Question

Walton Manufacturing Company (CMC) was started when it acquired $94,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $64,400. CMC also incurred $78,200 of engineering design and planning costs. There was a debate regarding how the design and planning costs should be classified. Advocates of Option 1 believe that the costs should be classified as general, selling, and administrative costs. Advocates of Option 2 believe it is more appropriate to classify the design and planning costs as product costs. During the year, CMC made 4,600 units of product and sold 4,000 units at a price of $38.00 each. All transactions were cash transactions.

Required

1. a-1. Prepare an income statement and balance sheet under option 1.

2. a-2. Prepare an income statement and balance sheet under option 2.

3. b. Identify the option that results in financial statements that are more likely to leave a favorable impression on investors and creditors.

4. c. Assume that CMC provides an incentive bonus to the company president equal to 14 percent of net income. Compute the amount of the bonus under each of the two options. Identify the option that provides the president with the higher bonus.

5. d. Assume a 35 percent income tax rate. Determine the amount of income tax expense under each of the two options. Identify the option that minimizes the amount of the company’s income tax expense.

Answer 1

Ans) a1 & a2

Income statement	Option 1	Option 2
Units sold	4000	4000
Sales (4000*$38)	152000	152000
less;Cost of Goods Sold( Unit product cost * units sold)	56000	124,000
Gross Margin	96000	28000
less; Selling & adm Exp	78200
Net Operating Income/Loss	17800	28000

Calculation;

Unit Product cost= Total Production cost/no of produced unit

Option1= 64,400/4600= 14

Option2= 64,400+78200/4600=31

Balance Sheet	Option 1	Option 2
Assets
Cash (total Liability - Inventory)	103400	103400
Inventory (unsold units * Per unit product cost)	8400	18600
Total Current Assets	111800	122000
Total Assets	111800	122000
Liabilities
Common Stock	94000	94000
Retained Earnings	17800	28000
Total Liability & Equity	111800	122000

b) As the Net Operation Income is high in case of Option B, therefore it will leave a favorable impression on investors and creditors.

c) Option 2 provides higher amount of bonus.

	Option 1	Option 2
Net Operating Income	17800	28000
Bonus @ 14%	2492	3920

d) Option 1 minimizes the amount of the company’s income tax expense.

	Option 1	Option 2
Net Operating Income	17800	28000
tax @ 35%	6230	9800