Ethical Issues

Jeremiah Wedgewood, the CFO, is adamant that the company needs to move ahead with the new line. While Josey also thinks that the new line is a good idea, she is a little worried about how it is going to affect their financial statements in the short run. After carefully considering what was likely to happen, Josey scheduled an appointment to visit with Jeremiah about her concerns.

"Josey!" Jeremiah said as she came into his office. "How are you doing today?" Josey smiled. Nothing ever seemed to really bother Jeremiah.

"I'm doing well, thanks, Uncle Jerry. Just a little worried about our new line."

"Worried?" Jeremiah asked. "About what?"

"Well, let me just start by saying that I agree that adding these new candles is a great idea. I think we have a really good idea of how much we can charge for them to break into the market and stay competitive in the long run. I also think while our costs will be high while we get the new line started, they will come down over time as we get settled. But I'm a little concerned about what the line will do to our profits for the next couple of years. The profits won't be nearly as good as they are for our traditional candles for at least two years."

"Well, Josey," Jeremiah replied, "keep in mind that this is a family-owned business, so that's not going to be a big deal. I mean, we don't have investors messing up our stock prices with every little piece of news. However," he paused, looking out his window for a moment as he thought about the changes. "We did just open up a new line of credit with our bank and our interest rate is contingent on maintaining profitability in each segment. Shoot! I didn't think about the new line when I signed that deal. They offered such a low rate that I wanted to make sure I locked it in." He looked at Josey. "We don't have to show a large profit, just a profit. What do you think our chances are of just being above zero with the new line?"

Josey shook her hand back and forth. "About 50-50, at least for the first year."

"That's not good enough," Jeremiah said, shaking his head. "What is we adjust the overhead allocation so that both lines show a profit?" Josey frowned. "Now, don't write me off as a bad guy, Josey. This wouldn't be right if we were a public company because we would be misleading investors, but, as I said, we don't have any investors, just the family.

"What about the bank?" Josey asked.

"Well think about it," Jeremiah said, a smile again forming on his lips. "They really just want to make sure that we pay them back, or that we have the cash to pay them back. What I'm talking about won't affect our cash flows at all. We're just shifting overhead from one line to another. Companies do that all the time."

Josey looked at Jeremiah and pondered. She was confident that the new line would be profitable soon, probably in just a year or two. And overhead is applied on a somewhat arbitrary basis, especially when using a single, plant-wide rate, or departmental rates. She chose all of those numbers anyway, after all. There was no way to really know if the amount of overhead being applied to any product was the "real" amount. Activity- based costing would get them closer to an actual cost, but she hadn't had time to get into that yet. And Jeremiah was certainly right; the last thing they needed now was for the bank to raise the interest rates over a bookkeeping technicality. Perhaps they could make a change to their overhead allocations...

Questions

1. Make a list of pros and cons of applying overhead strictly on the basis of specific departmental rates versus "adjusting" the allocations to keep each line profitable.

2. Review the four principles and four standards of the IMA's Statement of Ethical Professional Practice. Based on these principles and standards, do you believe that there are any ethical violations in Jeremiah's proposal? Explain which, if any, of the principles and/or standards Jeremiah's suggestion will violate. Does it matter that this is a family-owned company instead of one with outside investors? If there were no bank loan and Jeremiah wanted to do this just for internal reporting, would it change your answer?

Question 25

On February 1, 2017, Marsh Contractors agreed to construct a building at a contract price of $5,940,000. Marsh estimated total construction costs would be $4,112,000 and the project would be finished in 2019. Information relating to the costs and billings for this contract is as follows:

Fill in the correct amounts on the following schedule. For percentage-of-completion accounting and for completed-contract accounting, show the gross profit that should be recorded for 2017, 2018, and 2019.

Explain 302(b)(2)'s requirement of "substantially disproportionate with respect to the shareholder" for a redemption to be treated as an exchange (aka stock ownership testes).

Use these transactions to create an Income Statement, Balance Sheet, and Cash Flow Statement.

Vertical Analysis of Income Statement

Revenue and expense data for Innovation Quarter Inc. for two recent years are as follows:

a. Prepare an income statement in comparative form, stating each item for both years as a percent of sales. If required, round percentages to one decimal place. Enter all amounts as positive numbers.

b. The vertical analysis indicates that the cost of goods sold as a percent of sales   by 6 percentage points, while selling expenses  by 3 percentage points, and administrative expenses   by 2 percentage points. Thus, net income as a percent of sales   by 3 percentage points.

Brett operates a business that locates and purchases specialized items for clients, among other activities. Brett uses the accrual method of accounting but he doesn’t keep any significant inventories of the items that he sells. Brett reported the following financial information for his business activities during the year. For each of the following items determine the effect on the taxable business income.

a.      Brett paid $380 for entertaining a visiting out-of-town client. The client didn’t discuss business with Brett during this visit, but Brett wants to maintain good relations to encourage additional business next year.

b.      Brett paid a visit to his parents in Dallas over the Christmas holidays. While he was in the city, Brett spent $250 to attend a half-day business symposium. Brett paid $500 for airfare, $70 for meals during the symposium, and $30 on cab fare to the symposium.

c.       At the end of the year, Brett’s business reports $12,000 of accounts receivable. Based upon past experience, Brett believes that at least $3,000 of his new receivables will be uncollectible.

d.      In December of this year, Brett rented equipment to complete a large job. Brett paid $4,000 in December because the rental agency required a minimum rental of four months ($1,000 per month). Brett completed the job before year-end, but he returned the equipment at the end of the lease.

e.       Brett has signed a contract to sell gadgets to the city. The contract provides that sales of gadgets are dependent upon a test sample of gadgets operating successfully. In December, Brett delivers $22,000 worth of gadgets to the city that will be tested in March. Brett purchased the gadgets especially for this contract and paid $15,500.

Samuel is the owner of a 2018 Toyota corolla. After a standard service he was informed that the rings in the engine are damaged. There is nothing visibly wrong with the car, the performance is good and there is no excessive smoke. Samuel decides to sell the car without having it repaired. He sells the car to peter for the purchase price of N$ 4000 without disclosing the fact the vehicles is in need of repair. Shortly afterwards the car breaks down. The garage owner tells him the rings were damaged and the cost of the repair would be N$ 3000. Advise Peter as to his rights and the remedies he may against Samuel.

Claire Corporation’s trial balance includes the following expenses:

Assuming no change in the work in process and finished goods inventory balances for the year, what total amount should Claire report as a product expense?

Select one:

a. $171,500

b. $185,500

c. $186,500

d. $236,500

Explain and provide an example of the judicial principle of continuity of business enterprise.

A company is considering a project that requires an initial investment of $607,500 and has a useful life of 9 years. Expected cash receipts from the project will be $185,000 each year. The salvage value of the assets used in the project will be $70,000. The company’s tax rate is 30%. For tax purposes, the entire initial investment (without any reduction for salvage value) will be depreciated over 9 years. The company uses a discount rate of 16%.

Excel input:

Excel / calculator input:

Compare and contrast the federal income tax treatment of a net capital loss and a net operating loss.

Gitano Products operates a job-order costing system and applies overhead cost to jobs on the basis of direct materials used in production (not on the basis of raw materials purchased). Its predetermined overhead rate was based on a cost formula that estimated $127,400 of manufacturing overhead for an estimated allocation base of $91,000 direct material dollars to be used in production. The company has provided the following data for the just completed year:

Required:

1. Compute the predetermined overhead rate for the year.

2. Compute the amount of underapplied or overapplied overhead for the year.

3. Prepare a schedule of cost of goods manufactured for the year. Assume all raw materials are used in production as direct materials.

4. Compute the unadjusted cost of goods sold for the year. Do not include any underapplied or overapplied overhead in your answer.

5. Assume that the $37,000 ending balance in Work in Process includes $8,000 of direct materials. Given this assumption, supply the information missing below:

Thanks!

On October 1, Ebony Ernst organized Ernst Consulting; on October 3, the owner contributed $83,220 in assets in exchange for its common stock to launch the business. On October 31, the company’s records show the following items and amounts.  

Also assume the following:

1. The owner’s initial investment consists of $37,380 cash and $45,840 in land in exchange for its common stock..
2. The company’s $17,200 equipment purchase is paid in cash.
3. The accounts payable balance of $7,810 consists of the $2,530 office supplies purchase and $5,280 in employee salaries yet to be paid.
4. The company’s rent, telephone, and miscellaneous expenses are paid in cash.
5. No cash has been collected on the $12,000 consulting fees earned.

Using the above information prepare an October 31 statement of cash flows for Ernst Consulting. (Cash outflows should be indicated by a minus sign.)

1. Hockley Brewing has produced a new craft lager beer that will be branded Hockley Classic Lager. The market for craft beer is about $20 million retail per year and the average retail price across all craft beer producers is $2.50. The following information applies to Hockley’s new craft lager beer.

Factory production costs                                                $1.05 / can

Beer ingredients                                                            $0.35 / can

Packaging                                                                     $0.20 / can

Advertising and promotion                                            $60,000

Channel listing fees                                                       $30,000

Hockley’s wholesale price to retailers                             $2.40 / can

(Hockley’s) manufacturer’s suggested retail price           $2.55 / can

a. What is Hockley’s unit contribution (measured in $ per can) and contribution margin (measured in percentage)?

b. What is the break-even point in cans? in dollars?

c. What is the necessary sales volume in cans to achieve a $150,000 (target) profit?

d. What will Hockley’s net profit be if 100,000 cans of the new lager are sold?

e. What will Hockley’s market share of craft beer be if they sell 100,000 cans? [Hint: to calculate the total number of cans sold in the market, use the total retail value of the market and industry average retail price given above.]

f. Their largest competitor is Mill Street Brewery whose Original Organic Lager has 2.5% market share of the craft beer market. Given Hockley’s market share calculated in part (e), what will Hockley’s relative market share (RMS) be for their Classic Lager?

g. The craft beer market is growing at 10% annually, higher than any other type of beer. With the RMS for Hockley Classic Lager calculated in part (f), at the end of their first year, where in Hockley’s portfolio will Classic Lager be positioned and what recommendation would follow?

h. Calculate the price elasticity of demand if they raise the MSRP from $2.55 to $2.75 and demand falls from 100,000 cans to 95,000 cans. Is demand for this product price elastic or inelastic?

Based on the following:

• The estimated purchase price for the equipment required to move the operation in-house would be $500,000. Additional net working capital to support production (in the form of cash used in Inventory, AR net of AP) would be needed in the amount of $25,000 per year starting in year 0 and through all 5 years of the project to support production.

• The current spending on this component (i.e. annual spend pool) is $875,000. The estimated cash flow savings of bringing the process in-house is 20% or annual savings of $175,000. This includes the additional labor and overhead costs required.

• Your company has access to a credit line and could borrow the funds at a rate of 6%.

• Finally, the equipment required is anticipated to have a somewhat short useful life, as a new wave of technology is on the horizon. Therefore, it is anticipated that the equipment will be sold after five years for $25,000. (i.e. the terminal value).

Your colleague from Sales is convinced that this capability would allow new revenue stream that could significantly offset operating expenses. He recommends savings that grow each year: 5-year project life, 10% discount rate, and a 10% compounded annual savings growth in years 2 through 5. In other words, instead of assuming savings stay flat, assume that they will grow by 10% in year 2, and then grow another 10% over year 2 in year 3, and so on.

Using the data presented above (and ignoring the extraneous information), for this profit and supply chain improvement project, calculate each of the following (where applicable): Show Calculations

o  Nominal Payback

o  Discounted Payback

o  Net Present Value

o  Internal Rate of Return