Problem 14 - Accounting

Question

The following events took place for Wreckin Ronnie Inc. during July 2008, the first month of operations as a producer of road bikes: \- Purchased \(\$ 165,800\) of materials. \- Used \(\$ 147,600\) of direct materials in production. \- Incurred \(\$ 96,250\) of direct labor wages. \- Applied factory overhead at a rate of \(80 \%\) of direct labor cost. \- Transferred \(\$ 302,900\) of work in process to finished goods. \- Sold goods with a cost of \(\$ 301,300\). \- Sold goods for \(\$ 520,000\). \- Incurred \$119,000 of selling expenses. \- Incurred \(\$ 52,100\) of administrative expenses. a. Prepare the July income statement for Wreckin Ronnie. Assume that Wreckin Ronnie uses the perpetual inventory method. b. Determine the inventory balances at the end of the first month of operations.

Step-by-Step Solution

Answer

Net Income for July is \( \$ 47,600 \). Ending Inventory: Materials \( \$ 18,200 \), Work in Process \( \$ 17,950 \), Finished Goods \( \$ 1,600 \).

Step 1: Calculate Factory Overhead

Factory overhead is applied based on direct labor cost. Since the direct labor cost is \( \\( 96,250 \) and overhead is applied at \( 80\% \), we calculate the overhead as follows: \[\text{Factory Overhead} = 0.80 \times 96,250 = \\) 77,000\]

Step 2: Calculate Total Manufacturing Costs

The total manufacturing costs include direct materials used, direct labor, and factory overhead. We calculate this as:\[\text{Total Manufacturing Costs} = 147,600 + 96,250 + 77,000 = \$ 320,850\]

Step 3: Prepare the Cost of Goods Manufactured Statement

The cost of goods manufactured is given as \( \$ 302,900 \). This value is used when calculating the ending work-in-process inventory.

Step 4: Prepare the Income Statement

To prepare the income statement, we follow these steps:1. **Sales Revenue**: \( \\( 520,000 \)2. **Cost of Goods Sold (COGS)**: \( \\) 301,300 \)3. **Gross Profit**: \[\text{Gross Profit} = 520,000 - 301,300 = \\( 218,700 \]4. **Expenses**: Sum of selling and administrative expenses:\[\text{Total Expenses} = 119,000 + 52,100 = \\) 171,100 \]5. **Net Income**: \[\text{Net Income} = 218,700 - 171,100 = \\( 47,600\]The income statement is:- Sales: \( \\) 520,000 \)- Less: COGS: \( \\( 301,300 \)- Gross Profit: \( \\) 218,700 \)- Less: Selling and Admin Expenses: \( \\( 171,100 \)- Net Income: \( \\) 47,600 \)

Step 5: Determine Inventory Balances

1. **Materials Inventory**: Purchased \( \\( 165,800 \) - Used \( \\) 147,600 \) = \( \\( 18,200 \)2. **Work in Process Inventory**: Beginning Inventory \( \\) 0 \) (since it's the first month) + Total Manufacturing Costs \( \\( 320,850 \) - Cost of Goods Manufactured \( \\) 302,900 \) = \( \\( 17,950 \)3. **Finished Goods Inventory**: Cost of Goods Manufactured \( \\) 302,900 \) - Cost of Goods Sold \( \\( 301,300 \) = \( \\) 1,600 \)The inventory balances at the end of the month are:- Materials Inventory: \( \\( 18,200 \)- Work in Process Inventory: \( \\) 17,950 \)- Finished Goods Inventory: \( \$ 1,600 \)

Key Concepts

Factory Overhead Calculation

Understanding how to calculate factory overhead is crucial in accurately reflecting a company's production costs. Factory overhead refers to all the indirect costs associated with manufacturing a product that are not directly tied to labor or materials. These might include costs like maintenance, utilities, and machine depreciation.

In our case with Wreckin Ronnie Inc., overhead is calculated as 80% of the direct labor cost, which means we take the direct labor, in this scenario $96,250, and multiply by 0.80 to find the overhead amount. This results in a factory overhead of $77,000 for the month.

Here's why this is important: By properly calculating and applying factory overhead, companies can determine how much it truly costs to manufacture a product. This ensures that product pricing covers all production expenses!

Cost of Goods Sold

The Cost of Goods Sold (COGS) is a vital figure used to determine the true cost of producing goods that were sold over a specific period. It includes all costs directly attributed to the production of products sold by a company, such as raw materials and direct labor.

For Wreckin Ronnie Inc., the COGS for July was calculated as $301,300. This figure is found by determining the cost of transferring completed products from work in process to finished goods and subsequently to sales. It reflects the expenses involved in creating goods that generate sales revenue.

The COGS is subtracted from the sales revenue to calculate the gross profit, an essential indicator of the financial health of the product sales in any given period. Properly managing COGS helps a business in setting strategies for pricing, inventory management, and profit maximization.

Perpetual Inventory Method

The perpetual inventory method is a system of keeping continuous, real-time records of inventory quantities and values. It updates inventory balance after every sale or purchase, providing ongoing insights into stock levels and the cost of goods.

Wreckin Ronnie Inc. utilized this method during its July operation. By using a perpetual inventory system, companies like Wreckin Ronnie can immediately adjust inventory accounts following each transaction, reducing the risk of shortages or overages and providing more accurate financial statements.

This method's continuous update allows businesses to maintain a streamlined and efficient supply chain, minimize carrying costs, and react quickly to changes in market demand. Essentially, a perpetual inventory system provides businesses with the ability to manage inventory accurately and make informed operational and sales decisions.