Question

The accounting records of Ortiz Manufactoring Company (OMC) revealed that the company incurred $3 million of materials, $5 of production labor, $4 million of manufacturing overhead, and $6 million of selling, general, and administrative expense during 2014. It was discovered that OMC's chief financial officer (CFO) included $1.5 million dollars of upstream research and development expense in the manufacturing overhead account when it should have been classified as selling, general, and administrative expense . OMC made 5,000 units of product and sold 4,000 units of product in 2014.

A, Indicate whether the elements on the 2014 financial statements (i.e., assets, liabilities, equity, revenue, expense, and net income) would be overstated or understated as a result of the misclassification of the upstream research and development expense. Determine the amount of the overstatement for each element.

B. Speculate as to what would cause the CFO to intentionally misclassify the research and development expense.

Answer 1

Answer:A

(a) The research and development cost of $1,500,000 has been expensed. Therefore, the CFO put the entire amount of $1,500,000 into an inventory account. Here, some of the inventories are not sold and some of the research and development costs are still in the inventory account.

A Computation of overstated and understated amount is as follows:

Misclassified cost per unit =$1,500,000/5000 units

= $300 per unit

Number of units in ending inventory = Inventory completed-Inventory sold

= 5,000 units - 4,000 units

= 1,000 units

A calculation of the portion of research and development cost in the ending inventory shown below.

Particulars	Amount
Misclassified cost per unit	$300 per unit
(multiplied by) units in ending inventory	1000 units
Portion of research and development cost in the ending inventory	$300000

The portion of the research and development cost of $300,000 has been expensed instead being kept in the inventory account. Therefore,

(1) Assets, retained earnings and net income are overstated by $300,000

(2) Expenses are understated by $300,000

Particulars	Affect	Amount
Assets	Overstated	$300000
Liabilities	Not affected
Retained Earnings	Overstated	$300000
Revenue	Not affected
Expense	Understated	$300000
Net income	Overstated	$300000

Answer:B The main cause of  misclassify the research and development expense by the CFO is due to manufacturing overhead are product cost and selling and distribution expenses are period cost.