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Cost and Management Accounting

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Cost & Management Accounting (MGT-402)
VU
LESSON# 5
PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS
Income Statement Ratios
Cost accountants are also required to analyze the results gathered from the financial
statements. These ratio analyses help the management to take certain decisions. These ratios do
not include complex ratios like financial ratios or investment ratio. Cost accountants are concerned
about the ratios relating to the profits and manufacturing cost. These might include:
1. Gross margin rate
2. Gross markup rate
3. Net profit ratio
4. Cost of goods sold to sales ratio
5. Inventory turnover ratio
6. Inventory holding period
These ratios will be calculated based on the information in the following cost of goods sold
statement and income statement.
Entity Name
Cost of Goods manufactured statement
for the year ended_______
Rupees
Direct Material Consumed
Opening inventory
10,000
Add Net Purchases
100,000
Material available for use
110,000
Less Closing inventory
(20,000)
Direct Material used
90,000
Add Direct labor
60,000
Prime cost
150,000
Add Factory overhead Cost (60,000 x 150%)
90,000
Total factory cost
240,000
Add Opening Work in process
30,000
Cost of good to be manufactured
270,000
Less Closing Work in process
50,000
Cost of good manufactured
220,000
Add Opening finish goods
100,000
Cost of good to be sold
320,000
Less closing finish goods
10,000
Cost of good to sold at normal
310,000
Income Statement
Rupees
Sales
600,000
Less Cost of goods sold (at normal)
(310,000)
Gross profit
290,000
Less Operating expenses
Selling and marketing
50,000
Distribution
30,000
Administrative
20,000
(100,000)
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Cost & Management Accounting (MGT-402)
VU
Operating profit
190,000
Less Financial Expenses
Interest on loan
(50,000)
Profit before tax
140,000
Less Income Tax
(60,000)
Net profit
80,000
Add over-applied FOH cost
10,000
Net profit
90,000
Gross Profit Margin Rate
Gross Profit margin rate = Gross Profit x 100 = %
Sales
This ratio identifies the ratio of gross profit over sales. In this ratio sale is held equal to 100%. The
%age of cost of goods sold is 100 ­ the %age margin. It means that if margin is 25% then %age
cost of goods sold will be 75%
Example:
290,000 x 100 = 48.33%
600,000
Gross Profit Markup Rate
Gross Profit markup rate =
Gross Profit
x 100 = %
Cost of goods sold
This ratio identifies the ratio of gross profit over cost of goods sold. In this ratio cost of goods
sold is held equal to 100%. The %age of sales is 100 + the %age of markup. It means that if
markup is 25% then %age of sales will be 125%
Example:
290,000 x 100 = 93.5%
310,000
These ratios are also known as cost structure ratios. The cost structure can best be explained as
below:
Incase of
Incase of
Margin
Markup
Sales
100%
125%
Cost of goods sold
75%
100%
Gross profit
25%
25%
As shown above in both of the cases gross profit is 25% but the base is different. Where the sale is
100% the cost of goods sold is 75%, where the cost of goods sold is 100% the sales is 125%.
At this stage some times sales figure is missing and it is required to calculate gross profit using the
margin rate (based on sales). The given information in this case is cost of goods sold. Most of the
students make a common error, they straight away calculate gross profit %age on the figure of cost
of goods sold, this is wrong in this situation as the base is the figure of sales which is not given.
Here the following formula will be used to calculate gross profit:
Required information = given information x
%age of required information
%age of given information
In the above situation where cost of goods sold is given and gross profit is to be calculated using
the margin rate (based on sales), following calculations will be followed:
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Cost & Management Accounting (MGT-402)
VU
Gross profit
=
Cost of goods sold (absolute amount) x 25%
75%
Same concept is followed where cost of goods sold figure is missing and it is required to calculate
gross profit using the markup rate (based on cost of goods sold). The given information in this
case is that of sales. Most of the students make a common error, they straight away calculate gross
profit %age on sales, this is wrong, as the base should be cost of goods sold where markup rate is
to be used. Here again the above formula will be used to calculate gross profit:
Required information = given information x
%age of required information
%age of given information
In the above situation where sales is given and gross profit is to be calculated using the markup
rate (based on cost of goods sold), following calculations will be followed:
Gross profit
=
Sales (absolute amount) x 25%
125%
Net Profit Ratio
Net Profit ratio = Net Profit x 100 = %
Sales
This ratio identifies the ratio of net profit over sales.
Example:
290,000 x 100 = 15%
600,000
Inventory turnover ratio
Inventory turnover ratio =
Cost of goods sold
Average inventory
Average inventory = Opening Inventory + Closing Inventory
2
Inventory turnover ratio =
310,000 = 5.54 times
55,000
Average inventory = 100,000 + 10,000 = 55,000
2
This ratio is expressed in times. It shows that, for how many time the inventory is turning over
towards cost of goods sold.
Inventory holding period
Inventory holding period in days =
Number of days in a year
Inventory turnover ratio
Alternatively
=
Average inventory x 365
Cost of goods sold
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Cost & Management Accounting (MGT-402)
VU
If this ratio is to be calculated in number of months then number of days will be replaced by
number of months in year.
Inventory holding period in months = 12 = 2.17 months
5.54
This ratio tells the period for which the inventory will remain in store/godown.
PRACTICE QUESTIONS
Q. 1
Sales = 800,000
Markup = 25% of cost
Calculate = COGS and Gross profit margin.
Hint:
Incase of
Incase of
Margin
Markup
Sales
100%
125%
Cost of goods sold
75%
100%
Gross profit
25%
25%
Gross profit
=
Sales (absolute amount) x 25%
125%
Q. 2
COGS = 50,000
GP Margin = 25% of sales
Calculate = Sales and gross profit margin
Hint:
Incase of
Incase of
Margin
Markup
Sales
100%
125%
Cost of goods sold
75%
100%
Gross profit
25%
25%
Gross profit
=
Cost of goods sold (absolute amount) x 25%
75%
Q. 3
Gross profit = 40,000
GP Margin = 25% of sales
Calculate = Sales and cost of goods sold
Hint:
Incase of
Incase of
Margin
Markup
Sales
100%
125%
Cost of goods sold
75%
100%
Gross profit
25%
25%
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Cost & Management Accounting (MGT-402)
VU
Sales
=
Gross profit (absolute amount) x 100%
25%
Cost of goods sold
=
Gross profit (absolute amount) x 75%
25%
Q. 4
Gross profit = 60,000
GP Markup = 25% of cost
Calculate = Sales and cost of goods sold
Hint:
Incase of
Incase of
Margin
Markup
Sales
100%
125%
Cost of goods sold
75%
100%
Gross profit
25%
25%
Sales
=
Gross profit (absolute amount) x 125%
25%
Cost of goods sold
=
Gross profit (absolute amount) x 100%
25%
Q. 5
Rupees
Sales
300,000
Direct Material purchased
100,000
Direct Labor
80,000
FOH
70,000
Increase in material inventory
10,000
Decrease in WIP inventory
5,000
Increase in finish goods inventory
30,000
Prepare cost goods sold statement and calculate the following ratios
1. Gross profit markup ratio
2. Gross profit margin ratio
3. Net profit ratio
4. Finished goods inventory turnover ratio
5. Finished goods inventory holding period in months
(Opening inventory Rs. 60,000 and Closing inventory Rs. 90,000)
Hint: Increase in inventory means closing inventory is greater than the opening inventory.
Decrease in inventory means closing inventory is lesser than the opening inventory.
Where the inventory is increased by a figure say Rs. 100, assume that the opening inventory was
zero and closing inventory is Rs. 100.
Where the inventory is decreased by a figure say Rs. 100, assume that the closing inventory is zero
and opening inventory was Rs. 100.
Q. 6
Total factory cost
?
WIP opening
20,000
WIP closing
10,000
Finish goods opening
30,000
Finis goods closing
50,000
Cost of goods sold
190,000
Calculate total factory cost
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Cost & Management Accounting (MGT-402)
VU
Hint:
Total factory cost will be calculated through a reverse calculation. Here cost of goods sold is given
this will be adjusted in reverse order for changes in finished goods inventory to get the figure of
cost of goods manufactured. The cost of goods manufactured will be adjusted in reverse order for
changes in work in process inventory to get the figure of total factory cost.
Q. 7
Opening material inventory
Rs. 10,000
Closing material inventory
5,000
Direct Labor
30,000
FOH
20,000
Total factory cost
80,000
Calculate the value of material purchased during the year.
Hint:
Cost of material consumed will be calculated through a reverse calculation starting from total
factory cost in which factory overhead cost and direct labor cost will be added, thereafter the cost
of material consumed will be adjusted in reverse order with the changes in material inventory to
know the amount of material purchased during the year.
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Table of Contents:
  1. COST CLASSIFICATION AND COST BEHAVIOR INTRODUCTION:COST CLASSIFICATION,
  2. IMPORTANT TERMINOLOGIES:Cost Center, Profit Centre, Differential Cost or Incremental cost
  3. FINANCIAL STATEMENTS:Inventory, Direct Material Consumed, Total Factory Cost
  4. FINANCIAL STATEMENTS:Adjustment in the Entire Production, Adjustment in the Income Statement
  5. PROBLEMS IN PREPARATION OF FINANCIAL STATEMENTS:Gross Profit Margin Rate, Net Profit Ratio
  6. MORE ABOUT PREPARATION OF FINANCIAL STATEMENTS:Conversion Cost
  7. MATERIAL:Inventory, Perpetual Inventory System, Weighted Average Method (W.Avg)
  8. CONTROL OVER MATERIAL:Order Level, Maximum Stock Level, Danger Level
  9. ECONOMIC ORDERING QUANTITY:EOQ Graph, PROBLEMS
  10. ACCOUNTING FOR LOSSES:Spoiled output, Accounting treatment, Inventory Turnover Ratio
  11. LABOR:Direct Labor Cost, Mechanical Methods, MAKING PAYMENTS TO EMPLOYEES
  12. PAYROLL AND INCENTIVES:Systems of Wages, Premium Plans
  13. PIECE RATE BASE PREMIUM PLANS:Suitability of Piece Rate System, GROUP BONUS SYSTEMS
  14. LABOR TURNOVER AND LABOR EFFICIENCY RATIOS & FACTORY OVERHEAD COST
  15. ALLOCATION AND APPORTIONMENT OF FOH COST
  16. FACTORY OVERHEAD COST:Marketing, Research and development
  17. FACTORY OVERHEAD COST:Spending Variance, Capacity/Volume Variance
  18. JOB ORDER COSTING SYSTEM:Direct Materials, Direct Labor, Factory Overhead
  19. PROCESS COSTING SYSTEM:Data Collection, Cost of Completed Output
  20. PROCESS COSTING SYSTEM:Cost of Production Report, Quantity Schedule
  21. PROCESS COSTING SYSTEM:Normal Loss at the End of Process
  22. PROCESS COSTING SYSTEM:PRACTICE QUESTION
  23. PROCESS COSTING SYSTEM:Partially-processed units, Equivalent units
  24. PROCESS COSTING SYSTEM:Weighted average method, Cost of Production Report
  25. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Accounting for joint products
  26. COSTING/VALUATION OF JOINT AND BY PRODUCTS:Problems of common costs
  27. MARGINAL AND ABSORPTION COSTING:Contribution Margin, Marginal cost per unit
  28. MARGINAL AND ABSORPTION COSTING:Contribution and profit
  29. COST VOLUME PROFIT ANALYSIS:Contribution Margin Approach & CVP Analysis
  30. COST VOLUME PROFIT ANALYSIS:Target Contribution Margin
  31. BREAK EVEN ANALYSIS MARGIN OF SAFETY:Margin of Safety (MOS), Using Budget profit
  32. BREAKEVEN ANALYSIS CHARTS AND GRAPHS:Usefulness of charts
  33. WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets
  34. Production & Sales Budget:Rolling budget, Sales budget
  35. Production & Sales Budget:Illustration 1, Production budget
  36. FLEXIBLE BUDGET:Capacity and volume, Theoretical Capacity
  37. FLEXIBLE BUDGET:ANALYSIS OF COST BEHAVIOR, Fixed Expenses
  38. TYPES OF BUDGET:Format of Cash Budget,
  39. Complex Cash Budget & Flexible Budget:Comparing actual with original budget
  40. FLEXIBLE & ZERO BASE BUDGETING:Efficiency Ratio, Performance budgeting
  41. DECISION MAKING IN MANAGEMENT ACCOUNTING:Spare capacity costs, Sunk cost
  42. DECISION MAKING:Size of fund, Income statement
  43. DECISION MAKING:Avoidable Costs, Non-Relevant Variable Costs, Absorbed Overhead
  44. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
  45. DECISION MAKING CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS:MAKE OR BUY DECISIONS