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Gray Stevens and Mary James are production managers in the customer electronics division of...

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Gray Stevens and Mary James are production managers in the customer 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, Iowa, while Gary manages the plant in EI 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 the target profit for the year.

The bonus is determined in March after the company's annual report has been prepared and issued to shareholders.

Shortly after the beginning of the New Year, Mary received a phone call from Gary that went like this:

Gary: How's it going, Mary?

Mary: Fine, Gary. How?s it going with you?

Gary: Great! I just got the preliminary profit figures for the division for the last year and we are with in $200,000 of making the year's target profits. All we have to do is to pull a few strings, and we'll be over the top!

Mary: What do you mean?

Gary: Well. One thing that would easy to change is your estimate of the percentage completion of your ending work in progress inventories.

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 sends the percentage completion figures to corporate headquarters.

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 not want the bonus check, but rest of us sure could use it.

The final processing department in Mary's production facility began the year with no work in progress inventories.

During the year, 210,000 units were transferred in from the prior processing department and 200,000 units were completed and sold.

Cost transferred in from the prior department totaled $39,375,000.

No materials are added in final processing department.

A total of $20,807,500 of conversion cost was incurred in the final processing department during the year.

Required:

1. Tom Winthrop estimated that the units in the ending inventory in the final processing department were 30% complete with respect to conversion costs of final processing department.

If this estimate of percentage completion is used, what would be the cost of goods sold for the year?

2. Does Gary Stevens want the estimated percentage to be increased of decreased?

Explain why?

3. What percentage completion would result in increasing reported net operating income by $200,000 over the net operating income that would be reported if the 30% figure were used?

4. Do you think Mary James should go along with the request to alter estimates of percentage completion?

5. If you are the CEO of the company, what do you think when you know this issue?

Any action to take?

Cost of goods sold:

Cost of goods sold is the book value of the goods that have been sold during the accounting period. Cost of goods sold is used to calculate the gross profit by detecting the cost of goods sold from the revenue.

Answer and Explanation:

1) Calculation of cost of goods sold for the year:

Given cost of transferred goods from prior department (210,000 units) = $39,375,000.

{eq}Transferred \ cost \ of \ completed \ and \ sold \ goods \ (200,000 \ units) = \dfrac{\$39,375,000}{210,000} \times 200,000 {/eq}

Transferred cost of completed and sold goods (200,000 units) = 37,500,000.


Given conversion cost incurred in final processing department (200,000 Completed units + 30% Completed of remaining goods) equal to $20,807,500.

{eq}Conversion \ cost \ of \ completed \ and \ sold \ goods \ (200,000 \ units) = \dfrac{\$20,807,500}{200,000} + 30\% (10,000) \times 200,000 {/eq}

Conversion cost of completed and sold goods (200,000 units) = $20,500,000.


Cost of goods sold for the year = Transferred cost + Conversion cost.

Cost of goods sold for the year = $37,500,000 + $20,500,000.

Cost of goods sold for the year = $58,000,000.


2) Does Gary Stevens want the estimated percentage to be increase or decrease.

Option 1: If the estimated percentage is decreased to 20% then the cost of goods for the year is,

Conversion cost of completed and sold goods (200,000 units) when the percentage is 20% {eq}= \dfrac{\$20,807,500}{200,000} + 20\% (10,000) \times 200,000 {/eq}

Conversion cost of completed and sold goods (200,000 units) when percentage is 20% = $20,601,485.


Cost of goods for the year is when estimated percentage is decreased to 20% = $37,500,000 + $20,601,485.

Cost of goods for the year is when the estimated percentage is decreased to 20% = $58,101,485.


Option 2: If estimated percentage is increased to 40% then cost of goods for the year is,

Conversion cost of completed and sold goods (200,000 units) when percentage is 40% {eq}= \dfrac{\$20,807,500}{200,000} + 40\% (10,000) \times 200,000 {/eq}

Conversion cost of completed and sold goods (200,000 units) when percentage is 40% = $20,399,510.


Cost of goods for the year is when estimated percentage is increased to 40% = $37,500,000 + $20,399,510

Cost of goods for the year is when the estimated percentage is increased to 40% = $57,899,510.

From the above, we absorbed that when an estimated percentage is increased to 40% results in a decrease in the cost of 100,490 (profit increased) Gary Stevens would want an increase in estimated percentage so he can avail the bonus.


3) Calculation of percentage at which results in an increase in net operating income by $200,000:

To increase net operating income by $200,000 then the cost of goods sold for the year would be $57,800,000.

Cost conversion would be at the cost of goods sold of $57,800,000 = $57,800,000 - $37,500,000

Cost conversion would be at the cost of goods sold of $57,800,000 = $20,300,000.

{eq}\dfrac{\$20,807,500}{200,000} + X\% (10,000) \times 200,000 = \$20,300,000 \\ \dfrac{\$20,807,500}{200,000} + X\% (10,000) = \dfrac{\$20,300,000}{200,000} \\ \dfrac{\$20,807,500}{200,000} + X\% (10,000) = \$101.5 \\ \dfrac{\$20,807,500}{\$101.5} = 200,000 + X\% (10,000) {/eq}

$205,000 = 200,000 + X% (10,000)

X% (10,000) = 5000

{eq}X\% = \dfrac{1}{2} {/eq}

X% = 0.5

X = 50%

At 50% would results in increase in net operating income by $200,000.


4) No, Mary James should not go along with the request to alter estimates of percentage completion.


5) If you are the CEO of the company, you come to know this issue then you should take immediate action like conducting audit and discussing issue with management and take proper action like reporting and removing responsible personal for those actions which amount to fraud and betraying company trust and disclose in management report to shareholders and board of the directors.


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