Question

Victor Holt, the accounting manager of Sexton, Inc., gathered the following information for year 4. Some of it can be used to construct an income statement for year 4. Ignore items that do not appear on an income statement. Some computation may be required. For example, the cost of manufacturing equipment would not appear on the income statement. However, the cost of manufacturing equipment is needed to compute the amount of depreciation. All units of product were started and completed in year 4.

1. Issued $864,000 of common stock.

2. Paid engineers in the product design department $10,000 for salaries that were accrued at the end of the previous year.

3. Incurred advertising expenses of $70,000.

4. Paid $720,000 for materials used to manufacture the company’s product.

5. Incurred utility costs of $160,000. These costs were allocated to different departments on the basis of square footage of floor space. Mr. Holt identified three departments and determined the square footage of floor space for each department to be as shown in the following table.

Department	Square Footage
Research and development		10,000
Manufacturing		60,000
Selling and administrative		30,000
Total		100,000

6. Paid $880,000 for wages of production workers.

7. Paid cash of $658,000 for salaries of administrative personnel. There was $16,000 of accrued salaries owed to administrative personnel at the end of year 4. There was no beginning balance in the Salaries Payable account for administrative personnel.

8. Purchased manufacturing equipment two years ago at a cost of $10,000,000. The equipment had an eight-year useful life and a $2,000,000 salvage value.

9. Paid $390,000 cash to engineers in the product design department.

10. Paid a $258,000 cash dividend to owners.

11. Paid $80,000 to set up manufacturing equipment for production.

12. Paid a one-time $186,000 restructuring cost to redesign the production process to implement a just-in-time inventory system.

13. Prepaid the premium on an insurance policy covering non-manufacturing employees. The policy cost $72,000 and had a one-year term with an effective starting date of May 1. Four employees work in the research and development department and eight employees work in the selling and administrative department. Assume a December 31 closing date.

14. Made 69,400 units of product and sold 60,000 units at a price of $70 each.

Required

1. a-1. Identify the items that are classified as product costs and determine the amount of cost of goods sold reported on the year 4 income statement.

2. a-2. Identify the items that are classified as upstream costs and determine the amount of upstream cost expensed on the year 4 income statement.

3. a-3. Identify the items that are classified as downstream costs and determine the amount of downstream cost expensed on the year 4 income statement.

Answer 1

a)
Raw materials	$            720,000.00
Utilities  (Note:  1)	$              96,000.00
Labor	$            880,000.00
Depreciation on manufacturing equipment ( ($10,000,000 - $2,000,000) / 8	$         1,000,000.00
Setup cost	$              80,000.00
Total	$         2,776,000.00
Cost of Goods Sold = $2,776,000 / 69,400 units =	$                     40.00
Cost of Goods Sold = $40 x 60,000 units	$         2,400,000.00
Note :1
Allocation Rate for Utilities = $160,000 / 100,000 =	1.6		per square foot
Research and development	10,000	x	$1.60	=	$16,000
Manufacturing	60,000	x	$1.60	=	$96,000
Selling and administrative	30,000	x	$1.60	=	$48,000
Total	100,000	x	$1.60	=	$160,000
b) Upstream Costs
Utilities  (Note:  1)	$              16,000.00
Salaries	$            390,000.00
Redesign cost	$            186,000.00
Insurance expense (Note: 2)	$              16,000.00
Total	$            608,000.00
Note:  The $10,000 of accrued engineer’s salaries is an upstream cost.  However, it would not be used in the computation of net income because it applies to the previous accounting period.
Notes: 2
Amount of prepaid insurance to recognize as expense  = ($72,000 / 12) x 8 =	$              48,000.00
Rate for insurance expense = $48,000 / 12  =	4000
Research and development	4	x	$4,000	=	$ 16,000.00
Selling and administrative	8	x	$4,000	=	$ 32,000.00
Total	12	x	$4,000	=	$ 48,000.00
c) Downstream Costs
Advertising	$              70,000.00
Utilities  (Note:  1)	$              48,000.00
Salaries ($658,000 + $16,000)	$            674,000.00
Insurance expense (Note: 2)	$              32,000.00
Total	$            824,000.00