Chapter 16, Problem 1CTC

a.

To determine

Identify the shortcomings and errors in the income statement, and explain the company’s actual net income for the first year would be higher or lower than the amount shown in the income statement.

Explanation of Solution

Identify the shortcomings and errors in the income statement, and explain the company’s actual net income for the first year would be higher or lower than the amount shown in the income statement as follows:

• Manufacturing costs: All manufacturing costs incurred during the first year of operating have incorrectly included in the cost of goods sold, because the portion of these costs would applicable to the ending inventories, and it should be deducted from the cost of goods sold to ascertain the corrected net income/(loss).
• Dividends declared on capital stock: Dividends declared on capital sock have incorrectly offset against revenue to ascertain the net income/ (loss). Dividends are not an operating expense and it should not be deducted from the revenue.
• Period costs: Period costs incurred during the year have incorrectly included in the cost of goods sold, because period costs are not related to inventory, hence these cost should not be added to the cost of goods sold. Therefore, these period cost would be decreased the value of net income/ (loss).

b.

To determine

Prepare the schedules to ascertain 1. The cost of direct material used, and 2. total manufacturing overhead.

Explanation of Solution

Direct material: Direct material cost is the cost of material that is directly involved in the production.

Manufacturing overhead: Manufacturing overhead is the expenses that are directly involved in the production process.

Prepare the schedules to ascertain 1. The cost of direct material used, and 2. The total manufacturing overhead as follows:

1. The cost of direct material used:

Particulars	$
Purchases of direct materials	460,000
Less: Material inventory, end of year	38,000
Cost of direct materials used	422,000

Table (1)

Therefore, the cost of direct material used during the year is $422,000.

2. Total manufacturing overhead:

Particulars	$
Total manufacturing overhead:
Indirect labor	90,000
Depreciation on machinery	50,000
Rent (1)	86,400
Insurance (2)	9,600
Utilities (3)	16,800
Miscellaneous manufacturing overhead	34,600
Total manufacturing overhead	287,400

Table (2)

Therefore, the total manufacturing overhead during the year is $287,400.

Working note:

Calculate the value of rent applies to the factory operations

$\begin{array}{c}\begin{array}{l}\text{Rent applies }\\ \text{to the factory operations}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total rent value }\times \\ \text{Percentage of rent applies to factory operation}\end{array}\right]\\ =\$144,000\times \frac{60}{100}\\ =\$86,400\end{array}$ (1)

Calculate the value of insurance applies to the factory operations

$\begin{array}{c}\begin{array}{l}\text{Insurance applies }\\ \text{to the factory operations}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total insurance value }\times \\ \text{Percentage of insurance applies to factory operation}\end{array}\right]\\ =\$16,000\times \frac{60}{100}\\ =\$9,600\end{array}$ (2)

Calculate the value of utilities applies to the factory operations

$\begin{array}{c}\begin{array}{l}\text{Utilities applies }\\ \text{to the factory operations}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total utilitiesvalue }\times \\ \text{Percentage of insurance applies to factory operation}\end{array}\right]\\ =\$28,000\times \frac{60}{100}\\ =\$16,800\end{array}$ (3)

c.

To determine

Prepare a schedule of cost of finished goods manufactured during the year.

Explanation of Solution

Prepare a schedule of cost of finished goods manufactured during the year as follows:

Company W
Schedule of the Cost of Finished Goods Manufactured
For the Year Ended December 31
Particulars	$	$
Manufacturing costs assigned to production:
Direct materials used [refer part b (1)]	422,000
Direct labor	225,000
Manufacturing overhead [ refer part b (2)]	287,400
Total manufacturing costs		934,400
Less: Work in process inventory, end of year		10,000
Cost of finished goods manufactured		924,400

Table (3)

Therefore, the cost of finished goods manufactured of Company W during the year is $924,400.

d.

To determine

Prepare a corrected income statement for the year, using a multiple step format.

Explanation of Solution

Prepare a corrected income statement for the year, using a multiple step format as follows:

Company W
Income Statement
For the Year Ended December 31
Particulars	$	$
Net sales		1,300,000
Add: Cost of goods sold:
Cost of finished goods manufactured	924,400
Less: Ending finished goods inventory	110,400
Cost of goods sold		814,000
Gross profit on sales		486,000
Less: Operating expenses:
Rent (4)	57,600
Insurance (5)	6,400
Utilities (6)	11,200
Other operating expenses	273,800
Total operating expenses		349,000
Income from operations		137,000
Less: Income taxes (7)		41,100
Net income		95,900

Table (4)

Therefore, the corrected net income of Company W is $95,900.

Working note:

Calculate the value of rent applies to the period cost

$\begin{array}{c}\begin{array}{l}\text{Rent applies }\\ \text{to the period cost}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total rent value }\times \\ \text{Percentage of rent applies to period cost}\end{array}\right]\\ =\$144,000\times \frac{40}{100}\\ =\$57,600\end{array}$ (4)

Calculate the value of insurance applies to the period cost

$\begin{array}{c}\begin{array}{l}\text{Insurance applies }\\ \text{to the period cost}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total insurance value }\times \\ \text{Percentage of insurance applies to period cost}\end{array}\right]\\ =\$16,000\times \frac{40}{100}\\ =\$6,400\end{array}$ (5)

Calculate the value of utilities applies to the period cost

$\begin{array}{c}\begin{array}{l}\text{Utilities applies }\\ \text{to the period cost}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total utilitiesvalue }\times \\ \text{Percentage of insurance applies to period cost}\end{array}\right]\\ =\$28,000\times \frac{40}{100}\\ =\$11,200\end{array}$ (6)

Calculate the income tax expense incurred during the year

$\begin{array}{c}\text{Income taxe expense = }\left[\text{Income from operations }\times \text{ Income tax rate}\right]\\ \text{=\$137,000}\times \frac{30}{100}\\ =\$41,100\end{array}$ (7)