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MGT101 - Financial Accounting - I - Lecture Handout 16

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COST OF GOODS SOLD STATEMENT AND VALUATION OF STOCK

In manufacturing concern, separate books are maintained to keep the record of every single work done in manufacturing process to ascertain cost incurred on production of goods. This record gives information about total cost incurred on manufacturing process and per unit cost of goods manufactured. When goods are produced, these are sold to the customers of the business and goods unsold are taken into stock. At the end of the financial year, manufacturing concern prepares a statement which gives the brief summary of the whole process.

This statement shows the value of raw material consumed, amount spent on labor and other factory expenses, finished goods produced and goods unsold (in stock). Such statement is called ‘cost of goods sold statement’. Manufacturing concerns, while presenting financial statements, also present cost of goods sold statement.

Standard format of cost of goods sold statement is given below:

Raw Material: O/S Raw Material
+ Purchases
+ Cost Incurred to Purchase RM
- C/S Raw Material
Cost of Material Consumed
Conversion Cost: + Direct Labor Cost
+ Factory Overheads
Total Factory Cost
Work in Process + O/S of WIP
- C/S of WIP
Cost of Goods Manufactured
Finished Goods + O/S of Finished Goods
- C/S of Finished Goods
Cost of Good Sold

Cost of material consumed – is the cost of material used for consumption that has been put in the production process. This head shows the raw material left unused from the previous year(opening stock), raw material purchased in the current year, expenses incurred in bringing the purchased material into the business premises and raw material that is not used in the current year (closing stock).

Over Heads Costs----are the other costs incurred in relation of manufacturing of goods.
Examples are factory utilities, supervisor salaries, equipment repairs etc.

Total factory cost – is the cost of material consumed plus labor and over heads. In other words it is the total cost incurred in the factory.

Cost of goods manufactured – is total factory cost plus opening stock of work in process less closing stock of work in process.

Cost of goods sold – is the cost of goods manufactured plus opening stock of finished goods less closing stock of finished goods.

Prime/Basic Cost = Cost of Direct Material Consumed + Direct Labor cost

Conversion cost it is the cost incurred to convert raw material to finished goods.

Conversion cost = Labor cost + factory overhead

Example
Using the following data calculate the Cost of Goods Sold of XYZ Co.

Stock levels O/S Rs. C/S Rs.
Raw material 100,000 85,000
Work in process 90,000 95,000
Finished goods 150,000 140,000
  • Purchase of raw material during the period Rs. 200,000
  • Paid to labor Rs. 180,000 out of which Rs. 150,000 used on production.
  • Other production costs Rs. 50,000

Solution

XYZ Co.
Cost of Goods Sols Statement
For the period ended-------
Raw Material:

Opening Stock Raw Material
+ Purchases
+ Cost Incurred to Purchase RM
- Closing Stock Raw Material
Cost of Material Consumed

100,000

200,000

(85,000)

215,000
Conversion Cost + Labor Cost
+Factory overhead 50,000

150,000

50,000

 
Total Factory Costs      
Work in process + O/S of WIP
- C/S of WIP

 

 

90000

(95000)

Cost of Goods Manufactured      
Finished Goods + O/S of Finished Goods
- C/S of Finished Goods
 

150,000

(140,000)

Cost of Goods Sold     420,000

Illustration

Following information of Ahmad & Company is given. Prepare a cost of goods sold statement.

Stock levels O/S Rs. C/S Rs.
Raw material 150,000 115,000
Work in process 50,000 55,000
Finished goods 120,000 100,000
  • Purchase of raw material during the period Rs. 100,000
  • Transportation charges of items purchased Rs. 5,000
  • Paid to labor Rs. 100,000.
  • Other production costs(FOH) Rs. 80,000

Solution

Raw Material: Opening Stock Raw Material 150,000
  + Purchases 100,000
  + Cost Incurred to Purchase RM 5,000
  - Closing Stock Raw Material (115,000)
  Cost of Material Consumed 140,000
Conversion Cost: + Labor 100,000
  + Factory Overheads 80,000
  Total Factory Cost 320,000
Work in Process: + O/S of WIP 50,000
  - C/S of WIP (55,000)
  Cost of Goods Manufactured 315,000
Finished Goods: + O/S of Finished Goods 120,000
  - C/S of Finished Goods (100,000)
  Cost of Good Sold 335,000

Stock Card

Stock card is used to keep the record of what has come in stock and what has gone out of it. Standard format of stock card is given below:

Stock Account Item 01
Date Receipts Qty Rate Amount Date Issues Qty Rate Amount
                   

Stock card has two parts:
• Receipt side
• Issue side

Both sides have similar columns that include:
• Nature of item to be kept in stock
• Quantity of items
• Rate at which it was purchased
• Total value of items

Receipt side is used to record data of items coming in the stock and issue side is used to record information of goods issued for manufacturing process.

Valuation of Stock

Any manufacturing organization purchases different material through out the year. The prices of purchases may be different due to inflationary conditions of the economy. The question is, what item should be issued first & what item should be issued later for manufacturing. For this purpose, the organization has to make a policy for issue of stock. All the issues for manufacturing and valuation of stock are recorded according to the policy of the organization. Mostly these three methods are used for the valuation of stock:
Methods of Stock valuation
• First in first out (FIFO)
• Last in first out (LIFO)
• Weighted average

First in first out (FIFO)
The FIFO method is based on the assumption that the first merchandise purchased is the first
merchandised issued. The FIFO uses actual purchase cost. Thus, if merchandise has been purchased at
several different costs, the inventory (stock) will have several different cost prices. The cost of goods sold
for a given sales transaction may involve several different cost prices.

Characteristics

  • This is widely used method for determining values of cost of goods sold and closing stock.
  • In the FIFO method, oldest available purchase costs are transferred to cost of goods sold. That means the cost if goods sold has a lower value and the profitability of the organization becomes higher.
  • As the current stock is valued at recent most prices, the current assets of the company have the latest assessed values.

Last in first out (LIFO)

As the name suggests, the LIFO method is based on the assumption that the recently purchased merchandise is issued first. The LIFO uses actual purchase cost. Thus, if merchandise has been purchased at several different costs, the inventory (stock) will have several different cost prices. The cost of goods sold for a given sales transaction may involve several different cost prices.

Characteristics

  • This is alternatively used method for determining values of cost of goods sold and closing stock.
  • In the LIFO method recent available purchase costs are transferred to cost of goods sold. That means the cost of goods sold has a higher value and the profitability of the organization becomes lower.
  • As the current stock is valued at oldest prices, the current assets of the company have the oldest assessed values.

Weighted average method

When weighted average method is in use, the average cost of all units in inventory, is computed after every purchase. This average cost is computed by dividing the total cost of goods available for sale by the number of units in inventory. Under the average cost assumption, all items in inventory are assigned the same per unit cost. Hence, it does not matter which units are sold; the cost of goods sold is always based on current average unit cost.

Characteristics

  • Under the average cost assumption, all items in inventory are assigned same per unit cost (the average cost). Hence it does not matter which units are sold first. The cost of goods sold is always on the current average unit cost.
  • Since all inventories are assigned same cost, this method does not make any effect on the profitability and does not increase/decrease any asset in the financial statements.
  • This is the alternatively used method for determining values of cost of goods sold and closing stock.

Example
Receipts:

  • 01 Jan 20--, 10 units @ Rs. 150 per unit
  • 02 Jan 20--, 15 units @ Rs. 200 per unit
  • 10 Jan 20--, 20 units @ Rs. 210 per unit

Issues:

  • 05 Jan 20--, 05 units
  • 06 Jan 20--, 10 units
  • 15 Jan 20--, 15

FIFO Method of Stock Valuation

Date Receipts Issues Value of Stock
01-01-20- 10 @ Rs. 150 =1,500   10 x 150 = 1500
02-01-20-- 15 @ Rs. 200 = 3,000   10 x 150 = 1500
15 x 200 = 3000 4500
05-01-20--   5 @ 150 = 750 750 5 x 150 = 750
15 x 200 = 3000 3750
06-01-20--   5 @ 150 = 750
5 @ 200 = 1000 1750
0 x 150 = 0
10 x 200 = 2000 2000
10-01-20-- 20 @ Rs. 210=4200   10 x 200 = 2000
20 x 210 = 4200 6200
15-01-20--   10 @ 200 = 2000
5 @ 210 = 1050 3050
0 x 200 = 0
15 x 210 = 3150 3150

Weighted Average Method of Stock Valuation

Date Receipts Issues Value of Stock Average
Cost
01-01-20- 10x150 = 1500   1500 1500/10=150
02-01-20-- 15x200 = 3000   1500 + 3000 = 4500 4500/25=180
05-01-20--   5x180 = 900 4500 – 900 = 3600 3600/20=180
06-01-20--   10x180 = 1800 3600 – 1800 = 1800 1800/10=180
10-01-20-- 20x210 = 4200   1800 + 4200 = 6000 6000/30=200
15-01-20--   15x200 = 3000 6000 – 3000 = 3000 3000/15=200

Effects of valuation method on profit

FIFO Method

  • Cost of Sales = 750 + 1750 + 3050 = 5,550
    Gross Profit = 7500 – 5550 = 1,950

Weighted Average Method

  • Cost of Sales = 900 + 1800 + 3000 = 5,700
    Gross Profit = 7500 – 5700 = 1,300

NOTE: Rs. 7,500 is assumed value.

Illustration

Hamid & company is a manufacturing concern. Following is the receipts & issues record for the month of May, 2002

Date Receipts Issues
May 7 200 units @ Rs. 50/unit  
May 9   60 units
May 13 150 units @ Rs. 75/unit  
May 18 100 units @ Rs. 60/unit  
May 22   150 units
May 24   100 units
May 27 100 units @ Rs. 50/unit  
May 30   200 units

Calculate the value of closing stock by

  • FIFO Method
  • Average Method

Solution

Valuation of Stock by FIFO Method

Date Receipts Issues Value of
Stock
Total
Amount
Remaining
No. of
units
Net
Balance
May 7 200 units @ Rs. 50/unit   200 x 50 =
10,000
10,000 200 10,000
May 9   60 units @
Rs. 50/unit
60 x 50 =
3,000
(3,000) 140 7,000
May 13 150 units @ Rs. 75/unit   75 x 150 =
11,250
11,250 290 18,250
May 18 100 units @ Rs. 60/unit   60 x 100 =
6,000
6,000 390 24,250
May 22   140 units @
Rs. 50/unit
10 units @
Rs. 75/unit
50 x 140 =
7,000
10 x 75 =
750
(7,750) 240 16,500
May 24   100 units @
Rs. 75/unit
75 x 100
=7,500
(7,500) 140 9,000
May 27 100 units @ Rs. 50/unit   50 x 100 =
5,000
5,000 240 14,000
May 30   40 units @
Rs. 75/unit
100 units @
Rs. 60/unit
60 units @
Rs. 50/unit
75 x 40 =
3,000
60 x 100 =
6,000
50 x 60 =
3,000
(12,000) 40 2,000

Valuation of Stock by Weighted Average Method:

Date Receipts Issues Value of
Stock
Total
Amount(Rs.)
Total
Units
Average
Cost(Rs.)/unit
Net Balance
(Rs.)
May 7 200 units
@ Rs.
50/unit
  200 x 50
=
10,000
10,000 200 50 10,000
May 9   60
units
60 x 50 =
3,000
(3,000) 140   7,000
May 13 150 units
@ Rs.
75/unit
  75 x 150 =
11,250
7,000+11250
=
18250
140+150
=
290
18250/290
=
62.9
18,250
May 18 100 units
@ Rs.
60/unit
  60 x 100 =
6,000
18250+6000
=
24250
290+100
=
390
24250/390
=
62.2
24,250
May 22   150
units
150 x 62.2
=
9330
(9,330) 390-150
=
240
  14,920
May 24   100
units
100 x 62.2
=
6220
(6,220) 240-100
=
140
  8,700
May 27 100 units
@ Rs.
50/unit
  100 x 50
=
5,000
8,700+5,000
=
13,700
140+100
=
240
13700/240
=
57.1
13,700
May 30   200
units
200 x 57.1
=
11,420
(11,420) 240-200
=
40
  2,280

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