Question

Jordan Manufacturing Company (CMC) was started when it acquired $92,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $55,900. CMC also incurred $64,500 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 4,300 units of product and sold 3,700 units at a price of $38.00 each. All transactions were cash transactions. Required a-1. Prepare an income statement and balance sheet under option 1. a-2. Prepare an income statement and balance sheet under option 2. 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 11 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

a-1.			Income statement
						$
	Sales revenue				(3700*38)	140600
	Less: Cost of goods sold				(Note:1)	48100
	Gross margin					92500
	Less: General,selling and administrative cost					64500
	Net income					28000
	Note:1
	Product cost=Materials,labor and overhead=$ 55900
	Cost per unit=Total product cost/Number of units produced=55900/4300=$ 13
	Cost of goods sold=Units sold*Cost per unit=3700*13=$ 48100
			Balance sheet
						$
		Assets
	Cash		(140600+92000-55900-64500)			112200
	Inventory				(Note:2)	7800
	Total assets					120000
		Stockholder's equity
	Common stock					92000
	Retained earnings					28000
	Total stockholder's equity					120000
	Note:2
	Inventory=Units in inventory*Cost per unit
	Units in inventory=Units produced-Units sold=4300-3700=600 units
	Inventory=600*13=$ 7800
a-2.			Income statement
						$
	Sales revenue				(3700*38)	140600
	Less: Cost of goods sold				(Note:1)	103600
	Gross margin					37000
	Less: General,selling and administrative cost					0
	Net income					37000
	Note:1
	Product cost=Materials,labor and overhead+Design ad planning cost=55900+64500=$ 120400
	Cost per unit=Total product cost/Number of units produced=120400/4300=$ 28
	Cost of goods sold=Units sold*Cost per unit=3700*28=$ 103600
			Balance sheet
						$
		Assets
	Cash		(140600+92000-55900-64500)			112200
	Inventory				(Note:2)	16800
	Total assets					129000
		Stockholder's equity
	Common stock					92000
	Retained earnings					37000
	Total stockholder's equity					129000
	Note:2
	Inventory=Units in inventory*Cost per unit
	Units in inventory=Units produced-Units sold=4300-3700=600 units
	Inventory=600*28=$ 16800
b.	Option 2 is the most favorable financial statement since it provides more net income than option 1
c.	Incentive bonus=Net income*11%
	Option 1:
	Incentive bonus=28000*11%=$ 3080
	Option 2:
	Incentive bonus=37000*11%=$ 4070
	Option 2 gives the higher bonus
d.	Income tax expense=Net income*30%
	Option 1:
	Income tax expense=28000*30%=$ 8400
	Option 2:
	Income tax expense=37000*30%=$ 11100
	Option 1 minimizes the income tax expense