Chapter 1, Problem 27PSB

a.

To determine

The balance sheet and income statement of Company CM for two options.

Answer to Problem 27PSB

Option 1

Calculation of income statement of Company B is as follows:

Table (1)

Hence, the net income of Company B is $44,000.

Calculation of balance sheet of Company B is as follows:

Table (2)

Option 2

Calculation of income statement of Company B is as follows:

Table (3)

Hence, the net income of Company CM is $32,000.

Calculation of balance sheet of Company B is as follows:

Table (4)

Explanation of Solution

Income statement:

Income statement is the financial statement of a company that shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

Balance sheet is one of the financial statements that summarizes the assets, the liabilities, and the shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Working notes:

Calculate the sale revenue:

$\begin{array}{c}\text{Sales revenue}=\text{Number of units sold}\times \text{Price of each }\\ =8,000\text{ units}\times \$20\\ =\$160,000\end{array}$

Hence, the sales revenue is $160,000.

(1)

Calculate the cost per unit:

$\begin{array}{c}\text{Cost per unit}=\frac{\text{Materials}+\text{Labor}+\text{Overheads }}{\text{Total number of units produced}}\\ =\frac{\$120,000}{10,000\text{ units}}\\ =\$12\end{array}$

Hence, the cost per unit is $12.

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost per unit}\times \text{Number of goods sold}\\ =\$12\times 8,000\text{ units}\\ =\$96,000\end{array}$

Hence, the cost of goods sold is $96,000.

(2)

Calculate the total cash:

$\begin{array}{c}\text{Total cash}=\text{Acquired capital}+\text{Sales revenue}-\text{Product cost}-\text{development cost}\\ =\$150,000+\$160,000-\$120,000-\$20,000\\ =\$310,000-140,000\\ =\$170,000\end{array}$

Hence, the total cash is $170,000.

(3)

Calculate the total finished goods:

$\begin{array}{c}\text{Finished goods}=\text{Cost per unit}\times \text{Completed goods}-\text{Number of goods sold}\\ =\$12\times 10,000\text{ units}-8,000\text{ units}\\ =\$12\times 2,000\text{ units}\\ =\$24,000\end{array}$

Hence, the finished goods is $24,000.

(4)

Calculate the cost per unit:

$\begin{array}{c}\text{Cost per unit}=\frac{\text{Materials}+\text{Labor}+\text{Overheads}+\text{development cost }}{\text{Total number of units produced}}\\ =\frac{\$120,000+\$20,000}{10,000\text{ units}}\\ =\frac{\$140,000}{10,000\text{ units}}\\ =\$14\end{array}$

Hence, the cost per unit is $14.

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost per unit}\times \text{Number of goods sold}\\ =\$14\times 8,000\text{ units}\\ =\$112,000\end{array}$

Hence, the cost of goods sold is $112,000.

(5)

Calculate the total finished goods:

$\begin{array}{c}\text{Finished goods}=\text{Cost per unit}\times \text{Completed goods}-\text{Number of goods sold}\\ =\$14\times 10,000\text{ units}-8,000\text{ units}\\ =\$14\times 2,000\text{ units}\\ =\$28,000\end{array}$

Hence, the finished goods is $28,000.

(6)

b.

To determine

The option in the financial statement that gives a favourable image to the creditors and investors.

Answer to Problem 27PSB

Option 2 is the financial statement that gives a favorable impression to the creditors and investors with a greater net income of $4,000 than option 1’s net income.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company that shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

Balance sheet is one of the financial statements that summarizes the assets, the liabilities, and the shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

The option that gives a favorable image to the creditors and investors is as follows:

Option 2 provides the financial statement that gives a favorable image to the creditors and investors because the net income in option 2 is greater than the net income in option 1.

c.

To determine

The amount of bonus under each option and recognize the option that provides the higher bonus.

Answer to Problem 27PSB

Option 2 provides the president with a higher bonus of $4,800.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company that shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

Balance sheet is one of the financial statements that summarizes the assets, the liabilities, and the shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Calculation of bonus under option 1 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 10\%\text{ on net income}\\ =\$44,000\times 20\%\\ =\$4,400\end{array}$

Hence, the bonus received by the president under option 1 is $4,400.

Calculation of bonus under option 2 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 10\%\text{ on net income}\\ =\$48,000\times 10\%\\ =\$4,800\end{array}$

Hence, the bonus received by the president under option 2 is $4,800.

d.

To determine

The amount of tax rate under each option and recognize which option pays less tax.

Answer to Problem 27PSB

Option 1 minimizes the cost of income tax expenses for the company by $15,400.

Explanation of Solution

Calculation of income tax under option 1 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 35\%\text{ income tax rate}\\ =\$44,000\times 35\%\\ =\$15,400\end{array}$

Hence, the income tax expenses under option 1 is $15,400.

Calculation of income tax under option 2 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 35\%\text{ income tax rate}\\ =\$48,000\times 35\%\\ =\$16,800\end{array}$

Hence, the bonus received by the president under option 2 is $16,800.

e.

To determine

Comment on the conflict between the company’s president as determined by requirement c and the owner-based requirement d, and define an incentive compensation plan that would avoid the conflict.

Explanation of Solution

The conflicts between the owner and the president are as follows:

Option 2 provides the president with a higher bonus of $4,800. Option 1 minimizes the cost of income tax expenses for the company by $15,400. These are the two conflicts between the owner and the president.

The reasons to avoid these conflicts are as follows:

• The bonus plans of the company can be tied up with the company’s stock price, instead of net income.
• Market efficiency increases; as a result, the performance of the company increases, which creates a value to the company’s stock price.