1 answer

Gary Stevens and Mary James are production managers in the Consumer Electronics Division of General Electronics...

Question:

Gary Stevens and Mary James are production managers in the Consumer Electronics Division of General Electronics Company, whic
not want the bonus check, but the rest of us sure could use it. The final processing department in Marys production facility
Gary Stevens and Mary James are production managers in the Consumer Electronics Division of General Electronics Company, which has several dozen plants scattered in locations throughout the world. Mary manages the plant located in Des Moines, lowa, while Gary manages the plant in El Segundo, California. Production managers are paid a salary and get an additional bonus equal to 5% of their base salary if the entire division meets or exceeds its target profits for the year. The bonus is determined in March after the company's annual report has been prepared and issued to stockholders. Shortly after the beginning of the new year, Mary received a phone call from Gary that went like this: 1. Gary: How's it going, Mary? 2. Mary: Fine, Gary. How's it going with you? 3. Gary: Great! I just got the preliminary profit figures for the division for last year and we are within $200,000 of making the year's target profits. All we have to do is pull a few strings, and we'll be over the top! 4. Mary: What do you mean? 5. Gary: Well, one thing that would be easy to change is your estimate of the percentage completion of your ending work in process inventories. 6. Mary: I don't know if I can do that, Gary. Those percentage completion figures are supplied by Tom Winthrop, my lead supervisor, who I have always trusted to provide us with good estimates. Besides, I have already sent the percentage completion figures to corporate headquarters.Page 181 7. Gary: You can always tell them there was a mistake. Think about it, Mary. All of us managers are doing as much as we can to pull this bonus out of the hat. You may
not want the bonus check, but the rest of us sure could use it. The final processing department in Mary's production facility began the year with no work in process inventory. During the year, 210,000 units were transferred in from the prior processing department and 200,000 units were completed and sold. Costs transferred in from the prior department totaled $39,375,000. No materials are added in the final processing department. A total of $20,807,500 of conversion cost was incurred in the final processing department during the year. Required: 1. Tom Winthrop estimated that the units in ending work in process inventory in the final processing department were 30% complete with respect to the conversion costs of the final processing department. If this estimate of the percentage completion is used, what would be the cost of goods sold for the year? 2. Does Gary Stevens want the estimated percentage completion to be increased or decreased? Explain why, 3. What percentage completion would result in increasing reported net operating income by $200,000 over the net operating income that would be reported if the 30% figure were used? 4. Do you think Mary James should go along with the request to alter estimates of the percentage completion? Why or why not?

Answers

Solution :

  • This case is difficult—particularly part 3, which requires analytical skills.
  • Because there are no beginning inventories, it makes no difference whether the weighted-average or FIFO method is used by the company. You may choose to specify that the FIFO method be used rather than the weighted-average method.

1.

Computation of the Cost of Goods Sold:

Transferred In

Conversion

Units completed and sold

200,000

200,000

Ending work in process:

Transferred in:
10,000 units × 100% complete

10,000

Conversion:
10,000 units × 30% complete

3,000

Equivalent units of production

210,000

203,000

Transferred In

Conversion

Cost of beginning work in process

$ 0

$ 0

Cost added during the period

39,375,000

20,807,500

Total cost (a)

$39,375,000

$20,807,500

Equivalent units of production (b)

210,000

203,000

Cost per equivalent unit, (a) ÷ (b)

$187.50

$102.50

  Cost of goods sold = 200,000 units × ($187.50 per unit + $102.50 per unit) = $58,000,000

2. The estimate of the percentage completion of ending work in process inventories affects the unit costs of finished goods and therefore the cost of goods sold. Gary Stevens would like the estimated percentage completion of the ending work in process to be increased. The higher the percentage of completion of ending work in process, the higher the equivalent units for the period and the lower the unit costs.

3.

Increasing the percentage of completion can increase net operating income by reducing the cost of goods sold. To increase net operating income by $200,000, the cost of goods sold would have to be decreased by $200,000 from $58,000,000 down to $57,800,000. See the next page for the necessary calculations.

The percentage of completion, X, affects the cost of goods sold by its effect on the unit cost, which can be determined as follows:

Unit cost = $187.50 + $20,807,500 200,000 + 10,000X

  And the cost of goods sold can be computed as follows:

Cost of goods sold = 200,000 × Unit cost

Because the cost of goods sold must be reduced down to $57,800,000, the unit cost must be $289.00 ($57,800,000 ÷ 200,000 units). Thus, the required percentage completion, X, to obtain the $200,000 reduction in cost of goods sold can be found by solving the following equation:

$187.50 + $20,807,500 200,000 + 10,000X $289.00

$20,807,500 $289.00 - $187.50 200,000 + 10,000X $20,807,500 $101.50 200,000 + 10,000X 200,000 + 10,000X 1 $20,807,500 $101.50

Thus, changing the percentage completion to 50% will decrease cost of goods sold and increase net operating income by $200,000

3.   

Computation of the Cost of Goods Sold:

Transferred In

Conversion

Units completed and sold

200,000

200,000

Ending work in process:

Transferred in:
10,000 units x 100% complete

10,000

Conversion:
10,000 units x 50% complete

5,000

Equivalent units of production

210,000

205,000

Transferred In

Conversion

Cost of beginning work in process

$ 0

$ 0

Cost added during the period

39,375,000

20,807,500

Total cost (a)

$39,375,000

$20,807,500

Equivalent units of production (b)

210,000

205,000

Cost per equivalent unit, (a) ÷ (b)

$187.50

$101.50

  

  Cost of goods sold = 200,000 units × ($187.50 per unit + $101.50 per unit) = $57,800,000

4.

Mary is in a very difficult position. Collaborating with Gary Stevens in subverting the integrity of the accounting system is unethical by almost any standard. To put the situation in its starkest light, Stevens is suggesting that the production managers lie in order to get their bonus. Having said that, the peer pressure to go along in this situation may be intense. It is difficult on a personal level to ignore such peer pressure.

Moreover, Mary probably prefers not to risk alienating people she might need to rely on in the future. On the other hand, Mary should be careful not to accept at face value Gary’s assertion that all of the other managers are “doing as much as they can to pull this bonus out of the hat.” Those who engage in unethical or illegal acts often rationalize their own behavior by exaggerating the extent to which others engage in the same kind of behavior. Other managers may actually be very uncomfortable “pulling strings” to make the target profit for the year.

.

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