A step-by-step audio-narrated series of slides is provided on the text website at www.mhhe.com/edmonds2008 Tuscan Manufacturing Company makes a unique headset for use with mobile phones. During 2008, its first year of operations, Tuscan experienced the following accounting events. Other than the adjusting entries for depreciation, assume that all transactions are cash transactions.

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1. Acquired $850,000 cash from the issue of common stock.
2. Paid $50,000 of research and development costs to develop the headset.
3. Paid $140,000 for the materials used to make headsets, all of which were started and completed during the year.
4. Paid salaries of $82,200 to selling and administrative employees.
5. Paid wages of $224,000 to production workers.
6. Paid $48,000 to purchase furniture used in selling and administrative offices.
7. Recognized depreciation on the office furniture. The furniture, acquired January 1, had an $8,000 estimated salvage value and a four-year useful life. The amount of depreciation is computed as [(cost – salvage) ÷ useful life]. Specifically, [($48,000 – $8,000) ÷ 4 = $10,000].
8. Paid $65,000 to purchase manufacturing equipment.
9. Recognized depreciation on the manufacturing equipment. The equipment, acquired January 1, had a $5,000 estimated salvage value and a three-year useful life. The amount of depreciation is computed as [(cost – salvage) ÷ useful life]. Specifically, [($65,000 – $5,000) ÷ 3 = $20,000].
10. Paid $136,000 for rent and utility costs on the manufacturing facility.
11. Paid $41,000 for inventory holding expenses for completed headsets (rental of warehouse space, salaries of warehouse personnel, and other general storage costs).
12. Tuscan started and completed 20,000 headset units during 2008. The company sold 18,400 headsets at a price of $38 per unit.
13. Compute the average product cost per unit and recognize the appropriate amount of cost of goods sold.

Required

1. Show how these events affect the balance sheet, income statement, and statement of cash flows by recording them in a horizontal financial statements model.
2. Explain why Tuscan’s recognition of cost of goods sold expense had no impact on cash flow.
3. Prepare a formal income statement for the year.
4. Distinguish between the product costs and the upstream and downstream costs that Tuscan incurred.
5. The company president believes that Tuscan could save money by buying the inventory that it currently makes. The warehouse supervisor said that would not be possible because the purchase price of $27 per unit was above the $26 average cost per unit of making the product. Assuming that the purchased inventory would be available on demand, explain how the company president could be correct and why the warehouse supervisor could be biased in his assessment of the option to buy the inventory.

Solution to Requirement a

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Solution to Requirement b

The impact on cash flow occurs when Tuscan pays for various product costs. In this case, cash outflows occurred when Tuscan paid for materials, labor, and overhead. The cash flow consequences of these transactions were recognized before the cost of goods sold expense was recognized.

Solution to Requirement c

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Solution to Requirement d

Inventory product costs for manufacturing companies focus on the costs necessary to make the product. The cost of research and development (Event 2) occurs before the inventory is made and is therefore an upstream cost, not an inventory (product) cost. The inventory holding costs (Event 11) are incurred after the inventory has been made and are therefore downstream costs, not product costs. Selling costs (included in Events 4 and 7) are normally incurred after products have been made and are therefore usually classified as downstream costs. Administrative costs (also included in Events 4 and 7) are not related to making products and are therefore not classified as product costs. Administrative costs may be incurred before, during, or after products are made, so they may be classified as either upstream or downstream costs. Only the costs of materials, labor, and overhead that are actually incurred for the purpose of making goods (Events 3, 5, 9, and 10) are classified as product costs.

Solution to Requirement e

Since the merchandise would be available on demand, Tuscan could operate a just-in-time inventory system thereby eliminating the inventory holding expense. Since the additional cost to purchase is $1 per unit ($27 – $26), it would cost Tuscan an additional $20,000 ($1 × 20,000 units) to purchase its product. However, the company would save $41,000 of inventory holding expense. The warehouse supervisor could be biased by the fact that his job would be lost if the company purchased its products and thereby could eliminate the need for warehousing inventory. If Tuscan does not maintain inventory, it would not need a warehouse supervisor.