Question

Empire Company is a manufacturer of smart phones. Its controller resigned in October 2017. An inexperienced assistant accountant has prepared the following income statement for the month of October 2020.EMPIRE COMPANYIncome StatementFor the Month Ended October 31, 2020Sales revenue $780,000Less:Operating expensesRaw materials purchases $264,000Direct labor cost 190,000Advertising expense 90,000Selling and administrative salaries 75,000Rent on factory facilities 60,000Depreciation on sales equipment 45,000Depreciation on factory equipment 31,000Indirect labor cost 28,000Utilities expense 12,000Insurance expense 8,000803,000Net loss $(23,000)Prior to October 2020, the company had been profitable every month. The company’s president is concerned about the accuracy of the income statement. As her friend, you have been asked to review the income statement and make necessary corrections. After examining other manufacturing cost data, you have acquired additional information as follows.1. Inventory balances at the beginning and end of October were:October 1 October 31Raw materials $18,000 $29,000Work in process 20,000 14,000Finished goods 30,000 50,0002. Only 75% of the utilities expense and 60% of the insurance expense apply to factory operations. The remaining amounts should be charged to selling and administrative activities.Prepare a letter to the president of the company, Shelly Phillips, describing the changes you made. Explain clearly why net income is different after the changes. Keep the following points in mind as you compose your letter.1. This is a letter to the president of a company, who is your friend. The style should be generally formal, but you may relax some requirements. For example, you may call the president by her first name.2. Executives are very busy. Your letter should tell the president your main results first (for example, the amount of net income).3. You should include brief explanations so that the president can understand the changes you made in the calculations.

Answer 1

Answer:

Tony Ohagwam, CPA, ACCA

Address & Telephone # & Email Address

June 26, 2020

The President

Empire Company

Address USA.

Attention: Shelly Phillips

Dear Shelly,

Re-Formatted Empire Company's Income Statement for the month ended October 31, 2020

As requested I have reformatted the company's Income Statement for the month ended October 31, 2020 (see attached), with some changes made.

The Net Income (not loss) is now $2,000.  This came about after taking into account the beginning and ending inventories of raw materials, work in process, and finished goods, which were not considered in the earlier version prepared internally.

The costs of Utilities and Insurance were re-classified into their factory and selling & administration elements.  The revised Income Statement also shows the cost of production, making it possible to determine the unit product cost.  There are also indications of the cost of sales and the gross profit.

With the re-classification of costs into factory and selling & administration expenses, you can review some of these costs to ascertain where cost-savings could be achieved.

I hope that this will encourage you to continue in business.

Yours sincerely,

Tony Ohagwam, CPA, ACCA

Explanation:

a) Utilities:

Factory, 75% of $12,000 = $9,000

Office, 25% of $12,000 = $3,000

b) Insurance:

Factory, 60% of $8,000 = $4,800

Office, 40% of $8,000 = $3,200

c) Preparation of the Income Statement for a manufacturing company should consider the various cost elements and classify them according to factory cost or cost of production, cost of sales, and cost of selling and administration.

This will help management to have a clearer picture of financial performance.  From this picture, it is easier for management to evaluate the various costs and make changes that will result to cost savings in order to ensure continued operations and profitability.

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