Chapter 27, Problem 1MP

Reese Manufacturing Company manufactures and sells a limited line of products made to customer order. The company uses a perpetual inventory system and keeps its accounts on a calendar year basis. A 6-column spreadsheet is presented on page 1100.

Additional information needed to prepare the income statement and schedule of cost of goods manufactured is as follows:

REQUIRED

1. 1. Prepare an income statement and schedule of cost of goods manufactured for the year ended December 31,20--.
2. 2. Prepare a statement of retained earnings for the year ended December 31,20--.
3. 3. Prepare a balance sheet as of December 31, 20--.
4. 4. Prepare the adjusting, closing, and reversing entries.

To determine

Prepare an income statement and a schedule for cost of goods manufactured of Company R for the year ended December 31, 20--.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Cost of goods manufactured:

Cost of goods manufactured refers to the cost incurred for a making a product, that are available for sales at the end of the accounting period.

Prepare an income statement and a schedule for cost of goods manufactured of Company R for the year ended December 31, 20—as follows:

Income statement:

Company R
Income Statement
For Year Ended December 31, 20--
Particulars	Amount ($)	Amount ($)
Net sales	537,137
Less: Sales return and allowances	10,840	526,297
Less: Cost of goods sold
Finished goods inventory, January 1	85,454
Add: Estimated returns inventory, January 1	70
Add: Cost of goods manufactured	239,269
Cost of goods available for sale	324,793
Less: Estimated returns inventory, December 31	640
Less: Finished goods inventory, December 31	42,675
Cost of goods sold		281,478
Gross profit		244,819
Less: Operating expenses:
Wages expense	58,380
Advertising expense	11,450
Office rent expense	5,443
Office supplies expense	800
Bad debt expense	956
Insurance expense—office equipment	98
Depreciation expense—office equipment	923
Total operating expenses		78,050
Operating income		166,769
Less: Other expense:
Interest expense		1,421
Income before income taxes		165,348
Less: Income tax		30,725
Net income		134,623

Table (1)

Schedule of cost of goods manufactured:

Company R
Schedule of Cost of Goods Manufactured
For Year Ended December 31, 20--
Particulars	Amount ($)	Amount ($)	Amount ($)
Work in process, January 1			22,600
Direct materials
Materials inventory, January 1	11,633
Add: Materials purchases	96,437
Materials available for use	108,070
Less: Materials inventory, December 31	22,353
Cost of materials used		85,717
Less: Indirect materials charged to production		3,200
Cost of direct materials used		82,517
Direct labor		107,740
Factory overhead		67,654
Total manufacturing costs			257,911
Total work in process during the period			280,511
Less: Work in process, December 31			41,242
Cost of goods manufactured			239,269

Table (2)

To determine

Prepare a statement of retained earnings of Company R for the year ended December 31, 20--.

Explanation of Solution

Statement of Retained Earnings:

This is a financial statement that determines the amount of earnings kept by the business as retained earnings at the end of the financial year. This statement shows the retained earnings held by the business at the beginning and at the end of the financial year, amount of net income earned during the year and the amount of dividend declared to the shareholder for the year.

Prepare a statement of retained earnings of Company R for the year ended December 31, 20—as follows:

Company R
Statement of Retained Earnings
For Year Ended December 31, 20--
Particulars	Amount ($)
Retained earnings, January 1	195,341
Add: Net income for the year	134,623
Subtotal	329,964
Less: Cash dividends	36,000
Retained earnings, December 31	293,964

Table (3)

To determine

Prepare a balance sheet of Company R as of December, 20--.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare a balance sheet of Company R as of December, 20—as follows:

Company R
Balance Sheet
December 31, 20--
Assets	Amount ($)	Amount ($)	Amount ($)
Current assets:
Cash		44,783
Accounts receivable	78,096
Less: Allowance for doubtful accounts	6,030	72,066
Inventories:
Finished goods	42,675
Work in process	41,242
Materials	22,353	106,270
Estimated returns inventory		640
Office supplies		2,746
Factory supplies		489
Prepaid insurance		46
Total current assets			227,040
Property, plant, and equipment:
Factory building	186,674
Less: Accumulated depreciation	36,054	150,620
Factory equipment	46,986
Less: Accumulated depreciation	3,839	43,147
Total property, plant, and equipment			193,767
Total assets			420,807
Liabilities
Current liabilities:
Notes payable		12,470
Accounts payable		10,356
Income tax payable		14,725
Customer refunds payable		1,160
Interest payable		132
Total liabilities			38,843
Stockholders’ Equity
Capital stock		88,000
Retained earnings		293,964
Total stockholders’ equity			381,964
Total liabilities and stockholders’ equity			420,807

Table (4)

To determine

Prepare the adjusting, closing, and reversing entries of Company R.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Reversing entries: Reversing entries are made at the beginning of the accounting period when the accountant needs to cancel any entry made in the previous accounting period. It is done in order to eliminate any errors that might have occurred in the calculation of the revenue or expenses and henceforth increase the efficiency of the financial statements for an improved decision making.

Closing entries: The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Prepare the adjusting, closing, and reversing entries of Company R as follows:

Adjusting entries:

Date		Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
December 31	a.	Interest Expense		132
		Interest Payable			132
		(To record the interest expense incurred at the end of the accounting year)
December 31	b.	Office Supplies Expense		800
		Office Supplies			800
		(To record the office supplies expense incurred at the end of the accounting year)
December 31	c.	Factory Overhead		1,389
		Factory Supplies			1,389
		(To record the factory overhead incurred at the end of the accounting year)
December 31	d.	Depreciation Expense-Office Equipment		923
		Accumulated Depreciation-Office Equipment			923
		(To record the depreciation expense incurred at the end of the accounting year)
December 31	e.	Factory Overhead (Depreciation expense-Factory Equipment)		12,553
		Accumulated Depreciation-Factory Equipment			12,553
		(To record the depreciation expense incurred at the end of the accounting year)
December 31	f.	Factory Overhead (Insurance Expense)		1,356
		Insurance Expense-Office Equipment		98
		Prepaid Insurance			1,454
		(To record the factory overhead and insurance expense incurred)
December 31	g.	Bad Debt Expense		956
		Allowance for Doubtful Accounts			956
		(To record the bad debt expense incurred at the end of the account)
December 31	h.	Sales return and allowances		570
		Customer refunds payable			570
		(To record the sales return from the customer)
December 31	i.	Estimated returns inventory		1,040
		Cost of goods sold			1,040
		(To record the expected return of cost of goods sold)
December 31	j.	Income Tax Expense		14,725
		Income Tax Payable			14,725
		(To record the income tax expense incurred at the end of the account)
December 31	k.	Work in Process Inventory		1,567
		Factory Overhead			1,567
		(To record the factory overhead transferred to the work in process inventory)
December 31	l.	Cost of Goods Sold		641
		Factory Overhead			641
		(To record the factory overhead transferred to the cost of goods sold)

Table (5)

Closing entries:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
December 31	Income Summary		67,654
	Factory Overhead (Subsidiary ledger account)			67,654
	(To close the subsidiary factory overheads account)
December 31	Factory Overhead		67,654
	Income Summary			67,654
	(To close the factory overhead account)
December 31	Sales		537,137
	Income Summary			537,137
	(To close the sales revenue account)
December 31	Income Summary		402,514
	Sales return and allowances			10,840
	Cost of Goods Sold			281,478
	Wages Expense			58,380
	Advertising Expense			11,450
	Office Rent Expense			5,443
	Office Supplies Expense			800
	Bad Debt Expense			956
	Insurance Expense-Office Equipment			98
	Depreciation Expense-Office Equipment			923
	Interest Expense			1,421
	Income Tax Expense			30,725
	(To close all expenses account)
December 31	Income Summary		134,623
	Retained Earnings (1)			134,623
	(To close the income summary account)
December 31	Retained Earnings		36,000
	Cash dividends			36,000
	(To close the cash dividends account)

Table (6)

Closing entry for factory overhead:

In this closing entry, the factory overhead account is closed by transferring the amount of factory overhead to the income summary account in order to bring the factory overhead accounts balance to zero.  Hence, debit the factory overhead account for $67,654, and credit the income summary account for $67,654.

Closing entry for revenue account:

In this closing entry, the sales revenue account is closed by transferring the amount of sales revenue to the income summary account in order to bring the revenue accounts balance to zero.  Hence, debit the sales revenue account for $537,137, and credit the income summary account for $537,137.

Closing entry for expenses account:

In this closing entry, all expenses are closed by transferring the amount of all expenses to the income summary account in order to bring all the expense accounts balance to zero. Hence, debit the income summary account for $402,514, and credit all the expenses account for $402,514.

Closing entry for income summary account:

In this closing entry, the income summary account is closed by transferring the amount of net income to the retained earnings account in order to bring the income summary balance to zero.  Hence, debit the income summary account for $134,623, and credit the retained earnings for $134,623.

Closing entry for dividends account:

The dividends are paid to the shareholders out of the retained earnings. Thus, retained earnings are debited since the earnings are decreased on payment of dividend. Dividends are a component of shareholders’ equity account. It is credited because dividends are transferred to retained earnings account.

Working note (1):

Calculate the value of retained earnings.

$\begin{array}{c}\text{Retained earnings =}\left(\begin{array}{l}\text{Credit balance of income summary account}-\\ \text{Debit balance of income summary account}\end{array}\right)\\ =\$537,137-\$402,514\\ =\$134,623\end{array}$

Reversing entries:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
January 1	Interest Payable		132
	Interest Expense			132
	(To record the reversing entry of interest expense)
January 1	Factory Overhead		1,567
	Work in Process Inventory			1,567
	(To record the reversing entry of factory overhead)

Table (7)

• ■ Interest payable is a liability account and it decreases in the value of liabilities. Hence, debit the interest payable with $132.
• ■ Interest expense is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the interest expense with $132.
• ■ Factory overhead (expense) is a component of owner’s equity, and there is an increase in the value of expense. Hence, debit the factory overhead account with $1,567.
• ■ Work in process inventory is an asset account, and it decreases the value of asset. Hence, credit the work in process inventory account with $1,567.