Importance of cost classification and ethicsCooke Manufacturing Company (CMC) was started...

Importance of cost classification and ethics

Cooke Manufacturing Company (CMC) was started when it acquired $40,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $24,000. CMC also incurred $16,000 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 upstream 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 4,000 units of product and sold 3,000 units at a price of $24 each. All transactions were cash transactions.

Required

a.Prepare an income statement, balance sheet, and statement of cash flows under each of the two options.

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 CFO who is a CMA. The bonus is equal to 13 percent of net income. Compute the amount of the bonus under each of the two options. Identify the option that provides the CFO with the higher bonus.

d.Assume the CFO knows that the design and planning costs are upstream costs that must be recognized as general, selling, and administrative expenses (Option 1). Even so, the CFO convinces management to classify the upstream costs as product cost in order to increase his bonus. Identify two principles in the Statement of Ethical Professional Practice that are violated by the CFO’s behavior.

e.Comment on the conflict of interest between the company president as determined in Requirement c and owners of the company as indicated in Requirement d. Describe an incentive compensation plan that would avoid a conflict of interest between the president and the owners.