Question 1 (10 Marks)
Jazeera Publishing House produces consumer magazines. The house and home division which sells home improvement and home decorating magazines, has seen a 20% reduction in operating income over the past nine months, primarily due to the recent economic recession and the depressed consumer housing market. The division’s Controller, Henry Bald, has felt pressure from the CFO to improve his division’s performance by the end of the year. Henry is considering the following options for improving the division’s performance by year-end:
a) Cancelling two of the division’s least profitable magazines, resulting in the layoff of twenty-five employees.
b) Selling the new printing equipment that was purchased in January and replacing it with discarded equipment from one of the company’s other divisions. The previously discarded equipment no longer meets current safety standards.
c) Reducing the division’s Allowance for Bad Debt Expense. This transaction alone would increase operating income by 5%.
d) Recognizing advertising revenues that relate to January in December.
e) Switching from declining balance to straight-line depreciation expense in the current year.
1. What are the motivations for Henry to improve the division’s year-end operating earnings?
2. From the point of view of the “Standards of Ethical Behavior for Practitioners of Management Accounting and Financial Management,” identify which of the items from (a – e) are acceptable? Which are unacceptable? Explain your reasons.
3. What should Henry do about the pressure to improve performance?
Question 2 (10 Marks)
Wendy Jackson, the new plant manager of Binary Manufacturing has just reviewed a draft of his year-end financial statements. Wendy 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, Wendy demanded that his controller go back and “work the numbers” again. Wendy insisted that if he didn’t see a better operating income the next time he would be forced to look for a new controller. Binary 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. Wendy 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 Wendy happy.
1. Show numerically how operating income would improve by $325,000 just by classifying the preceding costs as product costs instead of period expense?
2. Is Wendy correct in his justification that these costs “are definitely related to our product”
3. What should the plant controller do?
Question 3 (10 Marks)
Kaiser Company just hired its fourth production manager in three years. All three previous managers had quit because they could not get the company above the break-even point, even though sales had increased somewhat each year. The company was operating at about 60 % of plant capacity. The flatware industry was growing, so increased sales were not out of the question.
I. R. Thinking took the job as manager of the production division with a very attractive salary package. After interviewing for the position, he proposed a salary and bonus package that would give him a very small salary but a large bonus if he took the operating income (using absorption costing) above the breakeven point during his very first year.
What do you think Mr. Thinking had in mind for increasing the company’s operating income? How can Kaiser Company counter measures for any manipulation schemes?
END OF QUESTIONS
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