Question

Sometimes compensation packages include bonuses designed to provide performance incentives to employees. The difficulty a bonus can cause accountants is not an accounting problem, but a math problem. The complication is that the bonus formula sometimes specifies that the calculation of the bonus is based in part on the bonus itself. This occurs anytime the bonus is a percentage of income because expenses are components of income, and the bonus is an expense. Regalia Fashions has an incentive compensation plan through which a division manager receives a bonus equal to 12% of the division’s net income. Division income in 2018 before the bonus and income tax was $140,000. The tax rate is 30%.

Answer 1

a) Express the bonus formula as one or more algebraic equation(s).

Let B = Bonus Let T = Taxes

B = 12% x ($140,000 – B – T)

T = 30% x ($140,000 – B)

b) Using these formulas calculate the amount of the bonus.

Substitute 30% x ($140,000 – B) for T in the first formula

B = 12% x [140,000 – B – 30% x ($140,000 – B)]

B = 12% x (140,000 – B – 42,000 + .3B)

B = 12% x 98,000 – .7B

B = 11,760 – .08B

1.08B = 11,760

B = 11,760 ÷ 1.08

B = 10,889

c) Prepare the adjusting entry to record the bonus compensation.

Bonus compensation expense Dr 10,889

Bonus compensation payable Cr 10,889