Rick Pines and Joe Lopez are the plant managers for High Mountain Lumber’s parti

Question

Rick Pines and Joe Lopez are the plant managers for High Mountain Lumber’s particle board division. High Mountain Lumber has adopted a just-in-time management philosophy. Each plant combines wood chips with chemical adhesives to produce particle board to order, and all product is sold as soon as it is completed. Laura Green is High Mountain Lumber’s regional controller. All of High Mountain Lumber’s plants and divisions send Green their production and cost information. While reviewing the numbers of the two particle board plants, she is surprised to find that both plants estimate their ending Work-in-Process Inventories at 75% complete, which is higher than usual. Green calls Lopez, whom she has known for some time. He admits that to ensure their division would meet its profit goal and that both he and Pines would make their bonus (which is based on division profit), they agreed to inflate the percentage completion.

Lopez explains, “Determining the percent complete always requires judgment. Whatever the percent complete, we’ll finish the Work-in-Process Inventory first thing next year.”

How would inflating the percentage completion of ending Work-in-Process Inventory help Pines and Lopez get their bonus?

Explanation / Answer

Generally, plant managers follow so many strategies to record more net income due to the reason being plant manager's salary is based on profit of the division. The less the finished goods inventory the more the cost of goods sold. If cost of goods sold is more consequently sales would be more and profit of the division as well. Based on more profit, plant managers can earn more bonus as their bonus is based on profit of the division. Let us now observe an example showing how change in percentage completion of ending Work-in-Process Inventory help RP and JL get their bonus.

Example 1

Particulars

Amount

Opening finished goods inventory

$        200

Add: Finished goods inventory during the period

$        100

Cost of goods available for sale

$        300

Less: Ending finished goods inventory (100% completion)

$        100

Cost of goods sold

$        200

Example 2

Particulars

Amount

Opening finished goods inventory

$        200

Add: Finished goods inventory during the period

$        100

Cost of goods available for sale

$        300

Less: Ending finished goods inventory (75% completion)

$          75

Cost of goods sold

$        225

In example 1 and 2 all $ amounts are identical except Ending finished goods inventory. In detail, the only difference is what percentage of completion is added to ending finished goods inventory. In example 1 Ending finished goods inventory is taken as $100 but where in example 2 Ending finished goods inventory is taken as $75. When Ending finished goods inventory is taken $75, cost of goods sold increased to $225 from $200.

Particulars

Amount

Opening finished goods inventory

$        200

Add: Finished goods inventory during the period

$        100

Cost of goods available for sale

$        300

Less: Ending finished goods inventory (100% completion)

$        100

Cost of goods sold

$        200

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