Question

Sometimes compensation packages include bonuses designed to provide performance incentives to employees. The difficulty a bonus can cause accountants is not an accounting problem, but a math problem. The complication is that the bonus formula sometimes specifies that the calculation of the bonus is based in part on the bonus itself. This occurs anytime the bonus is a percentage of income because expenses are components of income, and the bonus is an expense.
  
Regalia Fashions has an incentive compensation plan through which a division manager receives a bonus equal to 10% of the division’s net income. Division income in 2021 before the bonus and income tax was $150,000. The tax rate is 30%.
   
Required:
2. Calculate the amount of the bonus.
3. Prepare the adjusting entry to record the bonus compensation.
4. Bonus arrangements take many forms. Suppose the bonus specifies that the bonus is 10% of the division’s income before tax, but after the bonus itself. Calculate the amount of the bonus.

Answer 1

Answer to the above question:

PART 1:

Expressing the bonus in algebraic equation is as follows:

Let B = Bonus

Let T = Taxes

B = 10% × ( $ 150,000 - B - T )

T = 30% × ( $ 150,000 - B )

PART 2:

Using these formulas calculate the amount of the bonus:

Now Substitute the value of T in Bonus equation.

B = 10% × { 150,000 - B -.30% ( 150,000 - B )}

B = 10% × { 150,000 - B - 45,000 + 0.3B }

B = 10% × ( 150,000 - 45,000 - B + 0.3B )

B = 10% × ( 105,000 - 0.7B )

B = 10,500 - 0.07B

B + 0.07B = 10,500

1.07B = 10,500

B = 10,500 ÷ 1.07

B = 9,813

PART 3:

Prepare the adjusting entry to record the bonus compensation:

Particulars	Debit	Credit
Bonus compensation expense A/c Dr.	9,813
To bonus compensation payable A/c		9,813

PART 4:

Bonus arrangements take many forms. Suppose the bonus specifies that the bonus is 10% of the division's income before tax, but after the bonus itself. Calculate the amount of bonus:

Let B = Bonus

B = 10% × ( 150,000 - B )

B = 15,000 - 0.1B

B + 0.1B = 15,000

1.1B = 15,000

B = 15,000 ÷ 1.1

B = 13,636

Answer.