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 $70,470 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, 290,000 units were transferred in from the prior processing department and 261,000 units were completed and sold. Costs transferred in from the prior department totaled $76,270,000. No materials are added in the final processing department. A total of $19,099,400 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 $70,470 over the net operating income that would be reported if the 25% figure were used?

Answer 1

1. Cost if goods sold:

Equivalent units	Transferred in	Conversion Costs	Total
Units both started and completed in current period (a)	261000	261000
Units of ending WIP (b)	29000	29000
Percentage of completion of ending WIP (c)	100%	25%
Equivalent units in ending WIP (d=b*c))	29000	7250
Total equivalent units (a+d)	290,000	268,250
Costs	76,270,000	19,099,400	95,369,400
Cost per unit (Costs / Equivalent units)	263.00	71.20	334.20

Cost of Goods Sold
Cost transferred in (261000*263)	68,643,000.00
+ Conversion Costs (261000*71.2)	18,583,200.00
COGS	87,226,200.00

2. The COGS needs to be reduced by 70,470 if the profit is required to be increased. This can happen if the Inventory numbers are increased. Inventory will be overstated if the % of completion is increased.

3. To calculate the required % completion, we need to reverse the steps in point 1:

We know the total COGS of 261,000 units = 87,226,200

To increase profit by 70,470, desired COGS = 87,226,200 - 70,470 = 87,155,730

Cost per unit = 87,155,730 / 261,000 = 333,93

We know cost per unit transferred in = 263.00

Conversio cost per unit = 70.93

Total Conversion cost incurred = 19,099,400

Equivalent units = 19,099,400 / 70.93 = 269,271 (this means the cost of 19,099,400 was incurred on 269,271 units)

Number of units sold = 261,000

Ending WIP Equivalent units = 8,271

Actual units = 29,000

% Completed= 8,271/ 29,000 =28.5%

If the net profit is to be increased by 70,470, the % of completion will need to be stated @28.5%