Question

CASE 4–20 Ethics and the Manager, Understanding the Impact of Percentage Completion on Profit—Weighted-Average Method [Course Objective B] 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 5% 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 $200,000 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 inventories. During the year, 210,000 units were transferred in from the prior processing department and 200,000 units were completed and sold. Costs transferred in from the prior department totaled $39,375,000. No materials are added in the 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 ending inventory in the final processing department were 30% 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? (Note: Since all units completed were sold, the cost of goods transferred out = Cost of Goods Sold.)
2. Gary is recommending that the completion percentage by adjusted by 15 percentage points in order to assist the team in making their bonus.
a. Calculate the cost of goods sold if the ending inventory is 15% complete in regard to conversion costs. Would net income increase or decrease if this option was chosen over the 30% completion percentage? How much is the increase?
b. Calculate the cost of goods sold if the ending inventory is 45% complete in regard to conversion costs. Would net income increase or decrease if this option was chosen over the 30% completion percentage? How much is the increase?
c. Based on your calculations, which percentage is Gary suggesting that Mary use for her ending inventory calculations.
3. Do you think Mary James should go along with the request to alter estimates of the percentage completion? Why or why not?

Deliverables:
1. Submit an Excel spreadsheet that documents the calculations made for steps 1 and 2 above. All items should be clearly labeled, and appropriate formulas should be used to perform your calculations.

Answer 1

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

2.a. Cost of goods sold = $58,101,485

Net income would decrease by 58,101,485 - 58,000,000 = $101485 since the COGS has increased by that amount.

2. b.Cost of goods sold = $57,899,510

Net income would increase by 58,000,000 - 57,899,510 = $100,490 since the COGS has decreased by that amount.

Please note that all formulas for 2a and 2b are similar to those used in 1 which are uploaded herewith. The only change is in cell no. E14 where the % of completion has been considered as 30%, 20% and 40% for 1, 2a and 2b respectively.

2.c. Gary is suggesting Mary use 40% for her ending inventory calculations which will result in an increase in profits and help them get the bonus.

3. Mary should not alter the estimates as it would result in fradulently inflating the profits and would be against the principle of ethics.