Question

Benson Manufacturing Company (CMC) was started when it acquired $99,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $64,400. CMC also incurred $64,400 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, CMC made 4,600 units of product and sold 3,700 units at a price of $39.00 each. All transactions were cash transactions.

Required

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

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

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

c. Assume that CMC provides an incentive bonus to the company president equal to 13 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.

d. Assume a 40 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

a-1.		Income statement
	Sales	(3700*39)		144300
	Less: Cost of goods sold
	(Note:1)			51800
	Gross profit			92500
	Less: Engineering design and
	planning cost			64400
	Net income			28100
	Note:
	1. Cost of goods sold
	Identifiable product cost			64400
	Units produced			4600
	Cost per unit			14
	Cost of goods sold=Units sold*Cost per unit=3700*14=51800
		Balance sheet
	Cash	99000+(3700*39)		243300
	Inventory	(4600-3700)*14		12600
	Total assets			255900
	Accounts payable			128800
	Common stock			99000
	Retained earnings			28100
	Total liabilities			255900
a-2.		Income statement
	Sales	(3700*39)		144300
	Less: Cost of goods sold
	(Note:1)			103600
	Gross profit			40700
	Note:
	1. Cost of goods sold
	Identifiable product cost			64400
	Engineering design and planning
	cost			64400
	Total product cost			128800
	Units produced			4600
	Cost per unit			28
	Cost of goods sold=Units sold*Cost per unit=3700*28=103600
		Balance sheet
	Cash	99000+(3700*39)		243300
	Inventory	(4600-3700)*28		25200
	Total assets			268500
	Accounts payable			128800
	Common stock			99000
	Retained earnings			40700
	Total liabilities			268500
b.	Option 1 is more favorable since it shows a higher gross profit
c.	Incentive
	Option 1=28100*13%=3653
	Option 2=40700*13%=5291
	Option 2 that provides the president with the higher bonus.
d.	Option 1=28100*40%=11240
	Option 2=40700*40%=16280
	option 1 minimizes the amount of the company’s income tax expense