Vu Accounting Lesson 16

Financial Accounting - I – MGT101

VU Lesson # 16

COST OF GOODS SOLD STATEMENT AND VALUATION OF STOCK In manufacturing concern, separate books are maintained to keep the record of every single work done in manufacturing process to ascertain cost incurred on production of goods. This record gives information about total cost incurred on manufacturing process and per unit cost of goods manufactured. When goods are produced, these are sold to the customers of the business and goods unsold are taken into stock. At the end of the financial year, manufacturing concern prepares a statement which gives the brief summary of the whole process. This statement shows the value of raw material consumed, amount spent on labor and other factory expenses, finished goods produced and goods unsold (in stock). Such statement is called ‘cost of goods sold statement’. Manufacturing concerns, while presenting financial statements, also present cost of goods sold statement. Standard format of cost of goods sold statement is given below: Raw Material:

Conversion Cost: Work in Process Finished Goods

O/S Raw Material + Purchases + Cost Incurred to Purchase RM - C/S Raw Material Cost of Material Consumed + Direct Labor Cost + Factory Overheads Total Factory Cost + O/S of WIP - C/S of WIP Cost of Goods Manufactured + O/S of Finished Goods - C/S of Finished Goods Cost of Good Sold

Cost of material consumed – is the cost of material used for consumption that has been put in the production process. This head shows the raw material left unused from the previous year(opening stock), raw material purchased in the current year, expenses incurred in bringing the purchased material into the business premises and raw material that is not used in the current year (closing stock). Over Heads are the other costs incurred in relation of manufacturing of goods. Examples are factory utilities, supervisor salaries, equipment repairs etc. Total factory cost – is the cost of material consumed plus labor and over heads. In other words it is the total cost incurred in the factory. Cost of goods manufactured – is total factory cost plus opening stock of work in process less closing stock of work in process. © Copyright Virtual University of Pakistan

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Financial Accounting - I – MGT101 VU Cost of goods sold – is the cost of goods manufactured plus opening stock of finished goods less closing stock of finished goods. Prime/Basic Cost = Cost of Direct Material Consumed + Direct Labor cost Conversion cost

it is the cost incurred to convert raw material to finished goods.

Conversion cost = Labor cost + factory overhead Example: •

Using the following data calculate the Cost of Goods Sold of XYZ Co. „ Stock levels O/S Rs. C/S Rs. Raw material 100,000 85,000 Work in process 90,000 95,000 Finished goods 150,000 140,000 „ Purchase of raw material during the period Rs. 200,000 „ Paid to labor Rs. 180,000 out of which Rs. 150,000 used on production. „ Other production costs Rs. 50,000

Solution XYZ Co. Cost of Goods Sols Statement For the period ended------Raw Material:

Conversion Cost

Opening Stock Raw Material + Purchases + Cost Incurred to Purchase RM - Closing Stock Raw Material Cost of Material Consumed

100000 200000 0 (85000)

+ Labor Cost +Factory overhead

150000 50000

Total Factory Costs Work in process

+ O/S of WIP - C/S of WIP Cost of Goods Manufactured

Finished Goods

+ O/S of Finished Goods - C/S of Finished Goods

Cost of Goods Sold

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215000

200000 415000 90000 (95000 410000 150000 (140000) 420000

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Financial Accounting - I – MGT101 Illustration

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Following information of Ahmad & Company is given. Prepare a cost of goods sold statement. Stock levels O/S Rs. C/S Rs. Raw material 150,000 115,000 Work in process 50,000 55,000 Finished goods 120,000 100,000 „ Purchase of raw material during the period Rs. 100,000 „ Transportation charges of items purchased Rs. 5,000 „ Paid to labor Rs. 100,000. „ Other production costs(FOH) Rs. 80,000 Solution Raw Material:

Conversion Cost: Work in Process: Finished Goods:

Opening Stock Raw Material + Purchases + Cost Incurred to Purchase RM - Closing Stock Raw Material Cost of Material Consumed + Labor + Factory Overheads Total Factory Cost + O/S of WIP - C/S of WIP Cost of Goods Manufactured + O/S of Finished Goods - C/S of Finished Goods Cost of Good Sold

150,000 100,000 5,000 (115,000) 140,000 100,000 80,000 320,000 50,000 (55,000) 315,000 120,000 (100,000) 335,000

Stock Card Stock card is used to keep the record of what has come in stock and what has gone out of it. Standard format of stock card is given below: Stock Account Item 01 Date

Receipts

Qty Rate Amount Date

Issues

Qty Rate Amount

Stock card has two parts: • Receipt side • Issue side Both sides have similar columns that include: • Nature of item to be kept in stock • Quantity of items • Rate at which it was purchased • Total value of items

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Financial Accounting - I – MGT101 VU Receipt side is used to record data of items coming in the stock and issue side is used to record information of goods issued for manufacturing process. Valuation of Stock Any manufacturing organization purchases different material through out the year. The prices of purchases may be different due to inflationary conditions of the economy. The question is, what item should be issued first & what item should be issued later for manufacturing. For this purpose, the organization has to make a policy for issue of stock. All the issues for manufacturing and valuation of stock are recorded according to the policy of the organization. Mostly these three methods are used for the valuation of stock: • First in first out (FIFO) • Last in first out (LIFO) • Weighted average First in first out (FIFO) The FIFO method is based on the assumption that the first merchandise purchased is the first merchandised issued. The FIFO uses actual purchase cost. Thus, if merchandise has been purchased at several different costs, the inventory (stock) will have several different cost prices. The cost of goods sold for a given sales transaction may involve several different cost prices. Characteristics • • •

This is widely used method for determining values of cost of goods sold and closing stock. In the FIFO method, oldest available purchase costs are transferred to cost of goods sold. That means the cost if goods sold has a lower value and the profitability of the organization becomes higher. As the current stock is valued at recent most prices, the current assets of the company have the latest assessed values.

Last in first out (LIFO) As the name suggests, the LIFO method is based on the assumption that the recently purchased merchandise is issued first. The LIFO uses actual purchase cost. Thus, if merchandise has been purchased at several different costs, the inventory (stock) will have several different cost prices. The cost of goods sold for a given sales transaction may involve several different cost prices. Characteristics • • •

This is alternatively used method for determining values of cost of goods sold and closing stock. In the LIFO method recent available purchase costs are transferred to cost of goods sold. That means the cost of goods sold has a higher value and the profitability of the organization becomes lower. As the current stock is valued at oldest prices, the current assets of the company have the oldest assessed values. © Copyright Virtual University of Pakistan

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Financial Accounting - I – MGT101 Weighted average method

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When weighted average method is in use, the average cost of all units in inventory, is computed after every purchase. This average cost is computed by dividing the total cost of goods available for sale by the number of units in inventory. Under the average cost assumption, all items in inventory are assigned the same per unit cost. Hence, it does not matter which units are sold; the cost of goods sold is always based on current average unit cost. Characteristics • • •

Under the average cost assumption, all items in inventory are assigned same per unit cost (the average cost). Hence it does not matter which units are sold first. The cost of goods sold is always on the current average unit cost. Since all inventories are assigned same cost, this method does not make any effect on the profitability and does not increase/decrease any asset in the financial statements. This is the alternatively used method for determining values of cost of goods sold and closing stock.

Example: •

•

Receipts: „ 01 Jan 20--, „ 02 Jan 20--, „ 10 Jan 20--, Issues: „ 05 Jan 20--, „ 06 Jan 20--, „ 15 Jan 20--,

10 units @ Rs. 150 per unit 15 units @ Rs. 200 per unit 20 units @ Rs. 210 per unit 05 units 10 units 15 FIFO Method of Stock Valuation

Date Receipts 01-01-20-- 10 @ Rs. 150 02-01-20-- 15 @ Rs. 200 05-01-20-06-01-20-10-01-20-15-01-20--

Issues

Value of Stock 10 x 150 = 1500 10 x 150 = 1500 15 x 200 = 3000 4500 5 @ 150 = 750 750 5 x 150 = 750 15 x 200 = 3000 3750 5 @ 150 = 750 0 x 150 = 0 5 @ 200 = 1000 1750 10 x 200 = 2000 2000 20 @ Rs. 210 10 x 200 = 2000 20 x 210 = 4200 6200 10 @ 200 = 2000 0 x 200 = 0 5 @ 210 = 1050 3050 15 x 210 = 3150 3150 © Copyright Virtual University of Pakistan 131

Financial Accounting - I – MGT101

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Weighted Average Method of Stock Valuation Date

Receipts

Issues

01-01-20-- 10x150 = 1500 02-01-20-- 15x200 = 3000 05-01-20-5x180 = 900 06-01-20-10x180 = 1800 10-01-20-- 20x210 = 4200 15-01-20--

Value of Stock 1500 1500 + 3000 = 4500 4500 – 900 = 3600 3600 – 1800 = 1800 1800 + 4200 = 6000

Average Cost 1500/10=150 4500/25=180 3600/20=180 1800/10=180 6000/30=200

15x200 = 3000 6000 – 3000 = 3000 3000/15=200

Effects of valuation method on profit FIFO Method • Cost of Sales = 750 + 1750 + 3050 = 5,550 Gross Profit = 7500 – 5550 = 1,950 Weighted Average Method • Cost of Sales = 900 + 1800 + 3000 = 5,700 Gross Profit = 7500 – 5700 = 1,300 Illustration: Hamid & company is a manufacturing concern. Following is the receipts & issues record for the month of May, 2002 Date May 7 May 9 May 13 May 18 May 22 May 24 May 27 May 30

Receipts 200 units @ Rs. 50/unit

Issues 60 units

150 units @ Rs. 75/unit 100 units @ Rs. 60/unit 150 units 100 units 100 units @ Rs. 50/unit 200 units

Calculate the value of closing stock by • FIFO Method • Average Method

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Financial Accounting - I – MGT101 Solution: Valuation of Stock by FIFO Method Date

Receipts

Issues

May 7 200 units @ Rs. 50/unit May 9 60 units @ Rs. 50/unit May 13 150 units @ Rs. 75/unit May 18 100 units @ Rs. 60/unit May 22 140 units @ Rs. 50/unit 10 units @ Rs. 75/unit

Value of Stock 200 x 50 = 10,000

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Total Remaining Amount No. of units 10,000 200

Net Balance 10,000

60 x 50 = 3,000 75 x 150 = 11,250

(3,000)

140

7,000

11,250

290

18,250

60 x 100 = 6,000

6,000

390

24,250

50 x 140 = 7,000

(7,750)

240

16,500

(7,500)

140

9,000

5,000

240

14,000

(12,000)

40

2,000

10 x 75 = 750 May 24 100 units @ 75 x 100 Rs. 75/unit =7,500 May 27 100 units 50 x 100 = @ Rs. 5,000 50/unit May 30 40 units @ Rs. 75 x 40 = 75/unit 3,000 100 units @ Rs. 60/unit 60 x 100 = 60 units @ Rs. 6,000 50/unit 50 x 60 = 3,000

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Financial Accounting - I – MGT101 Valuation of Stock by Weighted Average Method: Date May 7 May 9 May 13 May 18 May 22

May 24

May 27 May 30

Receipts Issue Value of Total s Stock Amount(Rs. ) 200 units 200 x 50 10,000 @ Rs. = 50/unit 10,000 60 60 x 50 (3,000) units = 3,000 150 units 150 x 75 7,000+11250 @ Rs. = = 75/unit 11,250 18250 100 units 100 x 60 18250+6000 @ Rs. = = 60/unit 6,000 24250 150 150 x (9,330) units 62.2 = 9330 100 100 x (6,220) units 62.2 = 6220 100 units 100 x 50 8,700+5,000 @ Rs. = = 50/unit 5,000 13,700 200 200 x (11,420) units 57.1 = 11,420

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Total Units

Average Net Balance Cost(Rs.)/uni (Rs.) t 200 50 10,000

140 140+150 = 290 290+100 = 390 390-150 = 240

7,000 18250/290 = 62.9 24250/390 = 62.2

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24,250 14,920

240-100 = 140 140+100 = 240 240-200 = 40

18,250

8,700

13700/240 = 57.1

13,700 2,280

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