Question

Jane Austen was hired during January 2017 to manage the home products division of Waco Products. As part of her employment contract, she was told that she would get $5,000 of additional bonus for every 1% increase that the division's profits exceeded those of the previous year. Soon after coming on board, Jane met with her plant managers and explained that she wanted the plants to be run at full capacity. Previously, the plant had employed just-in-time inventory practices and had consequently produced units only as they were needed. Jane stated that under previous management the company had missed out on too many sales opportunities because it didn't have enough inventories on hand. Because previous management had employed just-in-time inventory practices, when Jane came on board there was virtually no beginning inventory. The selling price and variable costs per unit remained the same from 2016 to 2017. Additional information is provided below. 2016 2017 Net income $ 300,000 525,000 Units produced Units sold 30,000 25,000 $1,350,000 $1,350,000 $45 25,000 25,000 Fixed manufacturing overhead costs Fixed manufacturing overhead costs per unit $54 Required: A. Calculate Jane's bonus based upon the net income shown above. B. Re-compute the 2016 and 2017 results using variable costing, c. What will Jane's bonus be under variable costing method? D. What do you think of Jane's action? E. Provide some measure that the company should provide to ensure that the employees will behave ethically based on the above scenario.

Answer 1

a)
Calculate Jane's bonus based upon the net income shown above
Net income increased  ($525,000 –$300,000)	$ 225,000.00
Percentage Increased ($225,000 ÷ $300,000)	75%
Jane’s bonus =  75 X $5,000	$ 375,000.00
b)
Re-compute the 2016 and 2017 results using variable costing,
	2016	2017
Net income Variable costing	$ 300,000.00	$ 300,000.00
In 2016 the number of units produced and sold were equal. Thus, in 2016, net income under variable costing would have been $300,000. In 2017, units produced exceede dunits sold by 5,000 units. However, net income under variable costing is not impacted by the number of units produced. Since the number of units sold did not change from 2016 to 2017, and the selling price, variable cost per unit, and total fixed costs didn’t change, the division’s net income in 2017 would equal its2016 income of $300,000.
c)
Jane would not receive a bonus since in part (b) it was determined that the division’s net income would have been $300,000 in 2017 under variable costing. Since this is the same as 2016 net income.
d)
Based on the information provided we cant actually determine Jane's motives. He may have believed that just-in-time inventory was causing the company to lose sales due to stock-outs. If Jane intentionally overproduced inventory in order to increase his bonus, then his actions were unethical. Overproduction of inventory increases the company’s costs related to inventory,such as storage, handling, waste and theft.
e). Provide some measure that the company should provide to ensure that the employees will behave ethically based on the above scenario
The company should provide following measure  to ensure that the employees will behave ethically based on the above scenario   instead totally giving up on just-in-time practices. In order to eliminate any potential conflicts of interest between Jane and the company  to ensure that his actions are in the best interest of the company, the company could begin preparing variable costing income statements to supplement its absorption costing statements for the purpose of calculating bonuses. This would eliminate any incentive Jane might have to over-produce, as well as providing useful information for other internal management decision making.