Problem

William Nelson, the chief accountant of West Texas Guitar Company, was injured in an autom...

William Nelson, the chief accountant of West Texas Guitar Company, was injured in an automobile accident shortly before the end of the company’s first year of operations. At year-end, a clerk with a very limited understanding of accounting prepared the following income statement, which is unsatisfactory in several respects:

WEST TEXAS GUITAR COMPANY

Income Statement For the Year Ended December 31, 20__

Net sales 

 

$ 1,300,000

Cost of goods sold:

 

 Purchases of direct materials 

$460,000

 

 Direct labor 

225,000

 

 Indirect labor 

90,000

 

 Depreciation on machinery—factory 

50,000

 

 Rent 

144,000

 

 Insurance 

16,000

 

 Utilities 

28,000

 

 Miscellaneous manufacturing overhead 

34,600

 

 Other operating expenses 

273,800

 

 Dividends declared on capital stock 

46,000

 

Cost of goods sold  

 

$(1,367,400)

Loss for year 

 

$ (67,400)

You are asked to help management prepare a corrected income statement for the first year of operations. Management informs you that 60 percent of the rent, insurance, and utilities applies to factory operations, and that the remaining 40 percent should be classified as period expenses. Also, the correct ending inventories are as follows:

Material

$ 38,000

Work in process

   10,000

Finished goods 

110,400

As this is the first year of operations, there were no beginning inventories.

Instructions

a. Identify the shortcomings and errors in the above income statement. Based on the shortcomings you have identified. explain whether you would expect the company’s actual net income for the first year of operations to be higher or lower than the amount shown.


b. Prepare schedules to determine:

1. The cost of direct materials used.

2. Total manufacturing overhead.


c. Prepare a schedule of cost of finished goods manufactured during the year. (Use the amounts computed in part b as the costs of direct materials used and manufacturing overhead.)


d. Prepare a corrected income statement for the year, using a multiple-step format. Assume that income tax expense amounts to 30 percent of income before income taxes.

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