Question

Early in the year, John Raymond founded Raymond Engineering Co. for the purpose of manufacturing a special flow control valve that he had designed. Shortly after year-end, the company’s accountant was injured in a skiing accident, and no year-end financial statements were prepared. However, the accountant had correctly determined the year-end inventories at the following amounts.
	Ending Inventory	Beginning Inventory
Materials	46,000	-
Work in process	31,500	-
Finished goods (3,000 units)	88,500	-
As this was the first year of operations, there were no beginning inventories
While the accountant was in the hospital, Raymond improperly prepared the following income statement from the company's accounting records:
Net sales	610,600
Cost of goods sold:
Purchases of direct materials	181,000
Direct labor costs	110,000
Manufacturing overhead	170,000
Selling expenses	70,600
Administrative expenses	132,000
Total costs	663,600
Net loss for year	(53,000)
Raymond was very disappointed in these operating results. He stated, “Not only did we lose more than 50,000 this year, but look at our unit production costs. We sold 10,000 units this year at a cost of 663,600; that amounts to a cost of 66.36 per unit. I know some of our competitors are able to manufacture similar valves for about 35 per unit. I don’t need an accountant to know that this business is a failure.”
Instructions
If the company has earned any operating income, assume an income tax rate of 30 percent. (Omit earnings per share figures.)
d. Explain whether you agree or disagree with Raymond’s remarks that the business is unprofitable and that its unit cost of production (66.36, according to Raymond) is much higher than that of competitors (around 35). If you disagree with Raymond, explain any errors or shortcomings in his analysis. Raymond’s erroneous calculation of a net loss may be reconciled to the actual net income of the business as follows: Net loss calculated by Raymond          (53,000) Add: Product costs erroneously deducted as expense         166,000 Actual operating income         113,000 Less: Income taxes (ignored by Raymond)          (33,900) Actual net income           79,100

Answer 1

Raymond's calculations for thr Income statement were incorrect as the closing inventory was never taken into consideration. As shown in the last table, after adding the cost of inventory of $166,000 at the year end gives the net income of $79,100. So, the business is definately profitable.

Statement should look like:

Net Sales	610600
Cost of Goods sold:
Purchases	181000
-closing stock	-166000
Direct labour costs	110000
Manufacturing overhead	170000
Gross Profit	315600
Selling expense	70600
Administrative expenses	132000
Operating income	113000
Tax	33900
Net Income	79100

Total expense/cost = 663,600 - 166,000 = $497,600

No. of units sold during the year = 10,000

Unit cost of production = 497600 / 10000 = $49.76

This is again differenct that what Raymond mentioned in his remarks that unit cost of production is $66.36. Although, the correct unit cost of production is still higher than that of the competitor. The unit cost can be reduced furthur considering the fact that this is just the first year of operations.