The board of directors of Mesa Verde Tool Company set the profit goal for calendar year 2016 at $2,200,000. It also established a bonus plan in which the top five officers of the company will share $150,000 if the profit goal is met or exceeded. If the goal is not met, there is no bonus. T. J. Elias, the chief financial officer and one of the top five executives, prepared the following budgeted income statement for 2016, based on the board’s profit directive:Mesa Verde Tool CompanyBudgeted Income StatementFor the Year Ended December 31, 2016Sales (500,000 units)  $15,000,000Cost of goods sold   Beginning inventory$0  Cost of goods manufactured$8,000,000  Cost of goods available for sale$8,000,000  Ending inventory$0 $8,000,000Gross margin  $7,000,000Selling and administrative expenses:   Variable selling and administrative$2,800,000  Fixed selling and administrative$2,000,000 $4,800,000Net operating income  $2,200,000    *Variable manufacturing: 500,000 units x $5 per unit = $2,500,000; Fixed manufacturing: $5,500,000 By late September, it became apparent that sales were running below forecast and that annual sales would approximate 450,000 units, for an estimated net income of $1,230,000 and no bonus. In an executive committee strategy meeting, Bob Wrangell, vice president of Manufacturing, suggested that the production capacity was available to produce the entire 500,000 units or more, even if that sales level could not be reached. He remembered a presenter, from a seminar that he recently attended, describing how net income could be increased by producing more than can be sold. He urged Elias to determine how many extra units they would need to produce to achieve the profit goal and, thus, earn the bonus.Step 1 – Complete the following…If sales only reach 450,000 units for the year, how many additional units would have to be produced, given the current selling price and cost structure, to meet the budgeted profit of $2,200,000?Prepare an absorption costing income statement to prove your answer above.Step 2 – Referencing the information above, answer the following questions.  Each answer should be a minimum of 250 words (for a total of at least 500 words).What ethical responsibility, if any, does Elias have in this situation?What is there about the bonus plan that potentially encourages unethical behavior?

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Asked Apr 27, 2019
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The board of directors of Mesa Verde Tool Company set the profit goal for calendar year 2016 at $2,200,000. It also established a bonus plan in which the top five officers of the company will share $150,000 if the profit goal is met or exceeded. If the goal is not met, there is no bonus. T. J. Elias, the chief financial officer and one of the top five executives, prepared the following budgeted income statement for 2016, based on the board’s profit directive:

Mesa Verde Tool Company

Budgeted Income Statement

For the Year Ended December 31, 2016

Sales (500,000 units)

 

 

$15,000,000

Cost of goods sold

 

 

 

Beginning inventory

$0

 

 

Cost of goods manufactured

$8,000,000

 

 

Cost of goods available for sale

$8,000,000

 

 

Ending inventory

$0

 

$8,000,000

Gross margin

 

 

$7,000,000

Selling and administrative expenses:

 

 

 

Variable selling and administrative

$2,800,000

 

 

Fixed selling and administrative

$2,000,000

 

$4,800,000

Net operating income

 

 

$2,200,000

 

 

 

 

*Variable manufacturing: 500,000 units x $5 per unit = $2,500,000; Fixed manufacturing: $5,500,000

 

By late September, it became apparent that sales were running below forecast and that annual sales would approximate 450,000 units, for an estimated net income of $1,230,000 and no bonus. In an executive committee strategy meeting, Bob Wrangell, vice president of Manufacturing, suggested that the production capacity was available to produce the entire 500,000 units or more, even if that sales level could not be reached. He remembered a presenter, from a seminar that he recently attended, describing how net income could be increased by producing more than can be sold. He urged Elias to determine how many extra units they would need to produce to achieve the profit goal and, thus, earn the bonus.

Step 1 – Complete the following…

  1. If sales only reach 450,000 units for the year, how many additional units would have to be produced, given the current selling price and cost structure, to meet the budgeted profit of $2,200,000?
  2. Prepare an absorption costing income statement to prove your answer above.

Step 2 – Referencing the information above, answer the following questions.  Each answer should be a minimum of 250 words (for a total of at least 500 words).

  1. What ethical responsibility, if any, does Elias have in this situation?
  2. What is there about the bonus plan that potentially encourages unethical behavior?
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Expert Answer

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Step 1

In absorption costing, the cost of goods sold includes the fixed manufacturing costs. The fixed costs of production is allocated to all the units produced during the year and if the units produced are not sold, the cost is carried forward in the closing inventory.

Here, in order to arrive at the budgeted profits, only the adjustment needs to be done for allocation of fixed production overhead.

Step 2

1. The units to be produced to earn a budgeted income of $2,200,000 is 546,358 units approx and excess production is 546,358-450,000= 96,358 units

Step 3

Here, we have computed the estimated profits without charging fixed production cost. From the value of net operating profits without charging fixed production cost, we have subtracted the budgeted profits to arrive at the budgeted fixed cost of production for 450,000 units sold.

Then cost of fixed production charged to each units is calculated by dividing...

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