Question

Walton Manufacturing Company (WMC) was started when it acquired $95,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $55,200. WMC also incurred $78,200 of engineering design and planning costs. There was a debate regarding how the design and planning costs should be classified. Advocates of Option 1 believe that the costs should be classified as general, selling, and administrative costs. Advocates of Option 2 believe it is more appropriate to classify the design and planning costs as product costs. During the year, WMC made 4,600 units of product and sold 4,000 units at a price of $35.00 each. All transactions were cash transactions.

Required

1. a-1. Prepare a GAAP-based income statement and balance sheet under option 1.

2. a-2. Prepare a GAAP-based income statement and balance sheet under option 2.

3. b. Identify the option that results in financial statements that are more likely to leave a favorable impression on investors and creditors.

4. c. Assume that WMC provides an incentive bonus to the company president equal to 14 percent of net income. Compute the amount of the bonus under each of the two options. Identify the option that provides the president with the higher bonus.

5. d. Assume a 35 percent income tax rate. Determine the amount of income tax expense under each of the two options. Identify the option that minimizes the amount of the company’s income tax expense.

Answer 1

Solution

Ans) a1 & a2

Income statement	Option 1	Option 2
Units sold	4000	4000
Sales (4000*$35)	140000	140000
less;Cost of Goods Sold( Unit product cost * units sold)	48000	116,000
Gross Margin	92000	24000
less; Selling & adm Exp	78200
Net Operating Income/Loss	13800	24000

Calculation;

Unit Product cost= Total Production cost/no of produced unit

Option1= 55,200/4600= 12

Option2= 55,200+78200/4600=29

Balance Sheet	Option 1	Option 2
Assets
Cash (total Liability - Inventory)	101600	101600
Inventory (unsold units * Per unit product cost)	7200	17400
Total Current Assets	108800	119000
Total Assets	108800	119000
Liabilities
Common Stock	95000	95000
Retained Earnings	13800	24000
Total Liability & Equity	108800	119000

b) As the Net Operation Income is high in case of Option B, therefore it will leave a favorable impression on investors and creditors.

c) Option 2 provides higher amount of bonus.

	Option 1	Option 2
Net Operating Income	13800	24000
Bonus @ 14%	1932	3360

d) Option 1 minimizes the amount of the company’s income tax expense.

	Option 1	Option 2
Net Operating Income	13800	24000
tax @ 35%	4830	8400

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