Question

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

Answer 1

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 $101.50 200,000 + 10,000X = $20,807,500 $101.50 200,000 + 10,000X = 205,000 10,000X = 205,000 - 200,000 10,000X = 5,000 X = 5,000 = 50% 10,000

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.