Question

Stuart Manufacturing Company (CMC) was started when it acquired $90,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $63,700. CMC also incurred $88,200 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 4,900 units of product and sold 4,300 units at a price of $38.00 each. All transactions were cash transactions.

Prepare a GAAP-based income statement for Option 1.

STUART MANUFACTURING COMPANY
Income Statement
not attempted	not attempted
not attempted	not attempted
not attempted	0
not attempted	not attempted
not attempted	not attempted
not attempted	$0

Prepare a GAAP-based balance sheet for Option 1.

STUART MANUFACTURING COMPANY
Balance Sheet
Assets
not attempted	not attempted
not attempted	not attempted
not attempted	not attempted
Total assets	$0
Equity
not attempted	not attempted
not attempted	not attempted
not attempted	not attempted
Total equity	$0

Prepare a GAAP-based income statement for Option 2.

STUART MANUFACTURING COMPANY
Income Statement
not attempted	not attempted
not attempted	not attempted
not attempted	0
not attempted
not attempted	$0

Prepare a balance sheet for Option 2.

STUART MANUFACTURING COMPANY
Balance Sheet
Assets
not attempted	not attempted
not attempted	not attempted
not attempted	not attempted
Total assets	$0
Equity
not attempted	not attempted
not attempted	not attempted
not attempted	not attempted
Total equity	$0

Identify the option that results in financial statements that are more likely to leave a favorable impression on investors and creditors.

The option most favorable to investors and creditors

Assume that CMC provides an incentive bonus to the company president equal to 14 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. (Round your answers to the nearest whole dollar.)

Option no. 1 bonus	not attempted
Option no. 2 bonus	not attempted
The option that provides the president with the higher bonus

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. (Round your answers to the nearest whole dollar.)

Option no. 1 income tax expense	not attempted
Option no. 2 income tax expense	not attempted
The option that minimizes the amount of the company’s income tax expense

Answer 1

Part 1)

Part 2)

Notes -

Cash = Sales + Common Stock - Identifiable Product Cost - Engineering Cost

= 163,400 + 90,000 - 63,700 - 88,200

= 101,500

Inventory = ( Cost of Goods Sold / Total Production in Units ) * Closing Inventory in Units

= ( 63,700 / 4,900 ) * 600

= 7,800

Part 3)

Part 4)

Notes -

Cash = Sales + Common Stock - Identifiable Product Cost - Engineering Cost

= 163,400 + 90,000 - 63,700 - 88,200

= 101,500

Inventory = ( Cost of Goods Sold / Total Production in Units ) * Closing Inventory in Units

= ( (63,700 + 88,200) / 4,900 ) * 600

= 18,600

Part 5)

The option most favorable to investors and creditors is Option 2 since the net income ratio is higher.

Part 6)

The option that provides the president with the higher bonus is Option 2.

Part 7)

The option that minimizes the amount of the company’s income tax expense is Option 1.

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