Question

ABC Manufacturing Company has recently opened a plant in Bermuda in order to take advantage of certain tax benefits. In order to quality for these tax benefits, the company’s direct manufacturing labor costs must be at least 20% of total manufacturing costs for the period.

ABC Manufacturing normally classifies direct manufacturing wages as direct manufacturing labor, but classifies fringe benefits, overtime premiums, idle time, and vacation time and sick leave as indirect manufacturing labor (part of manufacturing overheads).

During the first period of operations in Bermuda, ABC incurs a total of $2,500,000 in manufacturing costs. Of that, $410,000 is direct manufacturing labor wages, $45,000 is overtime premium, $86,000 is fringe benefits, $20,500 is vacation time and sick leave, and $10,900 is idle time.

Required

1. Based on ABC Manufacturing Company’s normal cost classification practices, is the company likely to quality for the for the tax benefit? Show you calculations. (2 Points)
2. Bob Ryan, the manager of the new Bermuda plant, is concerned that he will not get a bonus this year because the plant will not get the tax benefit. Describe TWO specific adjustments to ABC Manufacturing normal cost classification practices that Bod Ryan might ask the plant controller to make to ensure that ABC gets the tax benefit? (Be very specific in your response). Provide a specific rationale that Bod Ryan might use to justify each of the adjustments you described above. (4 Point)
3. Indicate whether the plant controller should make EACH of the TWO adjustments you described in part 2 above. Support your opinion with appropriate and logical arguments. (4 Points)

Answer 1

the question says that in order to avail tax benefits, direct labor costs should be 20% of total manufacturing costs.

direct labor cost= $410000

total manufacturing cost = $2500000

20% of manufacturing cost= 20% * 2500000=$ 500000

in the current situation ABC does not qualify for tax benefits as direct labor cost is 410000 which is less than 20% of total manufacturing cost which is $500000.

ABC can include fringe benefits and paid sick leave  as direct labor costs. Direct cost is any cost that can be directly allocated. fringe benefits and paid sick leave is a direct cost as the can directly be allocated to labor cost as these are benefits and costs incurred for workers used for direct labor.

when these costs are allocated to direct labor, labor cost now becomes 410000+86000 + 20500=$516500 which is more than 20% of total manufacturing costs and hence ABC an avail there tax benefits with these two adjustments