You have just been hired as an accountant by Capital Industries, a manufacturer of tools for the oil, gas and mining industries based in Geraldton. The tools produced by Capital Industries are specialised, high quality tools suited to very specific tasks as required by the oil, gas and mining industries and as such, are priced accordingly. The owner of the company, Brendan Pierce, has always believed in pricing a quality product based on how much their larger competitors are pricing theirs. His argument has been that “our product is as good, if not better, than the mass producers of tools, so we should be charging at least as much, if not more, than what they charge”.
When you arrived at work for the first time, you learnt that although the company has been in existence for the last twelve years, they have never had an accountant. The accounts were typically prepared by the Jodie Watts, secretary of Brendan Pierce, and Tom Nicholson, a part-time accountant who came in once or twice a month. Tom has informed Brendan that he could no longer spare the time to come in and has suggested the need for an accountant on a full time basis, which is why you have been hired. Brendan, though, is still not convinced of the need for a full time accountant. “Look, why do I need a full-time accountant? At the end of the day, all I need to do is total up my revenues, total up my expenses and the difference is my profit. Do I really need to understand my product costs? What is the purpose of that? It’s not like I can lower my prices if my product costs are lower. We have a great product that is better than what the big boys like
Halliburton sells. Therefore, if Halliburton are not lowering their prices, why should I? Why do I need to know what my product costs are?” asked Brendan.
Jodie, who has been the secretary cum bookkeeper (of sorts) since the day the company started has prepared some information for you. “I do not know much about accounting,” said Jodie. “But Tom has said that we need a Schedule of Cost of Goods Manufactured, a Schedule of Cost of Goods Sold, whatever those two means, and an Income Statement. I have last month’s accounts and some additional information that was prepared by Tom, for you. I have also included extra information in there in case you need them, though I do not know what is relevant and what is not. So could you please prepare those schedules and the Income Statement and get it to Brendan? He gets cranky when he does not have all the information he needs. ” The information provided by Jodie can be found in Appendix A.
Four days into your work, there was a fire over the weekend in the main office that stored the accounts. The manufacturing facility was not affected and work could go on, however, most of the information that was for the current month’s accounts was damaged and only partial fragments were readable. These are shown in Appendix B. Luckily your work on last month’s accounts were not affected as you had brought them home to complete and was still in process of completing them.
“You need to get me back all the information that’s now lost! If you can’t do it, I’ll get someone else who can!” cried Brendan when he saw you.
Sifting through ashes and interviewing selected employees, you have gathered some additional information (Appendix B). Jodie also informs you that an additional piece of information is also included in Appendix B regarding a job that may be of use to you.
You are now ready to reconstruct the accounts and give Brendan the information he needs before you lose your job! When you went in to tell him that you can now start working on the information, Brendan tells you that he has spoken to Tom (their previous part-time accountant) and that the following information are required: “Tom says we need the following information: the predetermined overhead rate, which is based on direct labour costs, the Overhead applied, and the balance of the work-in-process accounts. He also suggested that we should be looking at whether the overhead was over- or under-applied, whatever that means.”
As you were about to leave, Brendan stopped you. “Listen, Gabriel down in accounts, believes that if we can identify the variable and fixed components of our costs, it will help us make better planning and control decisions. He thinks that there is a correlation between machine hours and the amount of indirect materials used. He has derived a cost estimate using least-squares regression and provided me with a formula (Appendix C). He said that it was derived from 40 observations. I don’t really understand what it means and neither do most of my senior staff, so can you please explain it to us? Someone also said that a high-low method can be used to do the same thing, but no one seems to be sure how to do it, so can you have a look at the data and analyse it for us?”
“Make sure you put all that I have asked for in the report for the next meeting. We will be discussing all of that then!”
REQUIRED:
Prepare a report (no more than 10-pages) for Brendan Pierce that addresses the following:
a) The purpose of a product costing system.
b) Preparation of a Schedule of Cost of Goods Manufactured, Cost of Goods Sold and Income Statement (Use only Appendix A for this section).
c) Prepare a Schedule of Cost of goods manufactured and determine the following (based only on Appendix B):
i. Predetermined overhead rate for June;
ii. Overhead applied for the month of June;
iii. Ending balance of the work-in-process inventory in June; and, iv. Over- or under-applied overhead in the month of June.
d) Discuss how overheads can be over- or under-applied and how the company should deal with the over- or under-application.
e) Explain the figures found in the regression equation provided in Appendix C and use it to estimate the cost of indirect materials if 850 machine hours are to be used during a month (assume that 850 machine hours falls within the relevant range).
f) Explain how you would determine the validity of the data used for the regression.
g) Use the high-low method to estimate the behaviour of the company’s indirect materials cost, based on the data in Appendix C. State the cost behaviour pattern in equation form.
h) Determine which cost estimate (regression or high-low) you would recommend to Brendan and the senior managers and explain why.
Appendix A
Capital Industries
Statement of Cost of Goods Sold
For the month ended April 30, 2015
Inventory of Finished Goods, March 31, 2015 $ 50,000
Cost of Goods Manufactured 790,000

Cost of Goods Available for Sale 840,000
Inventory of Finished Goods, April 30, 2015 247,000
Cost of Goods Sold 593,000

Capital Industries
Pre-closing Account Balances 31 May 2015
Cash and Marketable Securities $ 54,000
Accounts and notes receivable 210,000
Direct materials inventory (30 April 2015) 28,000
Work-in-process Inventory (30 April 2015) 150,000
Finished Goods Inventory (30 April 2015) 247,000
Property, Plant and Equipment (nett) 1,140,000
Accounts, notes and taxes payable 70,000
Bonds payable 600,000
Paid-in capital 100,000
Retained earnings 930,000
Sales 1,488
Purchases of direct materials 510,000
Freight-inwards for materials purchases* 15,000
Direct labour 260,000
indirect factory labour 90,000
Office salaries 122,000
Sales salaries 42,000
Utilities* 135,000
Rent* 9,000
Property tax* 60,000
Insurance* 20,000
Depreciation* 54,000
* See additional information overleaf
Appendix A (continued)
Additional Information:
• Freight inwards is added to the cost of direct materials.
• Of the utilities, 80% relates to manufacturing of the tools and 20% relates to the sales and administrative functions.
• Rent is for the office building
• Property taxes are assessed on the manufacturing plant.
• 60% of the insurance is related to manufacturing of the tools and the remaining 40% is related to the sales and administrative functions.
• Depreciation includes the following:
Manufacturing Plant $ 20,000
Manufacturing Equipment 30,000
Office Equipment 4,000
• The inventory balances at 31 May 2015, follow:
o Direct materials $23,000 o Work-in-process 220,000 o Finished goods 175,000
• Income tax rate for the company is 25%.
Appendix B
Inventories, 1 June 2015
Materials inventory (all direct) $ 42,500
Work-in-process inventory (Job AG-12) $ 54,000
Finished goods inventory
Inventories, 30 June 2015 $ 75,000
Materials inventory (all direct) ?
Work-in-process inventory (Job CZ-46 and Job MT-23) ?
Finished goods inventory $ 96,080
Cost of goods sold, June $ 102,000
Direct materials purchased, June $ 25,000
Direct materials issued to production $ 63,340
Job AG-12 $ 21,340
Job CZ-46 $ 26,000
Job MT-23 $ 16,000
Factory labour-hours used (rate is $5.50 per hour)
Job AG-12 2,800
Job CZ-46 3,800
Job MT-23 1,700 Indirect labour 900
Other factory overhead costs incurred
Rent $ 29,500.00
Utilities $ 8,600.00
Repairs and maintenance $ 4,600.00
Depreciation $ 27,100.00
Other $ 6,600.00
Additional Information:
• Application of overhead is based on a predetermined overhead rate. The rate is calculated based on direct labour cost.
• Job AG-12 is the only job completed during the month. The total cost of Job AG-12 is $123,080.
Appendix C
• The cost formula as derived by Gabriel:
TMC = $190 + $5 MH,
Where TMC = Total monthly indirect materials cost MH = machine hours.
• Additionally, Gabriel has provided the following:
o R-squared = 0.8316 o Sample size = 40
• Gabriel has also prepared data concerning machine hours and indirect material usage for the highest and lowest month of activity (as measured by machine hours) for the past four years, which happened to be April and August:
April August
Machine hours…………………………..…
Indirect materials: 1,000 700
Beginning inventory…………………. $1,300 $1,000
Ending inventory……………………… 1,350 3,000
Purchases………………………..……... 5,900 6,200