Cost Classifications Used in CTCs Income Statement - Assignment Example

Running header: Project accounting Student’s name: Instructor’s name Subject code: Date of submission: Cost classifications used in CTC’s income statement CTC classifies uses functions to classify costs. Cost classification using functions involves using the functions for which costs are incurred to classify them. In this regard, CTC has used various functions to classify its costs including i) Production costs- these are the costs used in producing the products the company offers. In this regard, the production costs include the cost of materials purchased and factory wages, electricity and equipment depreciation (Boyd, 2007). ii) Administration costs which include production supervisors salary and manager’s salary iii) Selling and distribution costs including advertising and salaries to sales staff and truck lease. After costs have been thus classified, the company then uses cost plus costing in determining the selling price for its products. In this regard, the company’s revenue is determined through marking up the estimates of direct material costs and direct labor costs by 35%. It should however be noted that this kind of cost classification may not be appropriate due to the fact that some costs are ignored when determining the price at which to sell the product. For instance, administrative costs and cost of electricity have not been factored in in determining the cost at which the company’s products will be sold (James, 2002). Thus, this kind of cost classification and hence costing may result in the company either over costing or under costing its products. Estimating the cost of goods manufactured and sold From the additional information, the following can be noted; i) Only 90% of direct materials has been used ii) 80% of rent relate to production iii) 95% of equipment is used in production iv) All electricity is used in production v) 50% of managers salary is used in production It should also be noted that 20% of manufacturing costs relate to work in process. This implies that; i) Only 70% of direct materials has been used on finished goods ii) 80% of the rent used in production relate to finished goods iii) 80% of the equipment depreciation relating to production is for finished goods iv) 80% electricity relate to finished goods v) 80% of the manager’s salary relating to production should be charged to finished goods (Cliffsnotes.com, 2014). vi) 80% of the supervisor’s salary relate to finished goods. vii) 80% of production staff salary relate to finished goods. From the above information, the cost of goods sold could be estimated as follows; Direct materials = 70/100× $300,000 = $210,000 Rent =80/100× 80/100× $80,000= $ 51,200 Depreciation = 80/100*95/100* $25,000 = $ 19,000 Electricity = 80/100* $12,000= = $ 9,600 Manager’s salary =80/100*50/100*$80,000 = $ 32,000 Supervisor’s salary = 80/100* $35,000 = $ 28, 000 Staff salary = 80/100*$250,000 = $ 200,000 Total production cost = $ 549,800 CTC Income Statement For the month ended 31st October 2014 Sales $980,000 Less expenses: Materials purchased $210,000 Factory wages $200,000 Production supervisor’s salary $28,000 Rent $67,200 Council rates $ 5,000 Sales staff $110,000 Advertising $ 18,000 Equipment depreciation $20,250 Electricity $9,600 Managers salary $72,000 Truck lease $10,000 Total expenses (750,050) Net profit $229,950 Comparison: Looking at the financial statement prepared by the company and the one I have prepared above, one will note that the income prepared by the company has far less net profit compared with the one I have prepared (Lister, 2011). While the company’s financial statement showed a net profit of $55,000, the income statement that I have prepared above reports a net profit of $229,950. In addition, the company reported direct materials worth $300,000 while I reported direct materials worth $210,000. The same case applies to other expenses that report less amounts than those reported by the company including production staff salary, managers’ salary, rent equipment depreciation, electricity and production supervisor’s salary. The differences between the reported net profit by the company as well as the expenses from those reported in the income statement I have prepared is attributable to the nature of cost analysis I have carried out. First, I have broken down the costs into two major categories including those used in production of goods for sale and those used in operations and administration (Jerrold, 2013). After that, I have been able to isolate the cost of production into closing direct materials, work in progress and goods produced and sold. In this regard, I have been able to subtract the cost of closing raw materials as well that of closing work in progress from the entire costs. This gave me a higher net profit than what the company had reported. The truth of the matter is that the company had incurred less costs for the current period than it had reported due to the fact that it had not subtracted costs related to closing raw materials as well as closing work in progress from the total expenses. A more useful format for analyzing costs The above formats for analyzing costs are not the best since they can lead to a firm either underreporting or overeporting profit. As such, the best method to use in analyzing cost is the one that breaks down production costs into either variable or fixed such that every cost incurred in the production process is captured either as fixed, variable or overhead (Josphine, 2010). In other words, we use cost behavior to classify cost. In this case, I would suggest a format such as the one shown below for the company; CTC Income Statement For the month ended 31st October 2014 Per unit Total Sales revenue xxx xxx Cost of goods sold expenses xxx xxx Gross margin xxx xxx Variable operating expenses xxx xxx Margin xxx xxx Fixed operating expenses xxx xxx Net profit xxx xxx In this case, the manufacturing cost for goods sold would be given by; Per unit total Raw materials xx xxx Direct labor xx xxx Variable manufacturing overhead costs xx xxx Total variable manufacturing costs xx xxx Fixed manufacturing overhead costs xx xxx Total manufacturing costs xx xxx Recommendations for change As has been observed above, the company’s current method of analyzing costs is not accurate since it leads to less net profits than that which the company has made in reality. This has resulted from use of a poor format for analyzing cost as well as including the value of work in progress and closing materials as part of the company’s expenses. As such, I would recommend that the company changes its cost analysis method to the one suggested above such that costs will be classified according to their behavior (Johansen, 2005). In addition, the company ought to change what it includes in its cost of goods sold in a bid to ensure goods that are still in the production process do not end up being counted as part of cost of sales. In essence, the company should consider hiring a professional accountant in a bid to ensure that its income is professionally accounted for. This will ensure that the company accurately reports its profits and hence income. References: Boyd, K2007, Cost accounting for Dummies, London, Rutledge. James, D2002, Accounting for Manufacturing Business, Oxford, Oxford university press Cliffsnotes.com, 2014, Accounting by manufacturing companies, Retrieved on 19th November 2014, from; http://www.cliffsnotes.com/more-subjects/accounting/accounting-principles-ii/managerial-and- cost-accounting-concepts/accounting-by-manufacturing-companies Lister, J2011, Accounting process for manufacturing companies, London, Rutledge. Jerrold, S2013, Lean accounting, Oxford, Oxford University Press. Josphine, N2010, Introduction to managerial accounting, New York, Taylor and Francis. Johansen, B2005, Managerial accounting, New York, John Wiley & Sons. Read More