An indispensable part of any system of accounting is programmed of periodical statements and reports to inform management of the current financial position of the business and of the progress made by, and the costs incurred for, each process, department and division. The number of statements and reports and their characters differ according to the requirements of management of each business enterprise. The following statements and supporting cost reports are commonly prepared for the management; (1) balance sheet, (2) profit and loss statement or income statement supported by statement of cost of goods manufactured and sold. Balance sheet is a statement of assets and liabilities which reveals the financial position of the business. A balance sheet prepared for a manufacturing enterprise is similar in form and contents to the balance sheet of concerns engaged in merchandising activities, with the exception that it requires three inventory accounts i.e., raw materials, work in process and finished goods. The income statement of a manufacturing company and a merchandising company reflects the basic difference in operations of these two types of enterprises.
The manufacturing company transforms raw material into finished goods through the use of labor and factory facilities (for example, a company manufacturing furniture from wood or timber). A merchandising company, such as a retail furniture store which buys finished furniture and sells it in the same form i.e., sells the goods it buys without changing the basic form. The income statement which is prepared by a merchandising concern needs no calculations of cost of goods manufactured. But the income statements prepared by the manufacturing concern requires the calculations for the cost of goods manufactured. The income statement or condensed statement of profit and loss shows the profit or loss of the business, while the cost of goods manufactured and sold
statement reveals the cost to make and sell. The cost of goods sold section of the income statement of a manufacturing business can be divided into five distinct parts:
(1) Direct materials section; it comprises of beginning inventory, purchases and purchases returns and allowances and ending inventory.
(2) Direct labor section; it includes the cost of employees whose work can be identified directly with the product manufactured.
(3) Factory overhead; it comprises of all those costs that assist in an indirect manner in the manufacturing of the product e.g., indirect materials, indirect labor, depreciation of plant and machinery, depreciation of building, rent of factory building, repairs and insurance of factory plant and machinery etc. It is to be noted that with regard to factory overhead recording, there may be three possibilities:
(A) Only actual factory overhead incurred are given. (B) Only applied factory overhead are provided. (C) Both actual and applied factory overhead are given. When both actual and applied factory overhead are known then the difference is analyzed which is known as under or over applied factory overhead which is shown in the cost of goods sold or income statement. Under or Over Applied Factory Overhead is the difference of actual factory over head and applied factory overhead. I applied factory overhead are less than actual factory overhead, the variance is known as under applied factory overhead. On the other hand when applied factory overhead are more than the actual factory overhead, the variance is called over applied factory overhead. Under applied overhead are added while over applied overhead are deducted from cost of goods sold at normal.
(4) Work in process inventories; these represent the costs in process at the beginning and costs still in process at the end of the fiscal period.
(5) Finished goods inventories; These represent the cost of finished goods inventories present at the beginning and at the end of the fiscal period. The income statement is based upon the sales or revenue, costs and expenses of manufacturing, selling or marketing, administrating, other income and expense items. The income statement is the complementary to the balance sheet.