College Accounting, by Heintz and Parry

Chapter 28:

Manufacturing Accounting: The Work Sheet and Financial Statements

Nick came back from his next discussion session with Rick Swagger and his accountant, and he seemed like he acquired more questions than answers.

“We looked at some financial statements for another business like the one we’re thinking of starting, and the financial statements seemed to be different from ours in more ways than we talked about last time.”

“Okay, then let’s go through a manufacturer’s financial statements in detail, starting with the work sheet.”

Eddie made up numbers for the company as a corporate manufacturer. This allowed them to discuss adjusting entries. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786Materials Inv. 2,218Factory Supplies 422Prepaid Insurance 992Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 Cost of Goods Sold 173,245 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The first entry applies factory overhead to work in process, using the 40% rate applied to direct labor costs of $320 included in the work in process balance ($320 X 40% = $128). The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422Prepaid Insurance 992Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 a)128 Cost of Goods Sold 173,245 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The second adjusting entry would be for factory supplies used. Because this is a production-related cost, it will be debited to factory overhead instead of supplies expense. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 Cost of Goods Sold 173,245 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The third adjusting entry would be for expired insurance on machinery. This production-related cost is also debited to factory overhead (instead of insurance expense). The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 Cost of Goods Sold 173,245 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The fourth adjusting entry would be for depreciation on machinery. Because the machinery is used for production, we debit factory overhead, not depreciation expense. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 d)150 Cost of Goods Sold 173,245 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The fifth adjusting entry would be for underapplied factory overhead. Whether it is underapplied or overapplied, factory overhead is normally closed to cost of goods sold. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800Inc. Tax Exp. 26,000

The sixth adjusting entry would be for accrual of interest payable. Unpaid interest would be calculated on all loans and notes payable. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 f)267Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 Bad Debt Exp. 0Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800 f)267Inc. Tax Exp. 26,000

The seventh adjusting entry would be the adjustment for estimated bad debts. Based on the percentage of sales method, an entry for $2,136 is needed. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 g)2,136Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 f)267Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 Bad Debt Exp. 0 g)2,136Depr’n. Exp.-St. Equip. 0Interest Exp. 2,800 f)267Inc. Tax Exp. 26,000

The eighth adjusting entry would be for depreciation on store equipment. Because the equipment is not used for production, this is an expense, not factory overhead. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 g)2,136Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220 h)175Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 f)267Income Tax Payable 0Factory Overhead 60,932 61,435 b)193 a)128 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 Bad Debt Exp. 0 g)2,136Depr’n. Exp.-St. Equip. 0 h)175Interest Exp. 2,800 f)267Inc. Tax Exp. 26,000

The last adjusting entry would be the adjustment for the excess of income taxes over the quarterly estimated tax payments. This creates a tax liability at the end of the year. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Debits Credits Debits CreditsAllow. for Bad Debts 1,467 g)2,136Finished Goods Inv. 1,295Work in Process Inv. 786 a)128 Materials Inv. 2,218Factory Supplies 422 b)193Prepaid Insurance 992 c)496Store Equipment 5,100Accum. Depr’n.-Equip. 1,220 h)175Machinery 12,665Accum. Depr’n.-Mach. 450 d)150Interest Payable 0 f)267Income Tax Payable 0 I)3,400Factory Overhead 60,932 61,435 b)193 a)128 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 Bad Debt Exp. 0 g)2,136Depr’n. Exp.-St. Equip. 0 h)175Interest Exp. 2,800 f)267Inc. Tax Exp. 26,000 I)3,400

The Adjusted Trial Balance would be different for a manufacturer in that factory overhead would show entries for the total debits and the total credits, but no balance would appear in the income statement and trial balance columns. The CD Side of Town Work Sheet (Partial) For Year Ended Dec. 31, 2002

Trial Balance Adjustments Adj. Trial Bal. Debits Credits Debits Credits Debits CreditsAllow. for Bad Debts 1,467 g)2,136 3,603 Finished Goods Inv. 1,295 1,295Work in Process Inv. 786 a)128 914 Materials Inv. 2,218 2,218Factory Supplies 422 b)193 229Prepaid Insurance 992 c)496 496Store Equipment 5,100 5,100Accum. Depr’n.-Equip. 1,220 h)175 1,395Machinery 12,665 12,665Accum. Depr’n.-Mach. 450 d)150 600Interest Payable 0 f)267 267 Income Tax Payable 0 I)3,400 3,400 Factory Overhead 60,932 61,435 b)193 a)128 61,771 61,771 c)496 e)208 d)150 Cost of Goods Sold 173,245 e)208 173,453 Bad Debt Exp. 0 g)2,136 2,136Depr’n. Exp.-St. Equip. 0 h)175 175Interest Exp. 2,800 f)267 3,067Inc. Tax Exp. 26,000 I)3,400 29,400

“As I said the last time we talked, a manufacturer’s financial statements are pretty much like ours, except that cost of goods sold is calculated in a different way. The calculation would look like this (differences in red).”

The CD Side of Town Partial Income Statement For Year Ended Dec. 31, 2002 Cost of Goods Sold: Finished Goods Inventory, Jan. 1, 2002 $ 3,417Cost of Goods Manufactured 171,331Goods Available for Sale $174,748Finished Goods Inventory, Dec. 31, 2002 1,295Cost of Goods Sold $173,453

“As we discussed last time, cost of goods manufactured is calculated by totaling manufacturing costs (direct materials, direct labor, and factory overhead) and subtracting any increase (or adding any decrease) in work in process.” The CD Side of Town Statement of Cost of Goods Manufactured For Year Ended Dec. 31, 2002

Work in Process, Jan. 1, 2002 $ 1,323 Materials inventory, Jan. 1, 2002 $ 1,145 Materials purchases 64,335 Materials available for use $65,480 Materials inventory, Dec. 31, 2002 2,218 $63,262 Direct labor 62,784 Overhead 44,876 Total manufacturing costs 170,922 Total work in process during the period $172,245 Work in process, Dec. 31, 2002 914 Cost of Goods Manufactured $171,331

“The statement of retained earnings for a manufacturer is similar to that of any other corporation. Here is a sample.”

The CD Side of Town Statement of Retained Earnings For Year Ended Dec. 31, 2002 Retained Earnings, Jan. 1 $120,000Add net income for the year 75,000 $195,000 Less: Cash Dividends $25,000 Stock Dividends 22,000 47,000Retained Earnings, Dec. 31 $148,000

“Closing entries would be a little different for a manufacturer as well. The first closing entry would transfer the total debits to factory overhead into the income summary account, which would also close the subsidiary factory overhead accounts. In the second entry, factory overhead total credits (which are equal in amount) would also be transferred to income summary.

Date Description P.R. Debit Credit Closing Entries 2002Dec 31 Income Summary 61,771.00 Factory Overhead 61,771.00

31 Factory Overhead 61,771.00 Income Summary 61,771.00

“The third closing entry would be the usual entry to close revenues (and contra expenses, if any). A credit to income summary would offset the debits to close these accounts.”

Date Description P.R. Debit Credit Closing Entries 2002Dec 31 Sales 317,342.00 Interest Revenue 1,682.00 Income Summary 319,024.00

“The fourth closing entry would be to close expenses (and contra revenues, if any). A debit to income summary would offset these credits.”

Date Description P.R. Debit Credit Closing Entries 2002Dec 31 Income Summary 244,024.00 Cost of Goods Sold 173,453.00 Wage Expense 24,385.00 Advertising Expense 6,730.00 Utilities Expense 4,678.00 Bad Debt Expense 2,136.00 Depr’n. Exp.-Store Eq. 175.00 Interest Expense 3,067.00 Income Tax Expense 29,400.00

“The fifth and final closing entry would close income summary. Assuming the company has net income, this would involve a debit to income summary and a credit to retained earnings.”

Date Description P.R. Debit Credit Closing Entries 2002Dec 31 Income Summary 75,000.00 Retained Earnings 75,000.00

“Of the adjusting entries we described, two of them would require reversing entries. One is the first entry, which applied factory overhead to work in process (overhead will be applied to these jobs again when they’re completed). The other one is the sixth entry, the one to accrue interest payable.”

Date Description P.R. Debit Credit Reversing Entries 2003Jan. 1 Factory Overhead 128.00 Work in Process Inv. 128.00

Interest Payable 267.00 Interest Expense 267.00

“Okay, Nick, you knew it was coming. See how you do on my quiz:

Questions: 1) The adjusting entry for used factory supplies would involve a debit to what account?

2) What account is factory overhead usually closed to?

3) What number is added to the beginning inventory of finished goods to get goods available for sale?

4) The two entries to close factory overhead involve what other account?”

Answers: 1) The adjusting entry for used factory supplies would involve a debit to factory overhead.

2) Factory overhead usually closed to cost of goods sold.

3) Cost of goods manufactured is added to the beginning inventory of finished goods to get goods available for sale.

4) The two entries to close factory overhead involve income summary.

“Okay, Eddie, I only got two out of four, but I can still be the co-owner of a manufacturing operation, right?”

“Sure, as long as you keep a brilliant accountant on your payroll . . . and raise his pay at least 10%.”

“Actually, I have a brilliant accountant on my payroll, but even a 10% raise may not be enough to keep him for long.”

“What do you mean?”

“Well, my rich and famous future co-owner, Rick, heard the accountant’s band, ‘Eddie and the Losers,’ on a basement tape called ‘Count On Me: A Calculator’s Tale.’ He says that we should donate studio time to the band, so that he can deliver a demo tape to some powerful people at his record company. You know, I’ve learned a lot about accounting, but I guess this just proves that there is still no accounting for taste.”

Eddie smiled. “You’re right, Nick. Some things can’t be accounted for, like a friend who’s a priceless asset. Thanks.”