Cost Flows and Income Statement

Floyd’s Tap Company manufacturers an extensive range of high-quality brass and chrome

taps and has an excellent reputation for quality. The company is managed by John Smith and

employs 20 people. It has annual sales averaging approximately $10 million. Although it has

been consistently profitable, Floyd’s Tap Company has experienced increasing pressure from

competitors in recent years. The company uses a cost-plus approach to pricing but is having to

reduce its mark-up constantly to maintain market share.

John qualified as an engineer. The business is small and has never been able to employ an

accountant. Instead, a bookkeeper calculates monthly profit as sales revenue minus expenses.

Prices are based on rough estimates of the cost of direct material and direct labour inputs plus

a 50 per cent mark-up.

With the decline in profit and constant pressure on prices, John began to feel uneasy about the

way costs and profits were calculated. The results for the month ending 31 January were:

Floyd’s Tap Company Profit for the month ending January 2021

Sales		1,960,000
Less Expenses:
Materials purchased	600,000
Factory wages – production line	500,000
Production line supervisor’s salary	70,000
Premises	160,000
Council rates	10,000
Sales and admin staff salaries	220,000
Advertising	36,000
Equipment depreciation (incl. the Truck)	50,000
Electricity	24,000
Manager’s Salary (John’s) salary	160,000
Truck lease	20,000	(1,850,000)
Net profit		110,000

Additional information:
• The inventory levels for the month:
o Raw materials, 1 January $50,000
o Raw materials, 31 January $60,000
o Work in Process, 1 January $200,000
o Work in Process, 31 January $280,000
o Finished Goods, 1 January $95,000
o Finished Goods, 31 January $150,000
• The factory occupies 80 per cent of the premises, the sales area occupies 15 per cent
and administration 5 per cent.
• Most of the equipment is used for manufacturing, with only 5 per cent of the book value
being used for sales and administrative functions.
• Almost all the electricity is consumed in the factory.
• The truck is used to deliver finished goods to customers.
• John spends about half of his time on factory management, the rest of his time in the
sales area and on administration.

Required: Show ALL your workings.

(i) Comment on the cost classifications currently being used in Floyd’s Tap Company’s profit statement.

(ii) Prepare a schedule of cost of goods manufactured for the month.

(iii) Prepare a schedule of cost of goods sold for the month.

(iv) Prepare a revised income statement for the month .

(v) Explain what constitutes the difference between the income statement you prepared in

part (iv) and the profit statement prepared by the company’s bookkeeper.

(vi) Evaluate the usefulness of product costs based on direct materials and direct labour.