Scott Hewitt, the new plant manager of Old World Manufacturing plant Number 7, has just reviewed a draft of his year-end financial statements. Hewitt receives a year-end bonus of 10% of the plant's operating income before tax. The year-end income statement provided by the plant's controller was disappointing to say the least. After reviewing the numbers, Hewitt demanded that his controller go back and "work the numbers" again. Hewitt insisted that if he didn't see a better operating income the next time he would be forced to look for a new controller. Old World manufacturing classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the product is sold. All other expenses, including finished goods warehousing costs of $3250000 are classified as period expenses. Hewitt had suggested that warehousing costs be included as product costs because they are "definitely related to our product". The company produced 200,000 units during the period and sold 180,000 units.
As the controller reworked the numbers he discovered that if he included warehousing costs as product costs, he could improve operating income by $325,000. He was also sure that these new numbers would make Hewitt happy.
Required:
1. What are the ethical issues involved?
2. Show numerically how operating income would improve by $325,000 just by classifying the preceding costs as product costs instead of period expense?
3. Is Hewitt correct in his justification that these costs "are definitely related to our product"
Scott Hewitt, the new plant manager of Old World Manufacturing plant Number 7, has just reviewed a draft of his year-end financial statements. Hewitt receives a year-end bonus of 10% of the plant's operating income before tax. The year-end income statement provided by the plant's controller was disappointing to say the least. After reviewing the numbers, Hewitt demanded that his controller go back and "work the numbers" again. Hewitt insisted that if he didn't see a better operating income the next time he would be forced to look for a new controller. Old World manufacturing classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the product is sold. All other expenses, including finished goods warehousing costs of $3250000 are classified as period expenses. Hewitt had suggested that warehousing costs be included as product costs because they are "definitely related to our product". The company produced 200,000 units during the period and sold 180,000 units.
As the controller reworked the numbers he discovered that if he included warehousing costs as product costs, he could improve operating income by $325,000. He was also sure that these new numbers would make Hewitt happy.
Required:
1. What are the ethical issues involved?
2. Show numerically how operating income would improve by $325,000 just by classifying the preceding costs as product costs instead of period expense?
3. Is Hewitt correct in his justification that these costs "are definitely related to our product"
Related questions
Budgeted Income Statement and Balance Sheet
As a preliminary to requesting budget estimates of sales, costs, and expenses for the fiscal year beginning January 1, 20Y9, the following tentative trial balance as of December 31, 20Y8, is prepared by the Accounting Department of Regina Soap Co.:
| Cash | $108,400 | ||
| Accounts Receivable | 204,900 | ||
| Finished Goods | 43,000 | ||
| Work in Process | 28,700 | ||
| Materials | 47,100 | ||
| Prepaid Expenses | 3,500 | ||
| Plant and Equipment | 498,600 | ||
| Accumulated DepreciationâPlant and Equipment | $214,400 | ||
| Accounts Payable | 183,200 | ||
| Common Stock, $10 par | 250,000 | ||
| Retained Earnings | 286,600 | ||
| $934,200 | $934,200 |
Factory output and sales for 20Y9 are expected to total 25,000 units of product, which are to be sold at $90 per unit. The quantities and costs of the inventories at December 31, 20Y9, are expected to remain unchanged from the balances at the beginning of the year.
Budget estimates of manufacturing costs and operating expenses for the year are summarized as follows:
| Estimated Costs and Expenses | ||||
| Fixed (Total for Year) | Variable (Per Unit Sold) | |||
| Cost of goods manufactured and sold: | ||||
| Direct materials | _ | $23 | ||
| Direct labor | _ | 7 | ||
| Factory overhead: | ||||
| Depreciation of plant and equipment | $25,000 | _ | ||
| Other factory overhead | 7,800 | 4 | ||
| Selling expenses: | ||||
| Sales salaries and commissions | 89,800 | 11.5 | ||
| Advertising | 75,000 | _ | ||
| Miscellaneous selling expense | 6,500 | 2 | ||
| Administrative expenses: | ||||
| Office and officers salaries | 59,000 | 5.5 | ||
| Supplies | 3,000 | 1 | ||
| Miscellaneous administrative expense | 1,600 | 1.5 | ||
Balances of accounts receivable, prepaid expenses, and accounts payable at the end of the year are not expected to differ significantly from the beginning balances. Federal income tax of $178,400 on 20Y9 taxable income will be paid during 20Y9. Regular quarterly cash dividends of $1 per share are expected to be declared and paid in March, June, September, and December on 25,000 shares of common stock outstanding. It is anticipated that fixed assets will be purchased for $135,000 cash in May.
Required:
1. Prepare a budgeted income statement for 20Y9.
| Regina Soap Co. | |||
| Budgeted Income Statement | |||
| For the Year Ending December 31, 20Y9 | |||
| $ | |||
| Cost of goods sold: | |||
| $ | |||
| Cost of goods sold | |||
| Gross profit | $ | ||
| Operating expenses: | |||
| Selling expenses: | |||
| $ | |||
| Total selling expenses | $ | ||
| Administrative expenses: | |||
| $ | |||
| Total administrative expenses | |||
| Total operating expenses | |||
| Income before income tax | $ | ||
| $ | |||
2. Prepare a budgeted balance sheet as of December 31, 20Y9.
| Regina Soap Co. Budgeted Balance Sheet December 31, 20Y9 | |||
|---|---|---|---|
| Assets | |||
| Current assets: | |||
| Inventories: | |||
| Total current assets | |||
| Property, plant, and equipment: | |||
| Total property, plant, and equipment | |||
| Total assets | |||
| Liabilities | |||
| Current liabilities: | |||
| Stockholders' Equity | |||
| Total stockholdersâ equity | |||
| Total liabilities and stockholdersâ equity | |||
