Overhead Costing

Questions: You have just been hired as an accountant by GoodStyle Furniture, a manufacturer of specialty, hand-made furniture based in South Australia. The furniture produced by Goodstyle is in two ranges, Modern and Classical. The two ranges are different in design, but both are high quality, hand-made furniture and are priced accordingly. The owner of the company, Brenton Pryce, has always believed in pricing a quality product based on how much their larger competitors are pricing theirs. His argument has been that our product is as good, if not better, than the mass producers of furniture, so we should be charging at least as much, if not more, than what they charge. When you arrived at work for the first time, you learnt that the though the company has been in existence for the last twelve years, they have never had an accountant. The accounts were typically prepared by the Laura Peters , secretary of Brenton Pryce and Tom Nichols, a part-time accountant who came in once or twice a month. T om has informed Brenton that he could no longer spare the time to come in and has suggested the need for an accountant on a full time basis, which is why you have been hired. Brenton, though, is still not convinced of the need for a full time accountant. Look, why do I need a full-time accountant? At the end of the day, all I need to do is total up my revenues, total up my expenses and the difference is my profit. Do I really need to understand my product costs? What is the purpose of that? Its not like I can lower my prices if my product costs are lower. I just follow the big guys like Hardly Normal and Super A-mart and price my product according to their prices. Why do I need to know what my product costs are? asked Brenton. Laura, who has been the secretary cum bookkeeper (of sorts) since the day the company started has prepared some information for you. Trying to be helpful, she has alphabetised the accounts. I do not know much about accounting, said Laura. But Tom has said that we need a Schedule of Cost of Goods Manufactured and a Schedule of Cost of Goods Sold, whatever that means. I have last years accounts for you, so could you please prepare those schedules or whatever and get it to Brenton? The alphabetised list of accounts can be found in Appendix A. Four days into your work, there was a fire over the weekend in the main office that stored the accounts. The manufacturing facility was not affected and work could go on, however, most of the information that was for the current years accounts was damaged and only partial fragments were readable. Luckily your work on last years accounts were not affected as you had brought them home to complete and was still in process of completing them.You need to get me back all the information thats now lost! My creditors want to see that information and I need you to work on it asap said BrentonSifting through ashes and interviewing selected employees, you have worked up some additional information: a) Laura remem bers clearly that the predetermined overhead rate was based on 60,000 direct-labour hours to be worked for the year and $180,000 in overhead costs. (Tom mentioned this before he left, Laura said. No idea why it is important, but if it can help you, good luck.) b) The work in process balance was $4,500 at 1st April . Also the production supervisors cost sheets showed only one job in process on 30th April. Materials of $2,600 had been added to this job, and 300 direct labour hours had been expended at $6 per hour on this job. c) The accounts payable are for raw material purchases only, according to Laura. She clearly remembers that the balance in the account on 1st April was $6,000. Checking with Brenton for his cheque stubs, payments of $40,000 were made to suppliers during April. (All materials used were direct materials.) .The balance in the Accounts Payable account was $8,000 at 30 April .d) A charred piece of the payroll ledger shows that 5,200 direct labour hours were recorded f or the month. Laura has confirmed that there were no variations in pay rate (i.e. all employees were paid $6 per hour.) e) Records in the warehouse indicate that the finished goods inventory totalled $11,000 on 1st April. Also the finished goods balance was $16,000 on 30th April .f) The balance in the Raw Materials account was $12,000 on 1st April.g)Actual Manufacturing overhead incurred during April was $14,800.h) From another charred piece of paper, you discerned that the cost of goods manufactured for April was $89,000. You are now ready to and give Brenton the information he needs before you lose your job! When you went in to tell him that you can now start working on the information, Brenton tells you that he has spoken to Tom (their previous part-time accountant) and that the following information are required: Tom says we need the following information: Work in process at the end of April, raw materials purchased in April, Overhead applied, Cost of goods sold in April, and Ra w materials used in April. He also suggested that we should be looking at whether the overhead was over- or under-applied, whatever that means. Required: Prepare a report (no more than 10-pages) for Brenton Pryce that addresses the following: a) The purpose of a product costing system. b) Preparation of a Schedule of Cost of Goods Manufactured and Cost of Goods Sold for last year. (The schedules may be in the appendix). Explain why some items have been excluded from the schedules. c)An Income Statement for last year assuming that tax is charged at 30% on Income before taxd) Determine the values for the following:i. Work in Process at the end of April; ii. Raw materials purchased in April; iii. Overhead applied in April; iv. Cost of Goods sold in April; v. Raw materials used in April; and, vi. Over- or under-applied overhead in April. e) Discuss how overheads can be over- or under-applied and how the company should deal with the over- or under-application. Schedule ALast years accoun ts Administrative salaries $2,400 Advertising expense 1,200 Depreciation factory building 800 Depreciation -- factory equipment 1,600 Depreciation -- office equipment 180 Direct labour cost 21,900 Raw materials inventory, beginning 2,100 Raw materials inventory, ending 3,200 Finished goods inventory, beginning 46,980 Finished goods inventory,. ending 44,410 General liability insurance expense 240 Indirect labour cost 11,800 Insurance on factory 1,400 Purchases of raw materials 14,600 Repairs and maintenance of factory Sales 110,000 900 Sales salaries 2,000 Taxes on factory 450 Travel and entertainment expense 1,410 Work in process inventory, beginning 1,670 Work in process inventory, ending 1,110 Answer: Part (B) Cost of Goods Manufactured Cost of Goods Sold Cost sheet of new goodstyle furniture Particulars $ $ Raw material consumed Opening stock $2,100.00 Add Purchase $14,600.00 Less Closing stock $3,200.00 $13,500.00 Add Direct labor $21,900.00 Prime cost(note 1) $35,400.00 Add Indirect labor $11,800.00 Add Insurance factory $1,400.00 Add Rates on factory $450.00 Add Repairs maintaince of factory $900.00 Add Depreciation fac - building $800.00 Add Depreciation fac - equipment $1,600.00 Works cost(note 2) $52,350.00 Add Opening wip $1,670.00 Less Closing wip $1,110.00 Factory overhead(note 3) $52,910.00 Office administrative expense Add Administrative salaries $2,400.00 Add Depreciation office equipment $180.00 Add Travel entertainment exps $1,410.00 (A) Cost of production(note 4) $56,900.00 (cost of goods manufactured) Add Opening stock of finished goods $46,980.00 Less Closing stock of finished goods $44,410.00 (B) Cost of goods sold(note 5) $59,470.00 (cost of goods sold) Selling Add Advertising exps $1,200.00 Add Sales salaries $2,000.00 Cost of sales(note 6) $62,670.00 Note 1: Prime Cost: Under prime cost we include three basic elements. Direct Material-We include the raw material consumed part Direct Labor- Labor directly related with the production of goods and services Direct Expenses- Expenses directly related with production Note 2: Works Cost: Under works cost we include all indirect expense related to factory. These are factory insurance, fuel, depreciation, etc Note 3: Factory Overhead: It is the aggregate of Prime cost and Works cost. Note 4: Cost of Production: This is the actual cost of production of furniture. It requires adjustment of opening and closing Work In Progress Note 5: Cost of Goods Sold: When we adjust the opening and closing stock of finished goods we get Costs of Goods Sold Note 6: Cost of Sales: It includes all the expenses related to selling the goods and services. These are advertising expense, sales promotion expense, salesman salaries, etc The only thing that is excluded from the cost sheet is General Liability Insurance Expense. It does not have any connection with the production. It cannot be charges directly to the products and services produced. The other items that are to be excluded from the schedules are financial expenses like interest, legal expenses like filling suit in the court, etc. The reason being that they do not have any connection with the production. Part (C) Income Statement for Goodstyle Furniture Particular Amount Sales $1,10,000.00 Less: total cost Direct material $13,500.00 Direct labor $21,900.00 Indirect labor $11,800.00 Insurance factory $1,400.00 Rates on factory $450.00 Repairs maintaince of factory $900.00 Depreciation fac - building $800.00 Depreciation fac - equipment $1,600.00 Administrative salaries $2,400.00 Depreciation office equipment $180.00 Travel maintaince exps $1,410.00 Advertising exps $1,200.00 Sales salaries $2,000.00 Changes in w.i.p. $560.00 Changes in stock of finished goods $2,570.00 General insurance liability $240.00 Total cost $62,910.00 Profit before tax $47,090.00 Tax @ 30% $14,127.00 Profit after tax $32,963.00