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ACCT 1A Lecture Notes - Lecture 22: Moving Average, Cash Flow, European Cooperation In Science And Technology

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School
Irvine Valley College
Department
Accounting
Course
ACCT 1A
Professor
Bradshaw

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Document Summary

Inventory becomes a expense when it is sold. The account cogs or cost of sales is used to capture the amount of inventory expensed during a period. Net effect= assets and equity increase= gross profits. Inventory is expected to be sold within the year- reported in statement of financial position. Costs of goods sold is reported as a separate line on the statement of comprehensive income (sales-coggs = gross profit) When sale is made, inventory is decreased and cogs is increased for the cost of the inventory that is sold. Costing methods (filo- isn"t permitted in aus, yet used in japan and us: specific identification= determines cost of goods sold based on the actual cost of each inventory item sold. Average unit cost= cost of goods available for sale. Understanding income and tax effects of inventory cash flow assumption: specific identification= not possible, fifo=

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Related Questions

Variable Costing

An approach to measuring profitability that avoids the problemsinherent in making fixed overhead look like a variable cost isvariable costing. Variable costing (sometimes called directcosting) assigns only unit-level variable manufacturing costs tothe product; these costs include direct materials, direct labor,and variable overhead. Fixed overhead is treated as a period costand is not inventoried with the other product costs. Instead, it isexpensed in the period incurred.

The result of treating fixed manufacturing overhead as a periodexpense is to reduce the factory costs that are inventoriable.Under variable costing, only direct materials, direct labor, andvariable overhead are inventoried. (Remember that marketing andadministrative expenses are never inventoried-whether variable orfixed.)

Example: Fender Company showed the followingunit costs for its product:

Direct materials $1.15
Direct labor 0.60
Variable overhead 0.22
Fixed overhead* 2.44
*Based on capacity of 29,800units.

Last year, Fender made 29,800 units and sold 27,700 units at aprice of $9.01. Selling and administrative expense equaled $49,170(all fixed). Beginning Finished Goods Inventory contained 410 unitswith cost of $1,808.10.

Cost of one unit under variablecosting = Direct materials + Direct labor +Variable overhead
= $1.15 + $0.60 + $0.22 =$1.97
Units in ending Finished GoodsInventory = 410 + 29,800 - 27,700 = 2,510units
Ending Finished GoodsInventory = 2,510 × $1.97 = $4,944.70

The income statement for Fender Company is as follows:

Sales $249,577
Variable cost of Goods Sold ($1.97× 27,700) 54,569
Contribution margin $195,008
Less:
Fixed overhead 72,712
Selling andadministrative expense 49,170 121,882
Variable-costing operatingincome $73,126

Notice that all of the fixed factory overhead of $72,712 ($2.44× 29,800) and the variable cost of manufacturing for the units sold($1.97 × 27,700 units sold) appear on the variable-costing incomestatement. None of the fixed factory overhead is attached to unsoldunits added to Finished Goods inventory because the fixed overheadis treated as a period expense. Only the variable cost ofmanufacturing ($1.97 × 2,100) is added to Finished Goods inventory- attached to the 2,100 units that were produced but not sold.

1. Under variable costing, ifbeginning Finished Goods Inventory equaled zero, the value ofending Finished Goods Inventory would be $?? .
2. Ignoring question 1 above,if Fender Company sold 30,020 units, there wouldbe units in ending Finished Goods Inventory with a valueof $?? (round to the nearest cent).

Reconciling the Difference Between Absorption andVariable Costing

When inventories change from the beginning to the end of theperiod, the two costing approaches will give different operatingincomes. The reason for this is that absorption costing assignsfixed manufacturing overhead to units produced. If those units aresold, the fixed overhead appears on the income statement under costof goods sold. If the units are not sold, the fixed overhead goesinto inventory. Under variable costing, however, all fixed overheadfor the period is expensed. As a result, absorption costing allowsmanagers to manipulate operating income by producing for inventory.Let's compare the income statements under the two methods forFender Company.

Example: Fender Company showed the followingunit costs for its product:

Direct materials $1.15
Direct labor 0.60
Variable overhead 0.22
Fixed overhead* 2.44
*Based on capacity of 29,800units.

Last year, Fender made 29,800 units and sold 27,700 units at aprice of $9.01. Selling and administrative expense equaled $49,170(all fixed). Beginning Finished Goods Inventory contained 410 unitswith cost of $1,808.1.

Absorption-CostingIncome Variable CostingIncome
Sales $249,577.00 Sales $249,577.00
COGS ($4.41 × 27,700) 122,157.00 Variable COGS ($1.97 × 27,700) 54,569.00
Gross margin $127,420.00 Contribution margin $195,008.00
Less: Fixed overhead 72,712
Selling & admin.exp 49,170 Selling & admin. exp. 49,170
Operating income $78,250.00 Operating income $73,126.00

There is a difference of $5,124 between the absorption-costingoperating income and the variable-costing operating income. This$5,124 is caused by the different treatment of fixed factoryoverhead. Under absorption costing, the 2,100 units added to endinginventory took not only the $1.97 of variable manufacturing cost,but also $2.44 per unit in fixed overhead. Under variable costing,however, all the fixed factory overhead of $72,712 was expensed.None of it was added to units going into ending inventory.

Absorption-costing income -Variable-costing income = Change in inventory × fixedoverhead rate
= 2,100 units × $2.44 = $5,124

What if more units are sold than are produced? That is, what ifending inventory is less than beginning inventory? Let's look atthe comparative income statement assuming Fender sells 29,890units.

Absorption-CostingIncome Variable CostingIncome
Sales $269,308.9 Sales $269,308.9
COGS ($4.41 × 29,890) 131,814.9 Variable COGS ($1.97 × 29,890) 58,883.3
Gross margin $137,494 Contribution margin $210,425.6
Less: Fixed overhead 72,712
Selling & admin.exp 49,170 Selling & admin. exp. 49,170
Operating income $88,324 Operating income $88,543.6

Now we see that variable-costing income is higher thanabsorption costing income. This is because each of the 90 unitsthat came out of inventory had $2.44 of fixed overhead attached.However, this did not occur under variable costing.

Absorption-costing income -Variable-costing income = Change in inventory × fixedoverhead rate
= 90 units × $2.44 = $219.60

The following table summarizes the impact of changes ininventory on the difference between absorption-costing income andvariable-costing income.

Changes in Inventoryunder Absorption and Variable Costing
If Then
Production > Sales Absorption-costing income >Variable-costing income
Production < Sales Variable-costing income >Absorption-costing income
Production = Sales Absorption-costing income =Variable-costing income

The variable-costing income statement has an advantage inaddition to providing better signals regarding performance. It alsoprovides more useful information for management decision making.For example, how much more will Fender Company earn if it sells onemore unit? Under absorption costing, the per-unit gross profit is$4.60 ($9.01 - $4.41). However, that figure includes some fixedoverhead, and fixed overhead will not change if another unit isproduced and sold. The variable-costing gives more usefulinformation. Additional contribution margin of the extra unit is$7.04 ($9.01 - $1.97). The key insight of variable costing is thatfixed expenses do not change as units produced and sold change.Therefore, while the variable-costing income statement cannot beused for external reporting, it is a valuable tool for somemanagement decisions.

1. How should the balances of Progress Billings and Constructionin Progress be shown at reporting dates prior to completion of along-term contract

a. Progress billings as income, construciton in progress asinventory

b. Net , as income from construction if credit balance, and lossfrom construction if debit balance

c. Progress Billings as deferred income, Construction inProgress as a current asset

d. Net, as a current asset if debit balance and currentliability if credit balance

3. the competed-contract method of accounting for long-termconstruction-type contracts is preferable when

a. a contractor is involved in numerous projects

b. the contracts are of a relatively long duration

c. estimates of costs to complete and extent of progress towardcompletion are reasonably dependable

d. there are inherent uncertainties in the contract beyondnormal business risks

4. C & J Construction has consistently used the percentageof completion method of recognizing income. Last year C & Jstarted work on a $4,500,000 constuction contract, which wascompleted this year, the accounting records desclosed the followingdata for the last year

Progress billings - $1,650,000

Costs incurred - 1,350,000

Collections - 1,050,000

Estimated cost to complete - 2,700,000

How much income should C & J have recognized on thiscontract last year?

a. 105,000

b. 150,000

c. 300,000

d. 350,000

6. The use of the gross profit assumes

a. the amount of gross profit is the same as in prior years

b. sales and cost of goods sold have not changed from previousyears

c. inventory values have not increased from previous years

d. the relationship between selling price and cost of goods soldis similar to prior years

7. the gross profit method of inventory valuation is not validwhen

a. there is substantial increase in the quantity of inventoryduring the year

b. there is substantial increase in the cost of inventory duringthe year

c. the gross margin percentage changes significantly during theyear

d. all ending inventory is destroyed by dire before it can becounted

8. When the current year's ending inventory amount isoverstated,

a. the current year's cost of goods sold is overstated

b. the current year's total assets are understated

c. the current year's net income is overstated

d. the next year's income is overstated

9. If the ending inventory balance is understated, net income ofthe same period

a. will be overstated

b. will be understated

c. will be unaffected

d. cannot be determined from the above information

10. An overstatement of ending inventory in Period 1 wouldresult in income of Period 2 being

a. overstated

b. understated

c. correctly stated

d. the answer cannot be determined from the informationgiven

11. what is the maximum amount at which inventory can be valuedwhen the goods have experienced a permanent decline in value

a. historical cost

b. sales price

c. net realizable value

d. net realizable value reduced by a normal profit margin

12. Net realizable value can be defined as

a. selling price

b. selling price less costs to complete and sell

c. selling price plus costs to complete and sell

d. acquisition cost plus costs to complete and sell

13. Miller company needs an estimate of its ending inventorybalance. The following information is available

Cost Retail

sales revenue - 180,000

beginning inventory - 35,000 62,000

net purchases - 100,000 135,000

gross margin percentage - 30%

Given this information, when using the gross margin estimationmethod, ending inventory is approx

a. 1,000

b. 9,000

c. 19,000

d. 11,650

14. Which of the following would not be reported asinventory?

a. land acquired for resale by a real estate firm

b. stocks and bonds held for resale by a brokerage firm

c. partially completed goods held by a manufacturing company

d. machinery acquired by a manufacturing company for use in theproduction process

15. Cost of goods sold is equal to

a. the cost of inventory on hand at the end of a period plus netpurchases minus the cost of inventory on hand at the beginning

b. the cost of inventory on hand at the beginning of a periodminus net purchases plus the cost of inventory on hand at the endof a period

c. the cost of inventory on hand at the beginning of a periodplus net sales minus the cost of inventory on hand at the end of aperiod

d. the cost of inventory on hand at the beginning of a periodplus net purchases minus the cost of inventory on hand at the endof a period

17. In a period of falling prices, the use of which of thefolliwng inventory cost flow methods would typically result inhighest cost of goods sold?

a. FIFO

b. LIFO

c. Weighted average cost

d. Specific identification

18. In a period of rising prices, the inventory cost allocationmethod that tends to result in the lowest reported net incomeis

a. LIFO

b. FIFO

c. Moving average

d. Weighted average

19. The LIFO inventory cost flow method may be applied to whichof the following inventory systems?

Periodic Perpetual

a. no no

b. no yes

c. yes yes

d. yes no

Absorption and Variable Costing Income Statements for Two Months and Analysis

During the first month of operations ended July 31, Head Gear Inc. manufactured 26,800 hats, of which 25,500 were sold. Operating data for the month are summarized as follows:

Sales

$183,600

Manufacturing costs:

Direct materials

$109,880

Direct labor

29,480

Variable manufacturing cost

13,400

Fixed manufacturing cost

10,720

163,480

Selling and administrative expenses:

Variable

$10,200

Fixed

7,450

17,650

During August, Head Gear Inc. manufactured 24,200 designer hats and sold 25,500 hats. Operating data for August are summarized as follows:

Sales

$183,600

Manufacturing costs:

Direct materials

$99,220

Direct labor

26,620

Variable manufacturing cost

12,100

Fixed manufacturing cost

10,720

148,660

Selling and administrative expenses:

Variable

$10,200

Fixed

7,450

17,650

Required:

1a. Prepare an income statement for July using the absorption costing concept. Enter all amounts as positive numbers.

Head Gear Inc.

Absorption Costing Income Statement

For the Month Ended July 31

$

Cost of goods sold:

$

$

$

1b. Prepare an income statement for August using the absorption costing concept. Enter all amounts as positive numbers.

Head Gear Inc.

Absorption Costing Income Statement

For the Month Ended August 31

$

Cost of goods sold:

$

$

$

2a. Prepare an income statement for July using the variable costing concept. Enter all amounts as positive numbers.

Head Gear Inc.

Variable Costing Income Statement

For the Month Ended July 31

$

Variable cost of goods sold:

$

$

$

Fixed costs:

$

$

2b. Prepare an income statement for August using the variable costing concept. Enter all amounts as positive numbers.

Head Gear Inc.

Variable Costing Income Statement

For the Month Ended August 31

$

Variable cost of goods sold:

$

$

$

Fixed costs:

$

$

3a. For July, income from operations reported under costing is less than costing due to part of manufacturing costs that are expensed.

3b. When large changes in inventory levels occur from one period to the next, it is possible for management to misinterpret such increases (or decreases) in income from operations as due to changes in:

costs.

prices.

sales volume.

"sales volume", "prices" and "costs" are correct.

None of these choices is correct.

The correct answer is:

4. Based on your answers to (1) and (2), did Head Gear Inc. operate more profitably in July or in August? Explain.

Head Gear Inc. was under the variable costing concept. The difference in income reported under the absorption costing concept is due to allocating to the .