Question

The plant manager of Spectra Products Manufacturing Plant has just reviewed a draft of his year-end financial statements. The plant manager receives a year-end bonus of 6% of the plant's operating income before tax. The year-end income statement provided by the controller was disappointing to say the least. After reviewing the numbers, the plant manager demanded that his controller go back and "work the numbers" again. He insisted that if he didn't see a better operating income number the next time around he would be forced to look for a new controller.

Spectra Products 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 $2,400,000, are classified as period expenses. The plant manager suggested that warehousing costs be included as product costs because they are "definitely related to our product". The company produced 210,000 units during the period and sold 190,000 units.

1. If the controller reworks the numbers and reclassifies the warehouse costs as product costs, how much would operating income improve? Show all calculations.

2. Is the plant manager correct in saying the warehouse costs should be reclassified because they "definitely relate to our product"? Explain your answers.

3. How much will the plant manager benefit by this decision? Should the controller reclassify the costs? Explain why or why not.

Answer 1

Solution

1. If the controller reclassifies warehousing cost as product cost, the cost per unit would be $2,400,000/210000 = $11.43 per unit. As only 1,90,000 units are sold during the current period only $2171429 (190000*11.43) would be expenses off instead of $2,400,000. The operating Income would increase by $228600 ( 20000*11.43)

2. No, the plant manager is not correct because classifying costs as product costs and period cost is determined by GAAP and GAAP requires warehousing costs to be classified as period costs

3.He would benefit by 6% * $228600 = $13716. He should reclassify because it would violate the requirements of GAAP and would be considered as fraudulent act.