Question

Campus Press produces textbooks for high school accounting courses. The company recently hired a new​ editor, Jean ​Green, to handle production and sales of books for an introduction to accounting course. Jean​'s compensation depends on the gross margin associated with sales of this book. Jean needs to decide how many copies of the book to produce. The following information is available for the fall semester 2017​:

Estimated sales 22,000 books
Beginning inventory 0 books
Average selling price $81 per book
Variable production costs $51 per book
Fixed production costs $418,000 per semester

The​ fixed-cost allocation rate is based on expected sales and is therefore equal to $ 418 comma 000​/22 comma 000 books​ = $ 19 per book.

Jean has decided to produce either 22,000​, 27,500​, or 29,700 books.

REQUIREMENTS:

1.
Calculate expected gross margin if Jean produces 22,000​, 27,500​, or 29,700 books.​ (Make sure you include the​ production-volume variance as part of cost of goods​ sold.)

2.
Calculate ending inventory in units and in dollars for each production level.

3.
Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. There are metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this​ objective? Show your work.
a. Incorporate a charge of 10​% of the cost of the ending inventory as an expense for evaluating the manager.
b. Include nonfinancial measures when evaluating management and rewarding performance.

1. Calculate expected gross margin if Jean produces 22,000​, 27,500​, or 29,700 books.​ (Make sure you include the​ production-volume variance as part of cost of goods​ sold.)
Calculate the gross margin for each level of production. Begin with 22,000 ​books, then 27,500 ​books, and lastly 29,700 books. ​(Enter a​ "0" for any zero balance accounts. If an account does not have a​ variance, do not select a​ label.)

Requirement 1

	22,000 Books	27,500 Books	29,700 Books
Revenues
Cost of goods sold
Production - volume variance (U/F?)
Net Cost of Goods Sold
Gross Margin

Requirement 2: Calculate ending inventory in units and in dollars for each production level.

Requirement 2

	22,000 Books	27,500 Books	29,700 Books
Beginning Inventory
Production
Sales
Ending Inventory
Cost Per Book
Cost of Ending Inventory

Requirement 3: Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. There are metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this​ objective? Show your work.

a. Incorporate a charge of 10​% of the cost of the ending inventory as an expense for evaluating the manager.

	22,000 books	27,500 books	29,700 books
Gross Margin
Ending inventory charge
Adjusted gross margin

Do you think the metric would accomplish the objective of discouraging managers from producing products in excess of​ demand?

Adjusting for ending inventory __________(Options: Does not, Does to some degree, will always)  mitigate the increase in inventory associated with excess production.​ Therefore, it may be_______(Options: Difficult, easy)  to mechanically compensate for all of the increased income. In​ addition, it _________(Options: does nothing to hold the manager responsible for the poor decisions, rewards the manager for increasing production which is a good decision) from the​ organization's standpoint.

b. Include nonfinancial measures when evaluating management and rewarding performance.

One nonfinancial measure is to compute the excess production ratio. Determine the​ formula, then compute the ratio at each production level. ​

# of books Production / Sales = Excess production ratio

	Production /	Sales Units	=Excess Production Ratio
22,000			=
27,500			=
29,700			=

A ratio of ending inventory to beginning inventory is _______(Options: Not Possible, Possible)

The​ non-financial measures ________(Options: are only needed if we don't use the inventory metric. ,must be incorporated into the reward function of the manager to be useful.)

Answer 1

Requirement 1
	22,000 Books	27,500 Books	29,700 Books
Revenues (22000 x $81 per book)	$ 17,82,000.00	$ 17,82,000.00	$ 17,82,000.00
Cost of goods sold (22000 x ($51 + $19)	$ 15,40,000.00	$ 15,40,000.00	$ 15,40,000.00
Production - volume variance (U/F?)	$                  -	$ -1,04,500.00	$ -1,46,300.00
	N	F	F
Net Cost of Goods Sold	$ 15,40,000.00	$ 14,35,500.00	$ 13,93,700.00
Gross Margin	$   2,42,000.00	$   3,46,500.00	$   3,88,300.00
Production Volume variance =   Budgeted fixed cost – fixed overhead rate × production
Production Volume variance (22000) =   $418000 - ($19 x 22000)	0	N
Production Volume variance (27500) =   $418000 - ($19 x 27500)	-104500	F
Production Volume variance (29700) =   $418000 - ($19 x 29700)	-146300	F
Requirement 2: Calculate ending inventory in units and in dollars for each production level.
Requirement 2	22,000 Books	27,500 Books	29,700 Books
Beginning Inventory	0	0	0
Production	22000	27500	29700
Sales	22000	22000	22000
Ending Inventory	0	5500	7700
Cost Per Book (51 + 19 )	70	70	70
Cost of Ending Inventory	0	385000	539000
Requirement 3: Managers who are paid a bonus that is a function of gross margin may be inspired to produce a product in excess of demand to maximize their own bonus. There are metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this​ objective? Show your work.
a. Incorporate a charge of 10​% of the cost of the ending inventory as an expense for evaluating the manager.	22,000 books	27,500 books	29,700 books
Gross Margin	$   2,42,000.00	$   3,46,500.00	$   3,88,300.00
Ending inventory charge	0	-38500	-53900
Adjusted gross margin	$   2,42,000.00	$   3,08,000.00	$   3,34,400.00
Do you think the metric would accomplish the objective of discouraging managers from producing products in excess of​ demand?
Adjusting for ending inventory Does to some degree  mitigate the increase in inventory associated with excess production.​ Therefore, it may be Difficult  to mechanically compensate for all of the increased income. In​ addition, it does nothing to hold the manager responsible for the poor decisions from the organization's standpoint.
b. Include nonfinancial measures when evaluating management and rewarding performance.
One nonfinancial measure is to compute the excess production ratio. Determine the formula, then compute the ratio at each production level.
# of books Production / Sales = Excess production ratio	Production /	Sales Units	Excess Production Ratio
	22000	22000	1
	27,500	22000	1.25
	29,700	22000	1.35
A ratio of ending inventory to beginning inventory is Not Possible
The non-financial measures must be incorporated into the reward function of the manager to be useful.