Chapter 1, Problem 27PSA

a.

To determine

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

Answer to Problem 27PSA

Option 1

Calculation of income statement of Company CM is as follows:

Table (1)

Hence, the net income of Company CM is $20,000.

Calculation of balance sheet of Company CM is as follows:

Table (2)

Option 2

Calculation of income statement of Company CM is as follows:

Table (3)

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

Calculation of balance sheet of Company CM is as follows:

Table (4)

Explanation of Solution

Income statement:

It is the financial statement of a company that shows all the incomes earned and expenditures incurred by the company for a particular 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:

$\begin{array}{c}\text{Sales revenue}=\text{Number of units sold}\times \text{Price of each }\\ =4000\text{ units}\times \$35\\ =\$140,000\end{array}$

Hence, the sales revenue is $140,000.

(1)

Calculate the cost per unit:

$\begin{array}{c}\text{Cost per unit}=\frac{\text{Materials}+\text{Labor}+\text{Overheads }}{\text{Total number of units produced}}\\ =\frac{\$75,000}{5000\text{ units}}\\ =\$15\end{array}$

Hence, the cost per unit is $15.

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost per unit}\times \text{Number of goods sold}\\ =\$15\times 4,000\text{ units}\\ =\$60,000\end{array}$

Hence, the cost of goods sold is $60,000.

(2)

Calculate the total cash:

$\begin{array}{c}\text{Total cash}=\text{Acquired capital}+\text{Sales revenue}-\text{Product cost}-\text{Planning cost}\\ =\$80,000+\$140,000-\$75,000-\$60,000\\ =\$220,000-135,000\\ =\$85,000\end{array}$

Hence, the total cash is $85,000.

(3)

Calculate the total finished goods:

$\begin{array}{c}\text{Finished goods}=\text{Cost per unit}\times \text{Completed goods}-\text{Number of goods sold}\\ =\$15\times 5,000\text{ units}-4,000\text{ units}\\ =\$15\times 1,000\text{ units}\\ =\$15,000\end{array}$

Hence, the finished goods is $15,000.

(4)

Calculate the cost per unit:

$\begin{array}{c}\text{Cost per unit}=\frac{\text{Materials}+\text{Labor}+\text{Overheads}+\text{Planning cost }}{\text{Total number of units produced}}\\ =\frac{\$75,000+\$60,000}{5000\text{ units}}\\ =\frac{\$135,000}{5000\text{ units}}\\ =\$27\end{array}$

Hence, the cost per unit is $27.

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost per unit}\times \text{Number of goods sold}\\ =\$27\times 4,000\text{ units}\\ =\$108,000\end{array}$

Hence, the cost of goods sold is $108,000.

(5)

Calculate the total finished goods:

$\begin{array}{c}\text{Finished goods}=\text{Cost per unit}\times \text{Completed goods}-\text{Number of goods sold}\\ =\$27\times 5,000\text{ units}-4,000\text{ units}\\ =\$27\times 1,000\text{ units}\\ =\$27,000\end{array}$

Hence, the finished goods is $27,000.

(6)

b.

To determine

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

Answer to Problem 27PSA

Option 2 is the financial statement that gives a favorable impression to creditors and investors with a greater net income of $12,000 than option 1’s net income.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company that shows all the incomes gained and expenditures incurred by the company for a time period.

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 the 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 a higher bonus.

Answer to Problem 27PSA

Option 2 provides the president with a higher bonus of $6,400.

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:

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

Hence, the bonus received by the president under option 1 is $4,000.

Calculation of bonus under option 2 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 20\%\text{ on net income}\\ =\$32,000\times 20\%\\ =\$6,400\end{array}$

Hence, the bonus received by the president under option 2 is $6,400.

d.

To determine

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

Answer to Problem 27PSA

Option 1 minimizes the cost of income tax expenses for the company by $6,000.

Explanation of Solution

Calculation of income tax under option 1 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 30\%\text{ income tax rate}\\ =\$20,000\times 30\%\\ =\$6,000\end{array}$

Hence, the income tax expenses under option 1 is $6,000.

Calculation of income tax under option 2 is as follows:

$\begin{array}{c}\text{Bonus}=\text{Net income}\times 30\%\text{ income tax rate}\\ =\$32,000\times 30\%\\ =\$9,600\end{array}$

Hence, the bonus received by the president under option 2 is $9,600

e.

To determine

Comment on the conflict among the company’s president as determined in requirement c and the owner-based requirement d, and define an incentive compensation plan that will neglect 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 $6,400. Option 1 minimizes the cost of income tax expenses for the company by $6,000. 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.