Gray Stevens and Mary James are production managers in the customer electronics
ID: 2423289 • Letter: G
Question
Gray Stevens and Mary James are production managers in the customer electronics division of General
Electronics Company, which has several dozen plants scattered in locations throughout the world. Mary
manages the plant located in Des Moines, Iowa, while Gary manages the plant in EI Segundo, California.
Production managers are paid a salary and get an additional bonus equal to 5% of their base salary if the
entire division meets or exceeds the target profit for the year. The bonus is determined in March after the
company’s annual report has been prepared and issued to shareholders.
Shortly after the beginning of the New Year, Mary received a phone call from Gary that went like this:
Gary: How’s it going, Mary?
Mary: Fine, Gary. How’s it going with you?
Gary: Great! I just got the preliminary profit figures for the division for the last year and we are with in
$200,000 of making the year’s target profits. All we have to do is to pull a few strings, and we’ll
be over the top!
Mary: What do you mean?
Gary: Well. One thing that would easy to change is your estimate of the percentage completion of your
ending work in progress inventories.
Mary: I don’t know if I can do that, Gary. Those percentage completion figures are supplied by Tom
Winthrop, my lead supervisor, who I have always trusted to provide us with good estimates.
Besides, I have already sends the percentage completion figures to corporate headquarters.
Gary: You can always tell them there was a mistake. Think about it, Mary. All of us managers are doing
as much as we can to pull this bonus out of the hat. You may not want the bonus check, but rest
of us sure could use it.
The final processing department in Mary’s production facility began the year with no work in progress
inventories. During the year, 210,000 units were transferred in from the prior processing department and
200,000 units were completed and sold. Cost transferred in from the prior department totaled
$39,375,000. No materials are added in final processing department. A total of $20,807,500 of conversion
cost was incurred in the final processing department during the year.
Required:
1. Tom Winthrop estimated that the units in the ending inventory in the final processing department
were 30% complete with respect to conversion costs of final processing department. If this
estimate of percentage completion is used, what would be the cost of goods sold for the year?
2. Does Gary Stevens want the estimated percentage to be increased of decreased? Explain why?
3. What percentage completion would result in increasing reported net operating income by
$200,000 over the net operating income that would be reported if the 30% figure were used?
4. Do you think Mary James should go along with the request to alter estimates of percentage
completion?
5. If you are the CEO of the company, what do you think when you know this issue? Any action to
take?
Explanation / Answer
Answer:1 The conversion cost is the cost of 100% complete work on the 200,000 units sold, plus 30% complete work on 10,000 units in the inventory. A 30% complete work on 10,000 units is equivalent (for calculation purposes) to 100% complete work on 3,000 units.
( The conversion cost on the 200,000 units that were sold = 20,807,500 *200,000/203,000 = $20,500,000
( Cost incurred from the prior department = $39,375,000 ( sold units/total units) = $39,375,000 * 200,000/210,000 = $37,500,000)
Cost of goods sold for the year = $20,500,000 + $37,500,000 = $58000,000
Answer:2 Gary Stevens wants the estimated percentage completion on the ending inventory to be increased over 30% so that the cost of the goods sold will appear to be lower that reality and will be mistaken as a cost of completion. This will consequently bump up the profit estimates to the target profits, as Gary Stevens wants.
Answer:3 The 30% complete work on 10,000 units in the inventory cost $20,807,500 - $20,500,000 = $307,500. So each 1% increase in completion will cost 1/30(307500)= $10250. So to get an increase in the reported net operating income by $200000 over the net operating income that would be reported in the 30% figure, the percent completion would have to be 30% + 4.9% = 29.9 %
Answer:4 No Mary James should not go along with the request to alter estimates of the percentage completion because it is an unethical business practice. Not only is it unethical, it's illegal to bad financial documents for any reason; this action could land her jobless or even worse. ...in jail for fraud.
Answer:5
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