CASE 4–20 Ethics and the Manager, Understanding the Impact of Percentage Complet

Question

CASE 4–20 Ethics and the Manager, Understanding the Impact of Percentage Completion on Profit— Weighted-Average Method [Course Objective B] Gary Stevens and Mary James are production managers in the Consumer 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 El 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 its target profits for the year. The bonus is determined in March after the company’s annual report has been prepared and issued to stockholders. 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 last year and we are within $200,000 of making the year’s target profits. All we have to do is pull a few strings, and we’ll be over the top! Mary: What do you mean? Gary: Well, one thing that would be easy to change is your estimate of the percentage completion of your ending work-in-process inventories. Mary: I don’t know if I can do that, Gary. Those percentage completion figures are supplied by Tom Winthrop, my lead supervisor, whom I have always trusted to provide us with good estimates. Besides, I’ve already sent 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 the rest of us sure could use it.

IMPORTANT DATA FOR THIS PROBLEM: The processing area under Mary’s supervision started the year with 50,000 units in beginning WIP. During the year, 160,000 units were transferred in from the prior processing department and 200,000 units were completed and sold . Costs transferred in from the prior department totaled $39,375,000 ($30,000,000 in conversion value and $9,375,000 in materials value). A total of $20,807,500 in costs ($18,000,000 in conversion costs and $2,807,500 in materials costs) were incurred in Mary’s area during the period. Required: 1. Tom Winthrop, the lead production supervisor, estimated that the units in ending inventory in Mary’s area were 30% complete with respect to conversion costs, and all materials had been completely inserted in the process. If this estimate of the percentage completion is used, what would be the Cost of Goods Sold for the year? (Note: Since all units completed were also sold, in this case the cost of goods transferred out = Cost of Goods Sold.) 2. Gary is recommending that the completion percentage be adjusted by 10 percentage points in order to assist the team in making their bonus.

a. Calculate the Cost of Goods Sold if the ending inventory is 20% complete with respect to conversion costs. Would net income increase or decrease if this option were chosen over the original estimate of 30% completion percentage? How much is the increase or decrease?

b. Calculate the Cost of Goods Sold if the ending inventory is 40% complete with respect to conversion costs. Would net income increase or decrease if this option were chosen over the original estimate of 30% completion percentage? How much is the increase or decrease?

c. Based on your calculations, which percentage would you guess Gary is suggesting that Mary use for her ending inventory estimate?

3. Do you think Mary should go along with the request to alter estimates of the percentage completion for her production area at the end of the period? Why or why not? Deliverables:

Submit an Excel spreadsheet that documents the calculations made for Steps 1 and 2 above. All items should be clearly labeled, and appropriate formulas should be used to perform your calculations.

Explanation / Answer

Part 1)

To calculate the cost of goods sold, we need to determine the equivalent units of production equivalent cost per unit as below:

_____

_____

Now, we can calculate the value of cost of goods sold as below:

Cost of Goods Sold = Units Sold*(Total Equivalent Cost Per Unit) = 200,000*(187.50 + 102.50) = $58,000,000

_____

Part 2)

a)

We will have to calculate the revised equivalent cost per unit (conversion) and cost of goods sold as below:

_____

_____

Now, we can calculate the value of cost of goods sold as below:

Cost of Goods Sold = Units Sold*(Total Equivalent Cost Per Unit) = 200,000*(187.50 + 103) = $58,100,000 [there can be a slight difference in final answer on account off rounding values)

Since, cost of goods sold has increased at 20% conversion, the net income would decrease by $100,000 (58,100,000 - 58,000,000).

_____

b)

We will have to calculate the revised equivalent cost per unit (conversion) and cost of goods sold as below:

_____

_____

Now, we can calculate the value of cost of goods sold as below:

Cost of Goods Sold = Units Sold*(Total Equivalent Cost Per Unit) = 200,000*(187.50 + 102) = $57,900,000 [there can be a slight difference in final answer on account off rounding values)

Since, cost of goods sold has decreased at 40% conversion, the net income would increase by $100,000 (58,000,00 - 57,900,000).

_____

c)

Based on the calculations, Gary is obviously suggesting a completion of ending inventory at 40% (with respect to conversion costs) as it would result in higher net income and payout of expected bonus.

_____

Part 3)

No, Mary shouldn’t go along with the request to alter estimates of the percentage completion for her production area at the end of the period as it would be against ethical accounting practices. It is the responsibility of accountant (both financial and cost)/production manager to ensure that correct figures/estimates are used in the preparation of accounting records. Any alteration to figures or in the application of accounting rules/principles/standards/procedures can disrupt the entire accounting process which is unethical and can adversely affect business operations in the future.

Transferred In Conversion Units Completed and Transferred Out 200,000 (200,000*100%) 200,000 (200,000*100%) Ending Work in Process 10,000 (10,000*100%) 3,000 (10,000*30%) Equivalent Units of Production 210,000 203,000

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