Scott Hewitt, the new plant manager of Old World Manufacturing plant Number 7, h

Question

Scott Hewitt, the new plant manager of Old World Manufacturing plant Number 7, has just reviewed a draft of his year-end financial statements. Hewitt receives a year-end bonus of 10% of the plant's operating income before tax. The year-end income statement provided by the plant's controller was disappointing to say the least. After reviewing the numbers, Hewitt demanded that his controller go back and "work the numbers" again. Hewitt insisted that if he didn't see a better operating income the next time he would be forced to look for a new controller. Old World manufacturing classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the product is sold. All other expenses, including finished goods warehousing costs of $3250000 are classified as period expenses. Hewitt had suggested that warehousing costs be included as product costs because they are "definitely related to our product". The company produced 200,000 units during the period and sold 180,000 units.

As the controller reworked the numbers he discovered that if he included warehousing costs as product costs, he could improve operating income by $325,000. He was also sure that these new numbers would make Hewitt happy.

Required:

1. What are the ethical issues involved?

2. Show numerically how operating income would improve by $325,000 just by classifying the preceding costs as product costs instead of period expense?

3. Is Hewitt correct in his justification that these costs "are definitely related to our product"

Explanation / Answer

1) As per GAAP, presentation of the financial statement should be true and fair and it is the GAAP who says that R&D expenses as well as all costs related to eharehousing and distribution should be treated as period cost not as product cost to show as true and fair financial statement. Show it is not ethical to treat this cost as product cost instead of period cost. 2) Calculations Warehousing Cost          32,50,000 Existing System: Charged to P&L Charged to Inventory No of units produced            2,00,000     32,50,000 0 System As per wishes of Scott Hewitt Charged to P&L Charged to Inventory No of Units Sold            1,80,000     29,25,000 Inventory                20,000             3,25,000 3) No Scott Hewitt is not correct, as stated in part 1) it is not etictical to treat this as product cost

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