Question

Adams Manufacturing Company (CMC) was started when it acquired $95,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $70,500. CMC also incurred $70,500 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 4,700 units of product and sold 4,000 units at a price of $36.00 each. All transactions were cash transactions.

Required

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

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

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

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.

d. Assume a 30 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

X fac al AB $ 144,000 Option 1 income statement sales revenue materials, labor, and overhead costs contribution margin general, selling, and administrative costs net income $ 144,000 $ 60,000 $ 84,000 $ 70,500 $ 13,500 Option 2 income statement sales revenue less: cost of goods sold materials, labor, and overhead costs general, selling, and administrative costs net income $ 60,000 $ 60,000 $ 120,000 $ 24,000 balance sheet assets current assets cash $ 98,000 inventory $ 10,500 total assets $ 108,500 liabilities and stockholders' equity stockholders' equity common stock $ 95,000 retained earnings $ 13,500 total liabilities and stockholders' equity $ 108,500 balance sheet assets current assets cash inventory total assets liabilities and stockholders' equity stockholders' equity common stock retained earnings total liabilities and stockholders' equity $ 98,000 $ 21,000 $ 119,000 $ 95,000 $ 24,000 $ 119,000

financial statements under Option 2 are more likely to leave a favorable impression on investors and creditors reason - because under Option 2, the company's net income and total assets are more than Option 1 bonus under Option 1 = $13,500 * 14% = $1,890 bonus under Option 2 = $24,000 * 14% = $ 3,360 Option 2 provides the president with higher bonus income tax expense under Option 1 = ($13,500 - $1,890) * 30% = income tax expense under Option 2 = ($24,000 - $3,360) * 30% = $ 3,483 $ 6,192

for formulas and calculations, refer to the image below -

X fx al -4000*36 Option 1 income statement sales revenue =4000*36 materials, labor, and overhead costs =70500/4700*4000 contribution margin =D4-D5 general, selling, and administrative costs 70500 net income =D6-D7 Option 2 income statement sales revenue less: cost of goods sold materials, labor, and overhead costs =70500/4700*4000 general, selling, and administrative costs |=70500/4700*4000 net income =H6+H7 =14-17 balance sheet assets current assets cash =95000+144000-70500-70500 inventory =70500/4700*700 total assets =SUM(D13:014) liabilities and stockholders' equity stockholders' equity common stock 95000 retained earnings =D8 total liabilities and stockholders' equity =SUM(D18:D19) balance sheet assets current assets cash =95000+144000-70500-70500 inventory =(70500+70500)/4700*700 total assets =SUM(H13:H14) liabilities and stockholders' equity stockholders' equity common stock 95000 retained earnings =18 total liabilities and stockholders' equity =SUM(H18:H19)

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