Question

Gary Stevens and Mary James are production managers in the Consumer 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 El Segundo, California. Production managers are paid a salary and get an additional bonus equal to 10% of their base salary if the entire division meets or exceeds its target profits for the year. The bonus is determined in March after the company’s annual report has been prepared and issued to stockholders.

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 last year and we are within $62,100 of making the year’s target profits. All we have to do is pull a few strings, and we’ll be over the top!
Mary:	What do you mean?
Gary:	Well, one thing that would be easy to change is your estimate of the percentage completion of your ending work in process 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 sent 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 the rest of us sure could use it.

The final processing department in Mary’s production facility began the year with no work in process inventory. During the year, 280,000 units were transferred in from the prior processing department and 270,000 units were completed and sold. Costs transferred in from the prior department totaled $55,720,000. No materials are added in the final processing department. A total of $19,347,500 of conversion cost was incurred in the final processing department during the year.

Required:

1. Tom Winthrop estimated that the units in ending work in process inventory in the final processing department were 25% complete with respect to the conversion costs of the final processing department. If this estimate of the percentage completion is used, what would be the cost of goods sold for the year?

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

3. What percentage completion would result in increasing reported net operating income by $62,100 over the net operating income that would be reported if the 25% figure were used?

Answer 1

1	Equivalent untis:
				Transferred in	Conversion
	Units completed and sold			270000	270000
	Ending work in process
	(280000-270000=10000)			10000	2500
				(10000*100%)	(10000*25%)
	Equivalent units of production			280000	272500
	Cost per equivalent units=Total cost/Equivalent units of production
				Transferred in	Conversion
	Cost of beginning work-in-process			0	0
	Cost added			55720000	19347500
	Total cost			55720000	19347500
	Equivalent units of production			280000	272500
	Cost per equivalent units			199	71
	Cost of goods sold=Units sold*cost per equivalent units=270000*(199+71)=$ 72900000
2	Estimated percentage completion to be increased
	If percentage completion increased then equivalent units will increase and it results in lower cost per unit and leads to lower cost of goods sold.
	Lower cost of goods sold will result in higher net income.
3	Increase in operating income=Decrease in cost of goods sold=$ 62100
	Target cost of goods sold=72900000-62100=$ 72837900
	Cost of goods sold=Units sold*cost per equivalent units
	72837900=270000*cost per equivalent units
	Cost per equivalent unit=72837900/270000=$ 269.77
	Conversion cost per equivalent units=Cost per equivalent unit-Material cost per equivalnt unit=269.77-199=$ 70.77
	Target equivalent units of production for conversion=Total convesrion cost/Conversion cost per equivalent unit=19347500/70.77= 273385.6
	Target equivalent units of ending work in process=Target equivalent units of production for conversion-Equivalent units of production for units completed=273385.6-270000=$ 3385.6
	Percentage of completion required=Target equivalent units of ending work in process/Ending inventory=3385.6/10000=0.33856=33.86%
	Increase in percentage required=33.86%-25%=8.86%