Problem 22 - Accounting

Question

The following data were taken from the records of Parrott Company for December 2010: \(\begin{array}{lr}\text { Administrative expenses } & \$ 72,000 \\ \text { Cost of goods sold (at standard) } & 345,000 \\ \text { Direct materials price variance - favorable } & 900 \\ \text { Direct materials quantity variance-favorable } & 1,200 \\ \text { Direct labor rate variance- unfavorable } & 500 \\ \text { Direct labor time variance-favorable } & 450 \\\ \text { Variable factory overhead controllable variance-favorable } & 250 \\\ \text { Fixed factory overhead volume variance-unfavorable } & 3,200 \\\ \text { Interest expense } & 2,250 \\ \text { Sales } & 580,000 \\ \text { Selling expenses } & 85,800\end{array}\) Prepare an income statement for presentation to management.

Step-by-Step Solution

Answer

The Net Income for December 2010 is $74,050.

Step 1: Calculate Gross Profit

Start by calculating the Gross Profit. This is done by subtracting the Cost of Goods Sold at standard from the total Sales.\[\text{Gross Profit} = \text{Sales} - \text{Cost of Goods Sold (at standard)} = 580,000 - 345,000 = 235,000\]

Step 2: Include Variance Adjustments

Adjust the Gross Profit by incorporating all the variances provided into the calculation. To do this, sum all favorable and unfavorable variances to get a total variance adjustment. Note that favorable variances increase profit, while unfavorable ones decrease it.\[\text{Net Variance} = 900 + 1200 - 500 + 450 + 250 - 3200 = -900\]The negative net variance implies it is an unfavorable outcome overall, subtracting from the Gross Profit.

Step 3: Adjusted Gross Profit

Subtract the Net Variance from the Gross Profit calculated in Step 1 to get the Adjusted Gross Profit.\[\text{Adjusted Gross Profit} = 235,000 - 900 = 234,100\]

Step 4: Calculate Operating Profit Before Interest

Subtract the Administrative and Selling Expenses from the Adjusted Gross Profit to find the Operating Profit Before Interest.\[\text{Operating Profit Before Interest} = 234,100 - 72,000 - 85,800 = 76,300\]

Step 5: Calculate Net Income

Subtract the Interest Expense from the Operating Profit Before Interest to determine the Net Income.\[\text{Net Income} = 76,300 - 2,250 = 74,050\]

Step 6: Presentation of the Income Statement

Finally, the income statement to present is: Sales: 580,000 Cost of Goods Sold: 345,000 Gross Profit: 235,000 Variance Adjustments: (900) Adjusted Gross Profit: 234,100 Administrative Expenses: 72,000 Selling Expenses: 85,800 Operating Profit Before Interest: 76,300 Interest Expense: 2,250 Net Income: 74,050

Key Concepts

Understanding Variance Analysis

Variance analysis plays a crucial role in evaluating a company's financial performance by examining the differences between planned and actual figures. It helps businesses understand why actual numbers differ from expected outcomes. For Parrott Company, both favorable and unfavorable variances were noted regarding direct materials and labor.

• Favorable Variances: These occur when actual costs are less than the standard costs. They improve net income. Examples from the exercise include direct materials price and quantity variances.
• Unfavorable Variances: These occur when actual costs exceed the standard costs. They reduce net income. Instances here include the direct labor rate variance and fixed factory overhead volume variance.

By summing all variances, you identify the overall impact on the company's financials. In this exercise, an unfavorable net variance of -900 results, which means adjusting the gross profit downward by $900.

Breaking Down Cost of Goods Sold (COGS)

The Cost of Goods Sold (COGS) represents the direct costs attributable to the production of goods sold by a company. These are crucial for calculating gross profit and determining pricing strategies. COGS includes factors like direct materials and labor, alongside that Parrott Company follows predefined standards.
For Parrott Company, COGS was calculated as $345,000, which forms the basis for computing gross profit. It's essential to always double-check these numbers since an error here impacts all subsequent calculations. Furthermore, understanding COGS helps businesses remain competitive by monitoring production efficiency and cost control.

How to Calculate Gross Profit

Gross profit is a vital measure of a company's core profitability. It indicates how efficiently a business utilizes its resources to produce goods or services. To find gross profit, subtract the Cost of Goods Sold (COGS) from total sales.
In our example, Parrott Company generated a sales revenue of \(580,000 and a COGS of \)345,000. Calculating gross profit thus involved:\[\text{Gross Profit} = \text{Sales} - \text{COGS} = 580,000 - 345,000 = 235,000 \] This calculation provides insight into the company's ability to cover its operating expenses and maintain net profits, which is essential for financial health and investment decisions.

Net Income Calculation Explained

Net income, often called the "bottom line," is the total profit after all expenses, including variances, operating costs, and interest have been deducted from sales. It is a key indicator of a company's profitability and financial health.
For Parrott Company, the steps to calculate net income began after determining the gross profit and variances. The adjusted gross profit of \(234,100 was reduced by operating expenses, leading to an operating profit of \)76,300.
Subtracting interest expense from this operating profit gives us the net income:\[\text{Net Income} = \text{Operating Profit Before Interest} - \text{Interest Expense} = 76,300 - 2,250 = 74,050\] This figure reveals how much the company earned in December 2010 after all expenses, providing vital information for assessing business performance and planning future financial strategies.