Part 2 ebook “accounting principles: a business perspective ( vol 1: financial accounting)” has contents: control of cash, receivables and payables, property, plant, and equipment, plant asset disposals, natural resources, and intangible assets, analysis and interpretation of financial statements,… and other contents.
This book is licensed under a Creative Commons Attribution 3.0 License Control of cash Learning objective After studying this chapter, you should be able to: • Describe the necessity for and features of internal control • Define cash and list the objectives sought by management in handling a company's cash • Identify procedures for controlling cash receipts and disbursements • Prepare a bank reconciliation and make necessary journal entries based on that schedule • Explain why a company uses a petty cash fund, describe its operations, and make the necessary journal entries • Analyze and use the financial results-quick ratio A career in forensic accounting This chapter emphasizes the importance of having effective internal controls in every business Unfortunately, many smaller companies not heed this advice Failure to implement adequate internal controls can result in financial statement fraud (purposely misstated financial statements) or embezzlement (theft) This is when the services of a forensic accountant may be necessary Forensic accounting is the application of accounting methodology to legal issues It is frequently associated with the investigation of civil or criminal white-collar crime such as fraud, embezzlement, and general abuse of funds issues Typical tools used in forensic accounting are bank records, personal financial statements, interviews, and credit reports The forensic accountant's responsibility is to gather and analyze the evidence and deliver clear, accurate, and unbiased reports reflecting the results of the investigation Forensic accounting is commonly performed by Certified Fraud Examiners (CFEs) CFEs have extensive training and possess special expertise in investigation and interview techniques specifically designed to detect or prevent fraud A well-known agency performing forensic accounting in the United States is in the Federal Bureau of Investigation (FBI) You can learn more about the FBI from their homepage at www.fbi.gov Click on employment in the 'About Us' section and then click on special agent employment to learn more about what it takes to be an FBI special agent Did you know that the fastest track to becoming an FBI agent is with an accounting undergraduate degree? There are four entry programs for becoming an FBI special agent: accounting, law, language, and diversified Law requires an undergraduate degree and a law degree, language requires an undergraduate degree and proficiency in a second language, and diversified requires three years of work experience beyond an undergraduate degree The only entry program requiring only an undergraduate degree is one with an undergraduate accounting option Why accounting? Because an ever-increasing portion of crimes investigated by the FBI are white-collar crimes where accounting knowledge is essential Accounting Principles: A Business Perspective 354 A Global Text Control of cash In a small corporation the president might make all the important decisions and will usually maintain a close watch over the affairs of the business However, as the business grows and the need arises for additional employees, officers, and managers, the president begins to lose absolute control Realizing that precautions are necessary to protect the company's interests, the company establishes an internal control structure at this point The internal control structure of a company consists of "the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved".27 The three elements of an internal control structure are the control environment, the accounting system, and the control procedures The control environment reflects the overall attitude, awareness, and actions of the board of directors, management, and stockholders The accounting system consists of the methods and records that identify, assemble, analyze, classify, record, and report an entity's transactions to provide complete, accurate, and timely financial information The control procedures of a company are additional policies and procedures that management establishes to provide reasonable assurance that the company achieves its specific objectives These control procedures may pertain to proper authorization, segregation of duties, design and use of adequate documents and records, adequate safeguards over access to assets, and independent checks on performance Internal control not only prevents theft and fraud but also serves many purposes: (1) Companies must implement policies requiring compliance with federal law; (2) personnel must perform their assigned duties to promote efficiency of operations; and (3) correct accounting records must supply accurate and reliable information in the accounting reports This chapter discusses the internal control structure that a company establishes to protect its assets and promote the accuracy of its accounting records You will learn how to establish internal control through control of cash receipts and cash disbursements, proper use of the bank checking account, preparation of the bank reconciliation, and protection of petty cash funds The internal control structure is enhanced by hiring competent and trustworthy employees, a fact you will appreciate if you become a business owner Internal control An effective internal control structure includes a company's plan of organization and all the procedures and actions it takes to: • Protect its assets against theft and waste • Ensure compliance with company policies and federal law • Evaluate the performance of all personnel to promote efficient operations • Ensure accurate and reliable operating data and accounting reports 27 AICPA, Statement on Auditing Standards No 55, "Consideration of the Internal Control Structure in a Financial Statement Audit" (New York, 1988), p The sixth and seventh editions of this text use the terminology (internal control structure) of the AICPA Previous editions referred to the "internal control system." 355 This book is licensed under a Creative Commons Attribution 3.0 License As you study the basic procedures and actions of an effective internal control structure, remember that even small companies can benefit from using some internal control measures Preventing theft and waste is only a part of internal control In general terms, the purpose of internal control is to ensure the efficient operations of a business, thus enabling the business to effectively reach its goals Since additional control procedures are necessary in a computer environment, a discussion of these controls concludes this section on internal control An accounting perspective: Business insight When performing an audit, one of an outside auditor's first duties is to examine the internal control structure of the corporation To understand the internal control structure, an auditor focuses mainly on management's attitude and awareness concerning controls and the accounting system's processing of transactions To increase understanding, the auditor inspects documents in the accounting system, discusses external influences on the company with management, reads accounting manuals, and observes the happenings in the company This understanding of the company's control environment helps the auditor to plan the audit and to determine the nature, timing, and extent of tests Companies protect their assets by (1) segregating employee duties, (2) assigning specific duties to each employee, (3) rotating employee job assignments, and (4) using mechanical devices Segregation of employee duties Segregation of duties requires that someone other than the employee responsible for safeguarding an asset must maintain the accounting records for that asset Also, employees share responsibility for related transactions so that one employee's work serves as a check on the work of other employees When a company segregates the duties of employees, it minimizes the probability of an employee being able to steal assets and cover up the theft For example, an employee could not steal cash from a company and have the theft go undetected unless someone changes the cash records to cover the shortage To change the records, the employee stealing the cash must also maintain the cash records or be in collusion with the employee who maintains the cash records Assignment of specific duties to each employee When the responsibility for a particular work function is assigned to one employee, that employee is accountable for specific tasks Should a problem occur, the company can quickly identify the responsible employee When a company gives each employee specific duties, it can trace lost documents or determine how a particular transaction was recorded Also, the employee responsible for a given task can provide information about that task Being responsible for specific duties gives people a sense of pride and importance that usually makes them want to perform to the best of their ability Accounting Principles: A Business Perspective 356 A Global Text Control of cash Rotation of employee job assignments Some companies rotate job assignments to discourage employees from engaging in long-term schemes to steal from them Employees realize that if they steal from the company, the next employees assigned to their positions may discover the theft Frequently, companies have the policy that all employees must take an annual vacation This policy also discourages theft because many dishonest schemes collapse when the employee does not attend to the scheme on a daily basis Use of mechanical devices Companies use several mechanical devices to help protect their assets Check protectors (machines that perforate the check amount into the check), cash registers, and time clocks make it difficult for employees to alter certain company documents and records Internal control policies are effective only when employees follow them To ensure that they carry out its internal control policies, a company must hire competent and trustworthy employees Thus, the execution of effective internal control begins with the time and effort a company expends in hiring employees Once the company hires the employees, it must train those employees and clearly communicate to them company policies, such as obtaining proper authorization before making a cash disbursement Frequently, written job descriptions establish the responsibilities and duties of employees The initial training of employees should include a clear explanation of their duties and how to perform them In publicly held corporations, the company's internal control structure must satisfy the requirements of federal law In December 1977, Congress enacted the Foreign Corrupt Practices Act (FCPA) This law requires a publicly held corporation to devise and maintain an effective internal control structure and to keep accurate accounting records This law came about partly because company accounting records covered up bribes and kickbacks made to foreign governments or government officials The FCPA made this specific type of bribery illegal To evaluate how well employees are doing their jobs, many companies use an internal auditing staff Internal auditing consists of investigating and evaluating employees' compliance with the company's policies and procedures Companies employ internal auditors to perform these audits Trained in company policies and internal auditing duties, internal auditors periodically test the effectiveness of controls and procedures throughout the company Internal auditors encourage operating efficiency throughout the company and are alert for breakdowns in the company's internal control structure In addition, internal auditors make recommendations for the improvement of the company's internal control structure All companies and nonprofit organizations can benefit from internal auditing However, internal auditing is especially necessary in large organizations because the owners (stockholders) cannot be involved personally with all aspects of the business Companies should maintain complete and accurate accounting records The best method to ensure such accounting records is to hire and train competent and honest individuals Periodically, supervisors evaluate an employee's performance to make sure the employee is following company policies Inaccurate or inadequate accounting records serve as an invitation to theft by dishonest employees because theft can be concealed more easily 357 This book is licensed under a Creative Commons Attribution 3.0 License One or more business documents support most accounting transactions These source documents are an integral part of the internal control structure For optimal control, source documents should be serially numbered (Transaction documentation and related aspects of internal control are presented throughout the text.) PURCHASE REQUISITION No BRYAN WHOLESALE COMPANY From; Automotive Supplies Department Date: 2010 N o v e m b e r To: Purchasing Department Suggested supplier: W i l k e s R a d i o C o m p a n y Please purchase the following items; Description Item Number Quantity Estimated Price Model No 5868200 $50 per unit 24393 Reason for request: To be filled in by purchasing department: Customer order Dated ordered N o v e m b e r Baier Company Purchase order number N - M S Approved R S T Exhibit 65: Purchase requisition Since source documents serve as documentation of business transactions, from time to time firms check the validity of these documents For example, to review a purchase transaction, they check the documents used to record the transaction against the proper accounting records When the accounting department records a purchase transaction, it should receive copies of the following four documents: • A purchase requisition (Exhibit 65) is a written request from an employee inside the company to the purchasing department to purchase certain items • A purchase order (Exhibit 66) is a document sent from the purchasing department to a supplier requesting that merchandise or other items be shipped to the purchaser • An invoice (Exhibit 67) is the statement sent by the supplier to the purchaser requesting payment for the merchandise shipped • A receiving report is a document prepared by the receiving department showing the descriptions and quantities of all items received from a supplier in a particular shipment A copy of the purchase order can serve as a receiving report if the quantity ordered is omitted Then, because receiving department personnel not know what quantity to expect, they will count the quantity received more accurately These four documents together serve as authorization to pay for merchandise and should be checked against the accounting records Without these documents, a company might fail to pay a legitimate invoice, pay fictitious invoices, or pay an invoice more than once Companies can accomplish proper internal control only by periodically checking the source documents of business transactions with the accounting records of those transactions In Exhibit 68 we show the flow of documents and goods in a merchandise transaction Accounting Principles: A Business Perspective 358 A Global Text Control of cash PURCHASE ORDER No N-145 BRYAN WHOLESALE COMPANY 476 Mason Street Detroit, Michigan 48823 To: Wilkes Radio Company 2515 West Peachtree Street Date: 2010 November 21 Atlanta, Georgia 30303 Ship by: 2010 December 20 Ship to: Above address FOB terms requested: Destination Discount terms requested: 2/10, n/30 Please send the foil owing item; Price Total Description Item Number Quantity Per Unit Amount True-tone stereo Model No 200 $50 $10,000 radios 5868-24393 Ordered by: J a n e K n i g h t Please include order number on all invoice and shipments Exhibit 66: Purchase order Unfortunately, even though a company implements all of these features in its internal control structure, theft may still occur If employees are dishonest, they can usually figure out a way to steal from a company, thus circumventing even the most effective internal control structure Therefore, companies should carry adequate casualty insurance on assets This insurance reimburses the company for loss of a nonmonetary asset such as specialized equipment Companies should also have fidelity bonds on employees handling cash and other negotiable instruments These bonds ensure that a company is reimbursed for losses due to theft of cash and other monetary assets With both casualty insurance on assets and fidelity bonds on employees, a company can recover at least a portion of any loss that occurs According to the Committee of Sponsoring Organizations of the Treadway Commission, there are five components of an internal control structure When these components are linked to the organization's operations, they can quickly respond to shifting conditions The components are: • Control environment The control environment is the basis for all other elements of the internal control structure The control environment includes many factors such as ethical values, management's philosophy, the integrity of the employees of the corporation, and the guidance provided by management or the board of directors • Risk assessment After the entity sets objectives, the risks (such as theft and waste of assets) from external and internal sources must be assessed Examining the risks associated with each objective allows management to develop the means to control these risks • Control activities To address the risks associated with each objective, management establishes control activities These activities include procedures that employees must follow Examples include procedures to protect the assets through segregation of employee duties and the other means we discussed earlier • Information and communication Information relevant to decision making must be collected and reported in a timely manner The events that yield these data may come from internal or external sources Communication throughout the entity is important to achieve management's goals Employees must understand what is expected of them and how their responsibilities relate to the work of others Communication with external parties such as suppliers and shareholders is also important 359 This book is licensed under a Creative Commons Attribution 3.0 License • Monitoring After the internal control structure is in place, the firm should monitor its effectiveness so that it can make changes before serious problems arise In testing components of the internal control structure, companies base their thoroughness on the risk assigned to those components Internal control is the general responsibility of all members in an organization However, the following three groups have specific responsibilities regarding the internal control structure INVOICE Invoice No Date: 2010 Dec 15 WILXES RADIO COMPANY 2515 West Peachtree Street Atlanta, Georgia 30303 Customer's Orders No N-14S Sold to: Bryan Wholesale Co Address: 475 Mason Street Detroit, Michigan 4S823 Terms: 2/10, n/30, FOB destination Date shipped: 2010 D e c e m b e r Shipped by: Description Nagel Trucking Co Item Number Quantity Price Per Unit Total Amount Model No 5868-24393 200 $50 $10,000 Total $10,000 Exhibit 67: Invoice Management holds ultimate responsibility for establishing and maintaining an effective internal control structure Through leadership and example, management demonstrates ethical behavior and integrity within the company The board of directors provides guidance to management Because board members have a working knowledge of the functions of the company, they help shield the company from managers who try to override some control procedures for dishonest purposes Often, an efficient board that has access to the company's internal auditors can discover such fraud Auditors within the organization evaluate the effectiveness of the internal control structure and determine whether company policies and procedures are being followed All employees are part of a communications network that enables an internal control structure to work effectively Computerized financial records require the same internal control principles of separation of duties and control over access as a manual accounting system The exact control steps depend on whether a company is using mainframe computers and minicomputers or microcomputers Large corporations might use all three types of computers in their accounting environments The size and complexity of mainframe computers and minicomputers require specially trained persons to keep these systems operating While systems specialists operate the computer system itself, programmers develop the programs that direct the computer to perform specific tasks In a mainframe or minicomputer environment, internal control should include the following: Accounting Principles: A Business Perspective 360 A Global Text Control of cash • Control computer access by placing the computer in an easily secured room, and allow only persons authorized to operate the computer to enter the room • Restrict the access of systems specialists (who operate the computer) to software programs and the access of programmers to the computer This policy prevents the running of unauthorized, altered programs • Require the use of passwords to access sensitive company data and confidential personal data Change the passwords as necessary Many smaller companies use microcomputers instead of a mainframe or a minicomputer Also, large companies might supply certain employees with personal computers The use of personal computers changes the control environment somewhat Small companies generally not employ systems specialists and programmers Instead, these companies use off-the-shelf programs such as accounting, spreadsheet, database management, and word processing packages The data created by use of these programs are valuable (e.g the company's accounting records) and often sensitive Thus, controls are also important In a personal computer environment, the following controls can be useful: Exhibit 68: Flow of documents and goods in a merchandising transaction 361 This book is licensed under a Creative Commons Attribution 3.0 License • Require computer users to have tight control over storage of programs and data Just as one person maintains custody over a certain set of records in a manual system, in a computer system one person maintains custody over certain information (such as the accounts receivable subsidiary ledger) Make backup copies that are retained in a different secured location • Require passwords (kept secret) to gain entry into data files maintained on the hard disk • In situations where a local area network (LAN) links the personal computers into one system, permit only certain computers and persons in the network to have access to some data files (the accounting records, for example) Computerized accounting systems not lessen the need for internal control In fact, access to a computer by an unauthorized person could result in significant theft in less time than with a manual system Controlling cash Since cash is the most liquid of all assets, a business cannot survive and prosper if it does not have adequate control over its cash In accounting, cash includes coins; currency; undeposited negotiable instruments such as checks, bank drafts, and money orders; amounts in checking and savings accounts; and demand certificates of deposit A certificate of deposit (CD) is an interest-bearing deposit that can be withdrawn from a bank at will (demand CD) or at a fixed maturity date (time CD) Only demand CDs that may be withdrawn at any time without prior notice or penalty are included in cash Cash does not include postage stamps, IOUs, time CDs, or notes receivable In its general ledger, a company usually maintains two cash accounts—Cash and Petty Cash On the company's balance sheet, it combines the balances of these two accounts into one amount reported as Cash An accounting perspective: Business insight Users of financial data must look to see the real meaning behind the numbers Reader's Digest publishes the world's most widely read magazine as well as various other books, home entertainment products, and special interest magazines In Reader's Digest's annual report, for example, the company defines cash and cash equivalents in this footnote: The company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents Since many business transactions involve cash, it is a vital factor in the operation of a business Of all the company's assets, cash is the most easily mishandled either through theft or carelessness To control and manage its cash, a company should: • Account for all cash transactions accurately so that correct information is available regarding cash flows and balances Accounting Principles: A Business Perspective 362 A Global Text Control of cash • Make certain that enough cash is available to pay bills as they come due • Avoid holding too much idle cash because excess cash could be invested to generate income, such as interest • Prevent loss of cash due to theft or fraud The need to control cash is clearly evident and has many aspects Without the proper timing of cash flows and the protection of idle cash, a business cannot survive This section discusses cash receipts and cash disbursements Later in the chapter, we explain the importance of preparing a bank reconciliation for each bank checking account and controlling the petty cash fund When a merchandising company sells its merchandise inventory, it may receive cash immediately or several days or weeks later A clerk receives the cash immediately over the counter, records it, and places it in a cash register The presence of the customer as the sale is rung up usually ensures that the cashier enters the correct amount of the sale in the cash register At the end of each day, stores reconcile the cash in each cash register with the cash register tape or computer printout for that register Payments received later are almost always in the form of checks Stores prepare a record of the checks received as soon as they are received Some merchandising companies receive all their cash receipts on a delayed basis as payments on accounts receivable (See the cash receipts cycle for merchandise transactions in Exhibit 69.) Although businesses vary their specific procedures for controlling cash receipts, they usually observe the following principles: • Prepare a record of all cash receipts as soon as cash is received Most thefts of cash occur before a record is made of the receipt Once a record is made, it is easier to trace a theft • Deposit all cash receipts intact as soon as feasible, preferably on the day they are received or on the next business day Undeposited cash is more susceptible to misappropriation • Arrange duties so that the employee who handles cash receipts does not record the receipts in the accounting records This control feature follows the general principle of segregation of duties given earlier in the chapter, as does the next principle • Arrange duties so that the employee who receives the cash does not disburse the cash This control measure is possible in all but the smallest companies Companies also need controls over cash disbursements Since a company spends most of its cash by check, many of the internal controls for cash disbursements deal with checks and authorizations for cash payments The basic principle of segregation of duties also applies in controlling cash disbursements Following are some basic control procedures for cash disbursements: • Make all disbursements by check or from petty cash Obtain proper approval for all disbursements and create a permanent record of each disbursement Many retail stores make refunds for returned merchandise from the cash register When this practice is followed, clerks should have refund tickets approved by a supervisor before refunding cash 363 18 Managerial accounting concepts/job costing Managerial accounting is for external use and gives less detailed information than financial accounting A manufacturer produces speedboats, and each one requires a motor The motors are considered direct materials and are product costs A Pepsi-Cola bottling plant is an example of a company that would use a job cost system A predetermined overhead rate is calculated by dividing the expected level of activity by the estimated total overhead cost Overhead cannot be entered in Work in Process Inventory when using a predetermined overhead rate Only when the actual overhead costs are determined is the overhead entered Selling and administrative expenses are part of period costs under both absorption and variable costing methods Multiple-choice Select the best answer for each of the following questions Under which cost category are indirect material costs included? a Direct materials b Overhead c Direct labor d None of the above For financial accounting and external reporting purposes, all selling and administrative expenses are treated as: a Period costs b Selling costs c Manufacturing overhead costs d Product costs What are the differences between the cost of goods sold sections in a manufacturer's and a merchandiser's income statements? a A merchandiser uses Merchandise Inventory and Direct Labor, whereas a manufacturer uses Finished Goods Inventory and Cost of Goods Manufactured b A merchandiser uses Merchandise Inventory and Cost of Goods Available for Sale, whereas a manufacturer uses Finished Goods Inventory and Cost of Goods Available for Sale c A merchandiser uses Work in Process Inventory and Cost of Goods Sold, whereas a manufacturer uses Finished Goods Inventory and Cost of Goods Sold d None of the above A job cost system is used: 803 This book is licensed under a Creative Commons Attribution 3.0 License a When there are dissimilar products b By manufacturers and service companies c When goods are produced to meet a customer's particular needs d All of the above Which of the following best describes the advantages of using a predetermined overhead rate? a Overhead costs are applied evenly throughout the year rather than fluctuating from month to month b Predetermined rates require managers to wait until long after the accounting period to get an estimate of product costs c Total unit costs of production are known sooner than using actual overhead rates, and overhead costs are evenly distributed throughout the year d Both (a) and (c) above The expected level of activity in a production center is 30,000 machine-hours Estimated overhead costs are indirect materials and indirect labor, USD 360,000; other overhead, USD 90,000 Which of the following is the predetermined overhead rate per machine-hour? a USD b USD 12 c USD 15 d USD 20 You are given the following data relating to a company: Estimated manufacturing overhead per year Expected level of activity per year Predetermined overhead rate Actual overhead costs incurred during year Actual machine-hours USD 24,000 40,000 machine-hours USD 0.60 per machine-hour USD 22,500 35,000 Which of the following are the correct journal entries for the preceding data? a Manufacturing overhead Various accounts Work in process inventory Manufacturing overhead 22,500 b Manufacturing overhead Various accounts Work in process inventory Manufacturing overhead 22,500 c Manufacturing overhead Various accounts Work in process inventory Manufacturing overhead 24,000 d Various accounts Manufacturing overhead Manufacturing overhead Work in process inventory 22,500 21,000 22,500 21,000 15,428 15,428 22,500 15,428 24,000 15,428 15,428 22,500 15,428 Accounting Principles: A Business Perspective 804 A Global Text 18 Managerial accounting concepts/job costing Now turn to “Answers to self-test” at the end of the chapter to check your answers Questions ➢ What are the major differences between managerial and financial accounting? ➢ Identify the three elements of cost incurred in manufacturing a product and indicate the distinguishing characteristics of each ➢ Why might a company claim that the total cost of employing a person is USD 15.30 per hour when the employee's wage rate is USD 10.50 per hour? How should this difference be classified and why? ➢ Why are certain costs referred to as period costs? What are the major types of period costs incurred by a manufacturer? ➢ Explain why the income statement of a manufacturing company differs from the income statement of a merchandising company ➢ What is the general content of a statement of cost of goods manufactured? What is its relationship to the income statement? ➢ What is the relationship between cost flows in the accounts and the flow of physical products through a factory? ➢ Define a job cost system and give an example of a situation in which it can be used ➢ What are the major reasons for using predetermined manufacturing overhead rates? ➢ What is the formula for computing a predetermined overhead rate? If the expected level of activity in a production center is 50,000 machine-hours and the estimated overhead costs are USD 750,000, what is the predetermined overhead rate? Show the calculation ➢ What is underapplied and overapplied overhead? What type of balance does each have in the Overhead account? ➢ Direct materials were issued to the following jobs: Material A was issued to Job No 101, USD 2,000; Job No 102, USD 1,000; and Job No 103, USD 5,000 Material B was issued to Job No 101, USD 5,000; Job No 102, USD 2,000; and Job No 103, USD 3,000 A total of USD 3,000 in indirect materials was issued to all jobs ➢ Record the direct and indirect materials issued in journal entry form ➢ Real world question Assume Domino's Pizza is considering offering a new product—a 6-inch (15.24 cm) pizza Why would it matter if Domino's Pizza knows how much it costs to produce and deliver this 6-inch (15.24 cm) pizza? ➢ Real world question Why is it becoming more important that the managers of hospitals understand their product costs? ➢ Real world question Besides law firms and public accounting firms, name three service organizations that produce individual jobs and would use job costing 805 This book is licensed under a Creative Commons Attribution 3.0 License ➢ (Appendix) Under what specific circumstances would you expect net income to be larger under variable costing than under absorption costing? What is the reason for this difference? Exercises Exercise A The following costs are incurred by an electrical appliance manufacturer Classify these costs as direct materials, direct labor, manufacturing overhead, selling, or administrative a President's salary b Cost of electrical wire used in making appliances c Cost of janitorial supplies (the janitors work in the factory) d Wages of assembly-line workers e Cost of promotional displays f Assembly-line supervisor's salary g Cost accountant's salary (the accountant works in the factory) h Cost of cleaner used to clean appliances when they are completed i Cost of aluminum used for toasters j Cost of market research survey Exercise B Classify the costs listed in the previous exercise as either product costs or period costs Exercise C Gore Company makes products for sporting events The following data are for the year ended 2010 December 31: Materials inventory, 2010 January Materials inventory, 2010 December 31 Materials purchases Direct labor Work in process inventory, 2010 January Work in process inventory, 2010 December 31 Manufacturing overhead Finished goods inventory, 2010 January Finished goods inventory, 2010 December 31 $ 45,000 65,000 175,000 225,000 30,000 40,000 130,000 80,000 140,000 Prepare a Cost of Goods Manufactured Statement and compute the cost of goods sold Exercise D In June, Sierra Company worked only on Job No 100 and completed it on June 30 There were no prior costs accumulated on Job No 100 before June During the month, the company purchased and used USD 10,800 of direct materials, used 2,000 machine-hours, and incurred USD 19,200 of direct labor costs Assuming manufacturing overhead is applied at the rate of USD 12 per machine-hour, what is the total cost of Job No 100? Prepare journal entries to assign the materials, labor, and manufacturing overhead costs to production and to record the transfer of Job No 100 to Finished Goods Inventory Exercise E At the end of the second week in March, Job No 710 has an accumulated total cost of USD 37,800 In the third week, USD 9,000 of direct materials were used on Job 710, 300 hours of direct labor were charged to the job at USD 40 per hour, and manufacturing overhead was applied on the basis of USD 40 per machine-hour for overhead Job No 710 was the only job worked on in the third week It was also completed in the third week Job Accounting Principles: A Business Perspective 806 A Global Text 18 Managerial accounting concepts/job costing No 710 used 160 machine-hours during the third week in March Compute the cost of Job No 710, and give the journal entry required to record its completion and transfer to Finished Goods Inventory Exercise F Different companies use different bases in computing their predetermined overhead rates From the following estimated data, compute the predetermined rate to be used by each company: Machine-hours Direct labor-hours Direct labor cost Manufacturing overhead cost Company Paper 100,000 50,000 $800,000 $400,000 Rock 210,000 48,000 $735,000 $432,000 Scissors 125,000 39,000 $410,000 $375,000 Basis for determining predetermined overhead rate: Company Paper Rock Scissors Basis Direct labor cost Direct labor-hours Machine-hours Exercise G Refer to the previous exercise Assume the actual hours and cost data were: Actual Manufacturing overhead Direct labor cost Direct labor-hours Machine-hours Paper $450,000 $850,000 45,000 105,000 Rock $400,000 $700,000 46,000 200,000 Scissors $375,000 $400,000 38,000 130,000 a Compute overapplied or underapplied overhead for each company b Prepare journal entries to transfer overapplied or underapplied overhead to Cost of Goods Sold for each company Exercise H Ernest Peat Consultants uses a job cost system and had the following activity during December: There were no jobs in beginning Work in Process or Finished Goods Inventory Three jobs were started: No 222, 223, and 224 Job No 222 was completed and the customer was billed for USD 10,000 on account Job No 223 was completed and in Finished Goods Inventory awaiting billing to the client at the end of the month Job No 224 was still in process at month-end Direct labor costs incurred for: Job No 222 Job No 223 Job No 224 200 hours @ $21/hour 300 hours @ $18/hour 120 hours @ $17/hour Assume overhead is applied at the rate of USD 10 per labor-hour Actual overhead was USD 6,400 (The credit part of the journal entry is to Accounts Payable Prepare journal entries to record the preceding data, as well as the transfer of underapplied or overapplied overhead to Cost of Goods Sold Exercise I The following data relate to Socks Company for the year ended 2010 December 31: Cost of production: Direct materials (variable) Direct labor (variable) Manufacturing overhead: Variable Fixed Sales commissions (variable) Sales salaries (fixed) Administrative expenses (fixed) $360,000 504,000 180,000 360,000 108,000 72,000 144,000 807 This book is licensed under a Creative Commons Attribution 3.0 License Units produced 150,000 Units sold (at $18 each) 120,000 Beginning inventory, 2010 January -0- There were no beginning inventories Assume direct materials and direct labor are variable costs Prepare two income statements—a variable costing income statement and an absorption costing income statement Problems Problem A Total Block, Inc., is considering a new sunscreen packet that contains a skin wipe with sunscreen on it These would be particularly useful for people who not want to carry a bottle of sunscreen, according to Sunspot's marketing manager Classify the following costs of this new product as direct materials, direct labor, manufacturing overhead, selling, or administrative a President's salary b Packages used to hold the skin wipes c Cleaning materials used to clean the skin wipe packages d Wages of workers who package the product e Cost of advertising the product f The salary of the supervisor of the workers who package the product g Cost accountant's salary (the accountant works in the factory) h Cost of a market research survey i Sales commissions paid as a percent of sales j Depreciation of administrative office building Problem B Classify the costs listed in the previous problem as either product costs or period costs Problem C Good Vibrations, Inc., produces videotapes of musical performances A newly hired executive of the company has asked you to sort through the records and prepare a statement of the company's cost of goods manufactured You find the following data from records prepared by Good Vibrations, Inc., for the year ended 2009 December 31: Inventories: Beginning direct materials inventory, 2009 January Ending direct materials inventory, 2009 December 31 Beginning work in process inventory, 2009 January Ending work in process inventory, 2009 December 31 Materials purchases Direct labor Indirect labor Factory utilities expense Factory supplies expense Depreciation expense – factory building Depreciation expense – Factory Equipment Other manufacturing overhead $ 6,000 10,500 10,000 9,500 50,000 40,000 15,000 7,000 5,000 14,000 10,500 25,000 Accounting Principles: A Business Perspective 808 A Global Text 18 Managerial accounting concepts/job costing You also learn that beginning Finished Goods Inventory on 2009 January 1, was USD 20,000 and ending Finished Goods Inventory on 2009 December 31, was USD 5,000 Sales for the year were USD 400,000 Selling expenses were USD 50,000 and administrative expenses were USD 75,000 a Prepare a statement of cost of goods manufactured for Good Vibrations, Inc., for the year ended 2009 December 31 b Prepare an income statement for Good Vibrations, Inc., for the year ended 2009 December 31 Problem D Log Cabin Homes, Inc., uses a job cost system to account for its jobs, which are prefabricated houses As of 2010 January 1, its records showed inventories as follows: Materials and supplies $100,000 Work in process (Job Nos 22 and 180,000 23) Finished goods (Job No 21) 140,000 The work in process inventory consisted of two jobs: Job No 22 23 Direct materials $36,000 40,000 Direct labor $40,000 28,000 $76,000 Manufacturing overhead $20,000 16,000 $68,000 Total $ 96,000 84,000 $180,000 Cost and sales data for 2010: Materials purchased on account, USD 400,000 Direct materials used: Job No 22, USD 60,000; Job No 23, USD 120,000; Job No 24, USD 180,000 Indirect materials used, USD 10,000 Direct labor costs: Job No 22, USD 100,000; Job No 23, USD 200,000; and Job No 24, USD 80,000 Indirect labor costs, USD 80,000 Overhead is assigned to jobs at USD 100 per machine-hour Job No 22 used 500 machine-hours, Job No 23 used 1,000 machine-hours, and Job No 24 used 300 machine-hours in January Job No 22 and 23 were completed and transferred to Finished Goods Inventory Job No 21 and 22 were sold on account for USD 1,200,000, total Manufacturing overhead costs incurred, other than indirect materials and indirect labor, were depreciation, USD 80,000, and heat, light, power, miscellaneous, USD 40,000 a Prepare journal entries to assign the preceding costs to jobs Show the appropriate entries debiting Finished Goods Inventory and Cost of Goods Sold Transfer overapplied or underapplied overhead to Cost of Goods Sold b Assuming selling and administrative expenses were USD 100,000, prepare an income statement for 2010 Problem E Green Thumb Landscaping Company uses a job cost system As of 2010 January 1, its records showed the following inventory balances: Materials (shrubs, trees, etc.) Work in process Finished goods (Job No 211) $ 13,500 25,800 30,000 809 This book is licensed under a Creative Commons Attribution 3.0 License The work in process inventory consisted of two jobs: Job No 212 213 10 Downing St 1010 Wilshire Blvd Direct Direct Materials Labor $4,500 $ 6,000 5,100 4,800 $9,600 $10,800 Manufacturing Overhead $2,400 3,000 $5,400 Total $12,900 12,900 $25,800 Here are data for the company for January: Materials purchased, USD 48,000 Landscaping direct labor costs: direct labor to Job No 212, USD 12,000; to Job No 213, USD 24,000; and to Job No 214, USD 36,000 Indirect labor, USD 30,000 Direct materials used: direct materials for Job No 212, USD 7,800; for Job No 213, USD 14,400; and for Job No 214, USD 24,000 Supplies (indirect materials) used amounted to USD 1,200 Overhead is assigned to jobs at USD per labor-hour, with 8,000 labor-hours to Job 212 and 2,000 labor-hours each to Jobs 213 and 214 Jobs 212 and 213 were completed and in Finished Goods Inventory at the end of January Sales revenues for January were USD 45,000; cost of goods sold was USD 30,000 for Job No 211 that was in Finished Goods Inventory on 2010 January Overhead costs incurred other than indirect labor and indirect materials were depreciation, USD 3,000, and utilities, fuel, and miscellaneous, USD 3,000 a Prepare journal entries to record the preceding transactions, including the transfer of underapplied or overapplied overhead to Cost of Goods Sold b Assuming selling and administrative expenses were USD 10,000, prepare an income statement for January Problem F Speedy Delivery, Inc., transports computer equipment for various computer manufacturers Speedy applies overhead to jobs using a predetermined overhead rate based on truck miles Estimated data for 2010 are: Estimated truck miles Estimated overhead for hauling operations (equivalent to manufacturing overhead) 20 million $12 million a Compute the predetermined overhead rate per mile b Assume that in 2010, actual manufacturing overhead for hauling operations amounted to USD 15 million, and 24 million truck miles were driven Compute the amount of underapplied or overapplied manufacturing overhead for 2010 c Prepare the journal entry to transfer underapplied or overapplied overhead to Cost of Goods Sold Problem G Costner Company uses an absorption costing system in accounting for the single product it manufactures The following selected data are for the year 2009: Sales (10,000 units) Direct materials used (variable cost) Direct labor costs (variable cost) Variable manufacturing overhead Fixed manufacturing overhead $360,000 129,600 43,200 12,960 17,280 Accounting Principles: A Business Perspective 810 A Global Text 18 Managerial accounting concepts/job costing Variable selling and administrative expenses Fixed selling and administrative expenses 21,600 72,000 The company produced 12,000 units and sold 10,000 units Direct materials and direct labor are variable costs One unit of direct material goes into each unit of finished goods Overhead rates are based on a volume of 12,000 units and are USD 1.08 and USD 1.44 per unit for variable and fixed overhead, respectively The ending inventory is the 2,000 units of finished goods on hand at the end of 2009 There was no inventory at the beginning of 2009 a Prepare an income statement for 2009 under variable costing b Prepare an income statement for 2009 under absorption costing c Explain the reason for the difference in net income between a and b Alternate problems Alternate problem A Pocket Umbrella, Inc., is considering producing a new type of umbrella This new pocket-sized umbrella would fit into a coat pocket or purse Classify the following costs of this new product as direct materials, direct labor, manufacturing overhead, selling, or administrative a Cost of advertising the product b Fabric used to make the umbrellas c Maintenance of cutting machines used to cut the umbrella fabric so it will fit the umbrella frame d Wages of workers who assemble the product e President's salary f The salary of the supervisor of the people who assemble the product g Wages of the product tester who stands in a shower to make sure the umbrellas not leak h Cost of market research survey i Salary of the company's sales managers j Depreciation of administrative office building Alternate problem B Classify the costs listed in Alternate problem A as either product costs or period costs Alternate problem C Presley Manufacturing Company is a producer of music compact discs (CDs) and tapes The following account balances are for the year ended 2009 December 31 Administrative expenses Depreciation expense – Manufacturing equipment Direct labor Manufacturing supplies expense Indirect labor Beginning inventories, 2009 January 1: Direct materials Work in process Finished goods Ending inventories, 2009 December 31 Direct materials Work in process Finished goods Direct materials purchases $ 60,000 50,000 468,000 40,000 36,000 14,000 20,000 128,000 44,000 56,000 92,000 216,000 811 This book is licensed under a Creative Commons Attribution 3.0 License Rent expense – Factory Sales Selling expense Other manufacturing overhead 28,000 1,400,000 72,000 126,000 a Prepare a statement of cost of goods manufactured for Presley Manufacturing Company for 2009 b Prepare an income statement for the year ended 2009 December 31 Alternate problem D Cathy's Catering Company uses a job cost system Its activities in November 2010, the first month of operations, were as follows: Direct materials cost (food) Direct labor cost Labor-hours Job First-rate Active life Universityhome $54,000 $36,000 $45,000 $40,500 2,900 3,500 Precocious School $81,000 $54,000 3,800 The company applies overhead at a rate of USD 16 per labor-hour It completed all jobs in November The total revenue for the three jobs was USD 400,000 The actual overhead for the month was USD 160,000, of which USD 120,000 should be credited to Accounts Payable and USD 40,000 should be credited to Accumulated Depreciation Prepare journal entries to record the costs of jobs and to record the transfer of completed jobs to Finished Goods Inventory and to Cost of Goods Sold Transfer any underapplied or overapplied overhead to Cost of Goods Sold The company had no beginning or ending inventories Alternate problem E Sullivan Company applied overhead to production using a predetermined overhead rate based on machine-hours Budgeted data for 2010 are: Budgeted machine-hours Budgeted manufacturing overhead 75,000 $870,000 a Compute the predetermined overhead rate b Assume that in 2010, actual manufacturing overhead amounted to USD 997,500, and 86,000 machine-hours were used Compute the amount of underapplied or overapplied manufacturing overhead for 2010 c Prepare the journal entry to transfer underapplied or overapplied overhead to Cost of Goods Sold Beyond the numbers—Critical thinking Business decision case A Companies often work on a cost-reimbursement basis That is, Company B reimburses Company A for the cost of doing work for Company B Suppose your company has a contract that calls for reimbursement of direct materials and direct labor, but not overhead Following are costs that various organizations incur; they fall into three categories: direct materials (DM), direct labor (DL), or overhead (OH) Glue used to attach labels to bottles containing a patented medicine Compressed air used in operating paint sprayers for Student Painters, a company that paints houses and apartments Insurance on a factory building and equipment A production department supervisor's salary Rent on factory machinery Iron ore in a steel mill Accounting Principles: A Business Perspective 812 A Global Text 18 Managerial accounting concepts/job costing Oil, gasoline, and grease for forklift trucks in a manufacturing company's warehouse Services of painters in building construction Cutting oils used in machining operations Cost of paper towels in a factory employees' washroom Payroll taxes and fringe benefits related to direct labor The plant electricians' salaries Crude oil to an oil refinery Copy editor's salary in a book publishing company a Classify each of these items as direct materials, direct labor, or overhead b Assume your classifications could be challenged in a court case Indicate to your attorneys which of your answers for part a might be successfully disputed by the opposing attorneys In which answers are you completely confident? Business decision case B Quality Painters, Inc., uses a job cost system As of 2010 January 1, its records showed the following inventory balances: Materials Work in process Finished goods $ 7,000 50,000 The work in process inventory consisted of two jobs: Job No 100 101 Direct Direct OverheadTotal Materials Labor $ 9,000 $12,000 $ 4,000 $25,000 Community housing Regal apartments 10,000 $19,000 9,000 6,000 $21,000 $10,00 25,000 $50,000 Here are data for the company for January: Materials purchased, USD 90,000 Direct labor costs: direct labor to Job No 100, USD 20,000; to Job No 101, USD 48,000; and to Job No 102 (a new job), USD 50,000 Indirect labor, USD 10,000 Direct materials used: direct materials for Job No 100, USD 15,600; for Job No 101, USD 28,800; and for Job No 102, USD 48,000 Supplies (indirect materials) used amounted to USD 4,000 Overhead is assigned to jobs at USD per labor-hour, with 1,000 labor-hours to Job 100 and 2,000 labor-hours each to Jobs 101 and 102 All three jobs were completed in January Sales revenues for January were USD 350,000 for the three jobs Overhead costs incurred other than indirect labor and indirect materials were depreciation, USD 6,000, and utilities, fuel, and miscellaneous, USD 6,000 813 This book is licensed under a Creative Commons Attribution 3.0 License Management is concerned about the relationship between costs incurred on jobs and the costs expected to be incurred, and has asked for your help Here are the expected total costs (direct materials, direct labor, and overhead) for the three jobs: Job 100 Job 101 Job 102 $ 60,000 120,000 130,000 These cost estimates cover the entire job, including both costs in beginning Work in Process Inventory and costs incurred during January a Compare the costs incurred on each job, including the costs in beginning Work in Process Inventory and costs incurred during January with the expected costs Is the company keeping its costs below the expected costs for each job? b Prepare an income statement for January 2010 assuming selling and administrative expenses for January were USD 50,000 Don't forget to transfer any underapplied or overapplied overhead balance to Cost of Goods Sold c Is the company profitable (that is, showing net income greater than zero)? What suggestions can you make for management to help increase the company's net income? Writing assignment C Refer to Presley Manufacturing company, Problem C Assume the newly hired executive is a whiz at marketing, but a person whose eyes glaze over at the sight of a number The executive wants you to explain the financial results for the year in words Essentially, assume the executive has not seen the financial statements prepared What would you say to convey the message in the financial statements? Keep it short —less than 100 words Ethics case – Writing experience D Refer to the Ethical Perspective discussion of Comserv's activities entitled “High pressure sales tactics and creative accounting” As a salesperson, how would you respond if your boss asked you to backdate contracts from 2010 January 3, to 2009 December 28? What if you were asked to backdate the contracts from 2010 February 1, to 2009 December 28? Assume December 31 is the company's fiscal year-end Ethics case E Suzie Garcia, an accountant for a consulting firm, had just received the monthly cost reports for the two jobs she supervises: one for Arrow Space, Inc., and one for the US government She immediately called her boss after reading the figures for the Arrow Space job "We are going to be way over budget on the Arrow Space contract," she informed her boss "The job is only about three-fourths complete, but we have spent all the money that we had budgeted for the entire job." "You had better watch these job costs more carefully in the future," her boss advised "Meanwhile, charge the rest of the costs needed to complete the Arrow Space job to your US government job The government will not notice the extra costs Besides, we get reimbursed for costs on the government job, so we will not lose any money on this problem you have with the Arrow Space contract." What should Suzie do? Does it matter that Suzie's company is reimbursed for costs on the US government contract? Explain Accounting Principles: A Business Perspective 814 A Global Text 18 Managerial accounting concepts/job costing Group project – Ethical perspective F Refer to the “An ethical perspective” discussion of Comserv's activities As a salesperson, suppose your boss asked you to write a side agreement that allowed a customer to back out of a contract, and insisted that you not reveal the side contract to anyone else in your organization You like your job a lot, and you will probably lose it if you not comply with your boss's wish In groups of three, discuss how you would respond to your boss Try to develop a creative way to handle this situation Choose a group spokesperson to report to the class Group project G In teams of two or three students, interview in person or by speakerphone, a businessperson in your community who uses job costing (for example, businesses that produce custom products such as homes, signs, or landscape design, or business consultants) Ask how this person assigns costs to products and how this information affects business decisions Keep in mind that many businesspeople use terms other than job costing and manufacturing overhead Be flexible with your use of accounting terminology in this interview Each team should write a memorandum to the instructor summarizing the results of the interview Information contained in the memo should include: Date: To: From: Subject: Content of the memo must include the name and title of the person interviewed, name of the company, date of the interview, examples of the use of accounting information for decision making, and any other pertinent information Group project H In teams of two or three students, interview the manager of a campus print shop or a print shop in the area about how the company bids on prospective jobs Does it use cost information from former jobs that are similar to prospective ones, for example? Does it have a specialist in cost estimation who estimates the costs of prospective jobs? Each team should write a memorandum to the instructor summarizing the results of the interview Information contained in the memo should include: Date: To: From: Subject: Content of the memo must include the name and title of the person interviewed, name of the company, date of the interview, and information responding to the questions above Using the Internet—A view of the real world Visit the website for a high technology company, such as HP, Intel Corporation, or IBM, and locate its annual report Review the annual report to gain a general understanding of the company's primary business segments and products Write a report addressing the following questions based on your research What products or services are provided by the company? How does the financial information provided in the annual report (focus on the income 815 This book is licensed under a Creative Commons Attribution 3.0 License statement) differ from financial information used for managerial accounting purposes? As a manager making business decisions within the company, what additional information would you need? (Remember that the income statement may be referred to using different terminology such as statement of earnings or statement of operations.) Company Website Hewlett Packard Http://www.hp.com Intel Corporation Http://www.intel.com IBM Http://www.ibm.com Visit the following website for Wells Fargo (a financial institution) and locate its annual report: http://www.wellsfargo.com Review the annual report to gain a general understanding of the company's primary business segments and products Write a report addressing the following questions based on your research What products or services are provided by the company? How does the financial information provided in the annual report (focus on the income statement) differ from financial information used for managerial accounting purposes? As a manager making business decisions within the company, what additional information would you need? (Remember that the income statement may be referred to using different terminology such as statement of earnings or statement of operations.) Visit the following website for Home Depot (a retail organization) and locate its annual report: http://www.homedepot.com Review the annual report to gain a general understanding of the company's primary business segments and products Write a report addressing the following questions based on your research What products or services are provided by the company? How does the financial information provided in the annual report (focus on the income statement) differ from financial information used for managerial accounting purposes? As a manager making business decisions within the company, what additional information would you need? (Remember that the income statement may be referred to using different terminology such as statement of earnings or statement of operations.) Answers to self-test True-false False Managerial accounting is for internal use by managers, not external use, and gives more detailed information than financial accounting True The motors are direct materials, and they are product costs False Because bottling soft drinks is a process, the plant would not use job costing False The answer is the opposite The estimated total overhead is the numerator, and the expected level of activity is the denominator False Overhead can be applied to jobs during the period Accounting Principles: A Business Perspective 816 A Global Text 18 Managerial accounting concepts/job costing True Selling and administrative expenses are part of period costs under both absorption and variable costing methods Multiple-choice b Indirect materials are included under overhead a Selling and administrative expenses are period costs for financial accounting purposes b A merchandiser uses Merchandise Inventory and Cost of Goods Available for Sale, whereas a manufacturer uses Finished Goods Inventory and Cost of Goods Available for Sale d All of the answers are true d Both (a) and (c) are advantages of using a predetermined overhead rate c USD 15= USD 360,000USD 90,000 30,000 machine− hours a Manufacturing overhead 22,500 Various accounts Work in process inventory 21,000 Manufacturing overhead 22,500 21,000 Note the predetermined overhead rate times the actual activity is USD 0.60 X 35,000 machine-hours = USD 21,000 817 ... transactions accurately so that correct information is available regarding cash flows and balances Accounting Principles: A Business Perspective 3 62 A Global Text Control of cash • Make certain... restaurant that has an ice cream parlor as a separate unit Your accountant comes in once a year to prepare financial statements and the tax return In the current year, you have a feeling that... programs such as accounting, spreadsheet, database management, and word processing packages The data created by use of these programs are valuable (e.g the company's accounting records) and often