Question

Assume you mistakenly treated the cost of production labor as a period cost (operating expense) and you sold all but one of the quilts you made (for the same price calculated in #1, $17.15).

What is resulting effect on the following financial statement elements?

a) Assets: Understated, Overstated, or No Effect

b) Cost of Goods Sold: Understated, Overstated, or No Effect

c) Gross Profit: Understated, Overstated, or No Effect

d) Net Income: Understated, Overstated, or No Effect

2) If manufacturing overhead was underapplied, would the cost of goods sold income account be increased or decreased because manufacturing overhead being underapplied.

Answer 1

Labor cost is a part of inventory cost and should have been reflected in ending inventory, however it was charged as a period cost in the Income Statement

Hence, the effect will be as follows:

a)Assets - Understated, since inventory is understated

b)Cost of Goods Sold - Overstated, since extra labor cost charged

c)Gross Profit- Understated, since cost is overstated

d)Net Income - Understated, since cost is overstated

2)The cost of goods sold would decrease, as the manufacturing overhead is a part of cost of goods sold which is underapplied.