However, these companies take a physical count periodically to ensure the accuracy of inventory accounts and use the cost flow equation and similar schedules to ensure their perpetual system balances are accurate. (Note: Companies using a perpetual inventory system do not necessarily prepare these formal schedules because perpetual systems update records immediately when inventory is transferred from one inventory account to another. At this point, your job is to understand how we use the inventory cost flow equation to calculate raw materials placed in production, cost of goods manufactured, and cost of goods sold. In Chapter 2 "How Is Job Costing Used to Track Production Costs?", we provide the detailed information necessary to prepare the schedules and income statement presented in Figure 1.7 "Income Statement Schedules for Custom Furniture Company" and Figure 1.8 "Income Statement for Custom Furniture Company". As you review Figure 1.7 "Income Statement Schedules for Custom Furniture Company" and Figure 1.8 "Income Statement for Custom Furniture Company", look back at Figure 1.6 "Flow of Product Costs through Balance Sheet and Income Statement Accounts" to see how costs flow through the three inventory accounts and the cost of goods sold account. Custom Furniture Company’s income statement for the month ended May 31 is shown in Figure 1.8 "Income Statement for Custom Furniture Company". The goal of going through the process shown in Figure 1.7 "Income Statement Schedules for Custom Furniture Company" is to arrive at a cost of goods sold amount, which is presented on the income statement. This is why you see abbreviations for each element of the equation: beginning balance (BB), transfers in (TI), ending balance (EB), and transfers out (TO). Remember the inventory cost flow equation is used for each schedule. As you review these schedules, note that each schedule provides information required for the next schedule, as indicated by the arrows. What information is included in these schedules, and what do they look like for Custom Furniture Company?Īnswer: Figure 1.7 "Income Statement Schedules for Custom Furniture Company" shows these three schedules for Custom Furniture Company for the month of May. Question: The basic cost flow equation can be used in three supporting schedules to help us determine the cost of goods sold amount on the income statement for manufacturing companies. Schedule of raw materials placed in production.We describe how to calculate these amounts using three formal schedules in the following order: Cost of goods sold represents the cost of goods that are sold and transferred out of finished goods inventory into cost of goods sold.Īccountants need all these amounts-raw materials placed in production, cost of goods manufactured, and cost of goods sold-to prepare an income statement for a manufacturing company. Cost of goods manufactured represents the cost of goods completed and transferred out of work-in-process (WIP) inventory into finished goods inventory. Raw materials used in production shows the cost of direct and indirect materials placed into the production process. We will apply this equation to the three inventory asset accounts discussed earlier (raw materials, work in process, and finished goods) to calculate the cost of raw materials used in production, cost of goods manufactured, and cost of goods sold. Key Equation Beginning balance (BB) + Transfers in (TI) – Ending balance (EB) = Transfers out (TO) Understanding income statements in a manufacturing setting begins with the inventory cost flow equation. Since income statements for manufacturing companies tend to be more complex than for service or merchandising companies, we devote this section to income statements for manufacturing companies. Why are accounting systems more complex for manufacturing companies?Īnswer: Accounting systems are more complex for manufacturing companies because they need a system that tracks manufacturing costs throughout the production process to the point at which goods are sold. Such companies require an accounting system that goes well beyond accounting solely for the purchase and sale of goods. Manufacturing companies, such as Johnson & Johnson and Honda Motor Company, produce and sell goods. Since merchandising companies must account for the purchase and sale of goods, their accounting systems are more complex than those of service companies. Merchandising companies (also called retail companies) like Macy’s and Home Depot buy and sell goods but typically do not manufacture goods. The accounting process and income statement for service companies are relatively simple. Question: Companies that provide services, such as Ernst & Young (accounting) and Accenture LLP (consulting), do not sell goods and therefore have no inventory. Describe how to prepare an income statement for a manufacturing company.
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