Classification of costs on financial statements

Statement of financial position (or balance sheet)

The statement of financial position of a manufacturing company is similar to that
of a merchandising company. However, their inventory account differ:
● A merchandising company has only one inventory account - the merchandise
inventory account. It refers to goods purchased from suppliers for resale to
customers.
● In contrast, manufacturing companies have three classes of inventories:
○ Raw materials​ are the materials that are used to make a product.
○ Work in process consists of units of product that are only partially
complete and will require further work before they are ready for sale to a
customer.
○ Finished goods consist of completed units of product that have not yet
been sold to customers.

The Income Statement

At first glance, the income statements of merchandising and manufacturing
companies are very similar. The only apparent difference is in the labels of some of the
entries in the computation of cost of goods sold. The computation of cost of goods sold
relies on the following basic equation for inventory accounts:
Basic Equation for Inventory Accounts
Beginning + Additions to = Ending + Withdrawals
Balance to inventory Balance from inventory
To calculate the ending balance therefore is as follows:
Beginning balance + Additions = Total available - Withdrawals = Ending balance

These concepts are used to determine the cost of goods sold for a merchandising
company as follows:
Cost of goods sold = Beginning merchandise + Purchases - Ending merchandise
Inventory inventory

The cost of goods sold for a manufacturing company is determined as follows:

Cost of goods sold = Beginning finished + Cost of goods - Ending finished
goods inventory manufactured goods inventory

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Schedule of Cost of Goods Manufactured
The schedule of cost of goods manufactured contains the three elements of
product costs discussed in Study Notes 1 - direct materials, direct labor and
manufacturing overhead. The schedule is presented in this manner:

Schedule of Cost of Goods Manufactured

Direct materials:
Beginning raw materials inventory xxx
Add: Purchases of raw materials xxx
Raw materials available for use xxx
Less: Ending raw materials inventory xxx
Raw materials used in production xxx
Direct labor xxx
Manufacturing overhead xxx
Total manufacturing cost xxx
Add: Beginning work in process inventory xxx
xxx
Less: Ending work in process inventory xxx
Cost of goods manufactured xxx
===

Illustrative problem:

The following data (in thousands of pesos) have been taken from the accounting records of
Lacop Corporation for the just completed year:

Sales P870,000

Purchases of raw materials P190,000

Direct labor P200,000

Manufacturing overhead P230,000

Administrative expenses P150,000

Selling expenses P140,000

Raw materials inventory, beg. P10,000

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 Raw materials inventory, end P40,000

Work in process inventory, beg. P20,000

Work in process inventory, end P50,000

Finished goods inventory, beg. P90,000

Finished goods inventory, end P130,000

Required:

1. Prepare a schedule of Cost of Goods Manufactured.

2. Compute the Cost of Goods Sold.
3. Using the data from your answers above as needed, prepare an Income Statement in
good form.

Answer to No. 1:
Lacop Corporation
Schedule of Cost of Goods Manufactured
For the year ended _________________

Raw materials inventory, beginning P10,000

Add: Purchases of raw materials 190,000
Raw materials available for use in production 200,000
Less: Raw materials inventory, end 40,000
Direct materials used in production P160,000
Direct labor 200,000
Manufacturing overhead 230,000
Total manufacturing costs P590,000
Add: Work in process inventory, beginning 20,000
Total cost of goods placed into production 610,000
Less: Work in process inventory, end 50,000
Cost of goods manufactured P560,000
=======

This schedule is the basic format of Cost of Goods Manufactured. The schedule
presents the three elements of product costs - direct materials, direct labor and
manufacturing overhead - that are used in the processing of the product. The sum of
these costs is identified as the total manufacturing costs. Work in process refers to the
total manufacturing costs of unfinished products as at the end of a period. Financial

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reports are prepared at the end of each period and work in process inventory are
accounted for as assets and presented in the statement of financial position. The cost of
goods manufactured will be charged (or debited) to the cost of goods sold.

Answer to No. 2 - computation of cost of goods sold:

Finished goods inventory, beginning P 90,000
Add: Cost of goods manufactured 560,000
Cost of goods available for sale P650,000
Less: Finished goods inventory, end 130,000
Cost of goods sold P520,000
=======

Answer to No. 3:
Lacop Corporation
Income Statement
For the year ended _____________

Sales P870,000
Less: Cost of goods sold 520,000
Gross income 350,000
Less: Operating expenses
Selling expenses P140,000
Administrative expenses 150,000 290,000
Net income P 60,000
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Note: Although the cost accounting system is also applicable to firms selling services,
we will focus only on manufacturing firms for our discussions on cost accounting.