Question:

A distraught employee, Fang W. Arson, put a torch to a manufacturing plant on a blustery February 26.
The resulting blaze destroyed the plant and its contents. Fortunately, certain accounting records were
kept in another building. They reveal the following for the period from January 1, 2011 to February 26,
2011: Direct materials purchased $160,000, Work-in-process inventory, 1/1/2011 $34,000 Direct
materials inventory, 1/1/2011 $16,000 Finished goods inventory, 1/1/2011 $30,000 Manufacturing
overhead costs 40% of conversion costs, Revenues $500,000, DL $180,000, Prime cost $294,000, Gross
margin percentage base on revenues 20%, Cost of goods available for sale $450,000. The loss is fully
covered by insurance. The insurance company wants to know the historical cost of the inventories as a
basis for negotiating a settlement, although the settlement is actually is actually to be based on
replacement cost, not historical cost. Calculate the cost of: 1. Finished goods inventory, 2/26,2009 2.
Work in process inventory, 2/26/2009 3. Direct materials inventory, 2/26/2009 This question has already
been answered but I am unsure about how overhead and cost of goods sold was calculated. Here is the
calculation for overhead: ($180,000/60)x40 – Where did the 60 and 40 come from? Here is the
calculation for COGS: $500,000x80% - Where did the 80% come from?

Answer:

Calculation of Overhead.

Conversion costs are the combination of direct labor costs plus manufacturing overhead costs.
As per this definition,

Direct Labor + Manufacturing Overhead = Conversion Costs.

Now, it has been given in the question that Manufacturing overhead is 40% of Conversion costs

So, putting this value in above equation,

Direct Labor + 40% of Conversion costs = Conversion Costs.

So, Direct Labor = Conversion Costs - 40% of Conversion costs

So, Direct Labor = 60% of Conversion Costs

So, Conversion Costs = Direct Labor / 60%

Now, Manufacturing overhead = 40% of Conversion costs

= 40% of (Direct Labor / 60%)

= ($180,000/60)x40

= $120,000
Calculation of COGS

It has been given that Gross margin percentage base on revenues is 20%.

When we deduct margin from revenue, the resultant is COGS.

Let Revenue = 100

Margin = 20% of 100 = 20

So, COGS = 100-20 = 80

So, COGS is 80% of Revenue = 80% of $500,000 = $400,000