Problem 14 - Accounting

Question

The following events took place for Salsa Inc. during May 2010, the first month of operations as a producer of road bikes: \- Purchased \(\$ 244,000\) of materials. \- Used \(\$ 210,000\) of direct materials in production. \- Incurred \$180,000 of direct labor wages. \- Applied factory overhead at a rate of \(75 \%\) of direct labor cost. \- Transferred \(\$ 510,000\) of work in process to finished goods. \- Sold goods with a cost of \(\$ 485,000\). \- Sold goods for \(\$ 870,000\). \- Incurred \(\$ 210,000\) of selling expenses. \- Incurred \$75,400 of administrative expenses. a. Prepare the May income statement for Salsa. Assume that Salsa uses the perpetual inventory method. b. Determine the inventory balances at the end of the first month of operations.

Step-by-Step Solution

Answer

a. Operating Income is $99,600. b. Ending Inventories: Raw Materials $34,000, WIP $15,000, Finished Goods $25,000.

Step 1: Calculate Cost of Goods Manufactured (COGM)

To determine the Cost of Goods Manufactured (COGM), we need to calculate the total manufacturing costs and adjust for work in process.- **Direct Materials Used:** \(210,000- **Direct Labor:** \)180,000- **Factory Overhead:** 75% of Direct Labor, which is \(0.75 \times 180,000 = 135,000\)**Total Manufacturing Costs:** 210,000 (Materials) + 180,000 (Labor) + 135,000 (Overhead) = \(525,000COGM is given as \)510,000, which indicates the total cost moved from Work in Process to Finished Goods.

Step 2: Prepare the Income Statement

To prepare the income statement, begin with sales revenue and subtract costs to find gross profit, then operating income. - **Sales Revenue:** $870,000 - **Cost of Goods Sold (COGS):** Given as $485,000 **Gross Profit:** 870,000 - 485,000 = $385,000 Subtract selling and administrative expenses: - **Selling Expenses:** $210,000 - **Administrative Expenses:** $75,400 **Operating Income:** 385,000 - 210,000 - 75,400 = $99,600.

Step 3: Calculate Inventory Balances

Calculate the ending balances for each inventory account: 1. **Raw Materials Inventory: ** - Purchased: $244,000 - Used: $210,000 - Remaining: 244,000 - 210,000 = $34,000 2. **Work in Process Inventory: ** - Began: $0 (first month) - Added: Total Manufacturing Costs = $525,000 - Transferred: $510,000 - Remaining WIP: 525,000 - 510,000 = $15,000 3. **Finished Goods Inventory: ** - Transferred to Finished Goods: $510,000 - COGS: $485,000 - Remaining: 510,000 - 485,000 = $25,000.

Key Concepts

Income Statement

An income statement is a financial document that provides an overview of a company's financial performance over a specific period. It is one of the main financial statements, helping stakeholders understand how the company generates its profit or loss. The statement is structured generally as follows:

• Revenues or Sales - the total income from goods sold or services provided, which in this case is $870,000 for Salsa Inc.
• Cost of Goods Sold (COGS) - the direct costs associated with producing the goods, here $485,000 for Salsa Inc.

The Gross Profit is calculated by subtracting COGS from Sales Revenue. For Salsa Inc., the Gross Profit amounts to $385,000.

Next, operating expenses, such as selling and administrative expenses, are deducted. Salsa Inc. had $210,000 in selling expenses and $75,400 in administrative expenses. After deducting these expenses, the Operating Income, which reflects the profit generated from the core business operations, results in $99,600 for Salsa Inc.

Inventory Management

Inventory management refers to the process of ordering, storing, and using a company's inventory. This includes raw materials, components, and finished products. Effective management ensures that a company has the right products in the right quantity available at the right time.

In Salsa Inc.'s case, accurate tracking started with purchasing and using materials for production. The purchased raw materials totaled $244,000, out of which $210,000 were used for production, leaving a balance of $34,000 as the ending Raw Materials Inventory.

• It involves managing these inventories to avoid overstocking or stockouts.
• Achieving this balance helps reduce holding costs and improve cash flow.

This meticulous tracking ensures financial records reflect the actual inventory on hand, which is crucial for financial reporting and decision-making.

Work in Process Inventory

Work in Process (WIP) Inventory includes materials that are not yet completed products. They are partially converted materials moving through the production process. For Salsa Inc., the WIP inventory was calculated based on Manufacturing Costs and the amounts transferred and remaining.

Key factors in WIP Inventory:

• Starting balance, which was $0 for Salsa Inc. as it was their first operational month.
• Additions made, represented by the total manufacturing costs that amounted to $525,000.
• Transfers to finished goods, which decreased WIP by $510,000.
• The ending balance in WIP Inventory was $15,000, representing incomplete goods remaining in production at the period end.

Tracking WIP is essential because it provides insight into production efficiency and helps identify process bottlenecks. Proper management of WIP Inventory adds to effective cost accounting by ensuring costs are accurately allocated between produced, sold, and in-process goods.

Perpetual Inventory System

A perpetual inventory system continually updates inventory levels with each transaction. As opposed to a periodic system, it records inventory changes in real-time based on sales, purchases, and adjustments.

For Salsa Inc., employing a perpetual inventory system means that record updates occur with every business activity. For instance:

• When materials were purchased or used in production, the system updated the raw materials inventory balances.
• With goods transferred to finished goods or when sales took place, these events were also logged immediately, ensuring accurate and up-to-date inventory records.
• It helps in quickly spotting trends and discrepancies, enabling swift corrective actions.

The perpetual inventory system aids in maintaining accurate financial reports and enhances decision-making by providing real-time data about stock levels, production progress, and sales.