct and indirect cost associated with selling a product.

General and administrative expenses:

These are basically the overheads of the company. These are the costs a company incurs to keep its business operational.

Requirement 2:

Income statement reporting separate categories for (a) selling expenses and (b) general and administrative expenses.

Answer to Problem 3PSB

Net income after income tax = $24, 97, 865

Explanation of Solution

To prepare the income statement categorizing selling or general and administrative expenses, firstly cost of goods sold would be calculated using the below- mentioned formula:

$Costofgoodssold=Costofgoodsmanufactured+Beginningfinishedgoodsinventory-Endingfinishedgoodsinventory$

We have already computed cost of goods manufactured as $18, 16, 995 in the previous requirement. Beginning finished goods inventory as $1, 77, 200 and ending finished goods inventory as $1, 41, 750. Thus,

$Costofgoodssold=\$18,16,995+\$1,77,200-\$1,41,750=\$18,52,445$

Further, Sales are given as $49, 42, 625. Gross profit would be calculated as follows:

$Grossprofit=Sales-Costofgoodssold=\$49,42,625-\$18,52,445=\$30,90,180$

Following would be covered under selling expenses:

Expenses for advertising = $20, 250

Expenses for depreciation = $10, 125

Expenses for rent = $27, 000

Expenses for sales salaries = $2, 95, 300

General and administrative expenses would include the following:

Expenses for depreciation = $8, 440

Expenses for sales salaries = $70, 875

Expenses for rent = $23, 625

Also, expense for income tax is given as $1, 36, 700 in the given problem. Net income after income tax would be calculates as under:

$\begin{array}{l}Netincomeafterincometax=Grossprofit-Sellingexpenses-Generalandadministrativeexpenses-Expenseforincometax\hfill \\ =\$30,90,180-\$3,52,675-\$1,02,940-\$1,36,700=\$24,97,865\hfill \end{array}$

Schedule of Income statement as asked in the given problem for 2015 is shown below:

Income statement of company (Amount in $):

Particulars	Amount	Amount
Sales		49, 42, 625
Less: Cost of goods sold
Cost of goods manufactured	18, 16, 995
Add: Beginning finished goods inventory	1, 77, 200
Goods available for sale		19, 94, 195
Less: Ending finished goods inventory	(1, 41, 750)
Cost of goods sold		(18, 52, 445)
Gross profit		30, 90, 180
Less: Selling expenses
Expenses for advertising	20.250
Expenses for depreciation	10, 125
Expenses for rent	27, 000
Expenses for sales salaries	2, 95, 300
Total selling expenses		(3, 52, 675)
Less: General and administrative expenses
Expenses for depreciation	8, 440
Expenses for sales salaries	70, 875
Expenses for rent	23, 625
Total general and administrative expenses		(1, 02, 940)
Net income before income tax expense		26, 34, 565
Less: Income tax expense		(1, 36, 700)
Net income after income tax		24, 97, 865

Thus, Net income after income tax is coming out to be $24, 97, 865.

To determine

Concept introduction:

Inventory turnover:

Inventory turnover, also known as merchandise turnover calculates the number of times a company sells or replaces its stock of goods during a period.

Raw material turnover is calculated by dividing the raw materials used with average raw materials used, i.e.

$Rawmaterialsturnover=Rawmaterialsused/Averagerawmaterialsinventory$

This is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. It is calculated by dividing the cost of goods sold with average inventory.

$Inventoryturnover=Costofgoodssold/Averageinventory$

Day’s sales in inventory measure the liquidity of inventory. For raw materials, it is calculated in the following manner:

$Day’ssalesininventoryforrawmaterialinventory=\left(Endingrawmaterialsinventory/Rawmaterialsused\right)*365$

Day’s sales for finished goods inventory would be calculated as follows:

$Day’ssalesininventory=\left(Endinginventory/Costofgoodssold\right)*365$

Requirement 3:

To calculate:

1. Inventory turnover defined as cost of goods sold divided by average inventory
2. Day’s sales in inventory defined as 365 times ending inventory divided by cost of goods sold for both raw materials inventory and finished goods inventory
3. Reasons for differences between these ratios for the two types of inventories

Answer to Problem 3PSB

1. Inventory turnover defined as cost of goods sold divided by average inventory
For raw materials inventory = 15.6 times

For finished goods inventory = 11.6 times

2. Days sales in inventory defined as 365 times ending inventory divided by cost of goods sold for both raw materials inventory and finished goods inventory

For raw materials inventory = 29.7 days For finished goods inventory = 27.9 days

3. Reasons for differences between these ratios for the two types of inventories

The company is having higher raw material inventory ratio which may be due to unexpected increased sales or it may be due to the negligence of company for procurement of its raw materials and in administering them.

Further, the lower inventory ratio of finished goods may be due to the reason that company is holding large quantity of inventory to support operations than it may need.

Explanation of Solution

1. Inventory turnover defined as cost of goods sold divided by average inventory

• Raw material turnover is calculated by dividing the raw materials used with average raw materials used, i.e.

$Rawmaterialsturnover=Rawmaterialsused/Averagerawmaterialsinventory$

Average inventory can be computed using the following formula:

$Averageinventory=\left(Beginninginventory+EndingInventory\right)/2$

In the given problem, Beginning raw materials inventory as $ 40, 375 and ending raw materials inventory as $70, 430. Thus,

$Averagerawmaterialsinventory=\left(\$40,375+\$70,430\right)/2=\$55,403\left(roundedoff\right)$

Further, Direct materials used have been calculated as $8, 64.320. Therefore, inventory turnover would be calculated as follows:

$Inventoryturnover=\$8,64,320/\$55,403=15.6times$

Hence, inventory turnover is coming out to be 15.6 times.

• Inventory turnover is calculated by dividing the cost of goods sold with average inventory, i.e.

$Inventoryturnover=Costofgoodssold/Averageinventory$

Average inventory can be computed using the following formula:

$Averageinventory=\left(Beginninginventory+EndingInventory\right)/2$

In the given problem, Beginning finished goods inventory as $1, 77, 200 and ending finished goods inventory as $1, 41, 750. Thus,

$Averageinventory=\left(\$1,77,200+\$1,41,750\right)/2=\$1,59,475$

Further, Cost of goods has been calculated as $18, 52, 445. Therefore, Inventory turnover would be:

$Inventoryturnover=\$18,52,445/\$1,59,475=11.6times$

Hence, inventory turnover = 11.6 times.

(b) Day’s sales in inventory defined as 365 times ending inventory divided by cost of goods sold for both raw materials inventory and finished goods inventory:

• Day’s sales for raw material inventory would be calculated as follows:

$Day’ssalesforrawmaterialinventory=\left(Endingrawmaterialsinventory/Rawmaterialsused\right)*365$

Ending raw materials inventory is given as $70, 430 and Direct materials used has been calculated as $8.64.320. Thus,

$Day’ssalesforrawmaterialinventory=\left(\$70,430/\$8,64,320\right)*365=29.7days$

Hence, Day’s sale for raw material inventory is coming out to be 29.7 days.

• Day’s sales in inventory measures liquidity of inventory and is calculated in the following manner:

$Day’ssalesininventory=\left(Endinginventory/Costofgoodssold\right)*365$

In the given problem, Ending finished goods inventory as $1, 41, 750 and Cost of goods has been calculated as $18, 52, 445. Thus,

$Day’ssalesinfinishedgoodsinventory=\left(1,41,750/\$18,52,445\right)*365=27.9days$

Hence, Day’s sale in finished goods inventory is coming to be 27.9 days.

(c) Reasons for differences between these ratios for the two types of inventories:

The turnover ratios as well as Day’s sales in inventory for both raw materials and finished goods has been shown below in the tabular form:

Particulars	Raw materials	Finished goods
Inventory Turnover ratios	15.6	11.6
Day’s sales in inventory	29.7	27.9

From the above table, it can be seen that turnover ratio of finished goods is lesser that that of raw materials inventory ratio. The company is having higher raw material inventory ratio which may be due to unexpected increased sales or it may be due to the negligence of company for procurement of its raw materials and in administering them.

Further, the lower inventory ratio of finished goods may be due to the reason that company is holding large quantity of inventory to support operations than it may need.

Also, the raw materials supply is carried for 29.7 days whereas that of finished goods inventory for 27.9 days by the company.