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.  

Answer 1

1. Cost of goods sold: $58,000,000

	Whole units	% Materials	EUP-Materials	% Conversion	EUP-Conversion
Units completed and transferred out	200000	100%	200000	100%	200000
Ending work in process - units	10000	100%	10000	30%	3000
Equivalent units			210000		203000

	Materials	Conversion	Total
Costs transferred in	39375000	0	39375000
Costs incurred during the year	0	20807500	20807500
Total cost $	39375000	20807500	60182500
Equivalent units	210000	203000
Cost per equivalent unit $	187.50	102.50	290.00

Cost of goods sold = 200000 x $290 = $58000000

2a. Cost of goods sold: $58,152,000

Net income would decrease by ($58,000,000 - $58,152,000) = $152,000.

Increase in cost of goods sold will result in a decrease in net income.

	Whole units	% Materials	EUP-Materials	% Conversion	EUP-Conversion
Units completed and transferred out	200000	100%	200000	100%	200000
Ending work in process - units	10000	100%	10000	15%	1500
Equivalent units			210000		201500

	Materials	Conversion	Total
Total cost $	39375000	20807500	60182500
Equivalent units	210000	201500
Cost per equivalent unit $	187.50	103.26	290.76

Cost of goods sold = 200000 x $290.76 = $58152000

b. Cost of goods sold: $57,850,000

Net income would increase by ($58,000,000 - $57,850,000) = $150,000.

Decrease in cost of goods sold will result in an increase in net net income.

	Whole units	% Materials	EUP-Materials	% Conversion	EUP-Conversion
Units completed and transferred out	200000	100%	200000	100%	200000
Ending work in process - units	10000	100%	10000	45%	4500
Equivalent units			210000		204500

	Materials	Conversion	Total
Total cost $	39375000	20807500	60182500
Equivalent units	210000	204500
Cost per equivalent unit $	187.50	101.75	289.25

Cost of goods sold = 200000 x $289.25 = $57,850,000

c. Gary is suggesting using 45% completion of ending inventory in regard to conversion costs so as to show an increase in net income so as to earn a bonus.