William Nelson, the chief accountant of West Texas Guitar Company, was injured in an automobile accident shortly before the end of the company’s first year of operations. At year-end, a clerk with a very limited understanding of accounting prepared the following income statement, which is unsatisfactory in several respects:

You are asked to help management prepare a corrected income statement for the first year of operations. Management informs you that 60 percent of the rent, insurance, and utilities applies to factory operations, and that the remaining 40 percent should be classified as period expenses. Also, the correct ending inventories are as follows:
Material. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 38,000
Work in process . . . . . . . . . . . . . . . . . . . . . . . . 10,000
Finished goods . . . . . . . . . . . . . . . . . . . . . . . 110,400

As this is the first year of operations, there were no beginning inventories.

Instructions
a. Identify the shortcomings and errors in the above income statement. On the basis of the shortcomings you have identified, explain whether you would expect the company’s actual net income for the first year of operations to be higher or lower than the amount shown.
b. Prepare schedules to determine:
1. The cost of direct materials used.
2. Total manufacturing overhead.
c. Prepare a schedule of cost of finished goods manufactured during the year. (Use the amounts computed in part b as the costs of direct materials used and manufacturing overhead.)
d. Prepare a corrected income statement for the year, using a multiple-step format. Assume that income tax expense amounts to 30 percent of income before incometaxes.

Transcribed Image Text:

WEST TEXAS GUITAR COMPANY INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20- 1,300,000 Net sales. Cost of goods sold: Purchases of direct materials Direct labor. Indirect labor Depreciation on machinery factory Rent Insurance .- Utilities Miscellaneous manufacturing overhead . .. 4 Other operating expenses Dividends declared on capital stock $460,000 225,000 . 90,000 50,000 144,000 ..16,000 28,000 34,600 273,800 46,000 Cost of goods sold Loss for year $(1,367,400) $(67,400) .