Question

Franklin Manufacturing Company (CMC) was started when it acquired $99,000 by issuing common stock. During the first year of operations, the company incurred specifically identifiable product costs (materials, labor, and overhead) amounting to $67,500. CMC also incurred $67,500 of engineering design and planning costs. There was a debate regarding how the design and planning costs should be classified. Advocates of Option 1 believe that the costs should be classified as general, selling, and administrative costs. Advocates of Option 2 believe it is more appropriate to classify the design and planning costs as product costs. During the year, CMC made 4,500 units of product and sold 3,900 units at a price of $36.00 each. All transactions were cash transactions. Required a-1. Prepare an income statement and balance sheet under option 1. a-2. Prepare an income statement and balance sheet under option 2. b. Identify the option that results in financial statements that are more likely to leave a favorable impression on investors and creditors. c. Assume that CMC provides an incentive bonus to the company president equal to 15 percent of net income. Compute the amount of the bonus under each of the two options. Identify the option that provides the president with the higher bonus. d. Assume a 35 percent income tax rate. Determine the amount of income tax expense under each of the two options. Identify the option that minimizes the amount of the company’s income tax expense.

Answer 1

Answer:

a 1) Income statement                                        option 1

sales ( 3,900 * $36)                                         $140,400

COGS (3,900*$15)                                         - $58,500

Gross profit                                                      $81,900

General Selling and Admin costs                 -$67,500

Net income                                                      $14,400

Balance sheet                                              

Assets

Current Assets

Inventory (600 *15)                                         $9,000

Bank                                                                $104,400

total Assets                                                     $113,400

Equity and Liabilities

Equity

Common stock                                                 $99,000

Retained Earnings                                           $14,400

Total Equity And Liabilities                             $113,400

a 2) Income Statement                                      option 2

sales ( 3,900 * $36)                                         $140,400

COGS (3,900 * 30)                                         -$117,000

Gross profit                                                      $23400

Net income                                                       $23,400

Balance sheet

Inventory (600 *30)                                         $18,000

Bank                                                                $104,400

total Assets                                                     $122,400

Equity and Liabilities

Equity

Common stock                                                 $99,000

Retained Earnings                                           $23,400

Total Equity And Liabilities                             $122,400

b ) Option 2 is more likely to leave a favorable impression on investors and creditors hence more profits, assets and ROA of 6.43% more than option 1.

c)                                                             option 1       option 2

Bonus (net income *15%)                     $2,160           $3,510

Option 2 has a higher bonus than option 1

d)                                                            option 1            option 2

Tax expense (35%) of net income      $5,040               $8,190

Option 1 Pays little tax therefore minimizes tax expense.

Explanation:

unit cost = Total cost of production / units produced

              = 67,500/4500

              = $15 option 1

unit cost = Total cost of production / units produced

               =(67500+67500) /4500

               =135000/4500

               = $30 option 2

closing inventory = 4500-3900= 600

Bank ( 99000-67500-67500 +140400) = 104400