The management of Sting Enterprises shares in a bonus that is determined and paid at the end of each year. The amount of the bonus is defined by multiplying net income from continuing operations (after tax) by 12 percent. The bonus is not used in the calculation of income from continuing operations. During 2018, Sting was a defendant in a lawsuit and was required to pay $480,000 over and above the amount covered by insurance. The loss is tax deductible, and the company’s tax rate is 35 percent. The company was last involved in a lawsuit five years ago. Net income from continuing operations (before tax) for 2018, excluding the loss from the lawsuit, was $800,000.
a. Compute management’s 2018 bonus.
b. Repeat (a) and (b) above, assuming that Sting was awarded the $480,000 settlement instead of having to pay it.
c. Explain how the loss can have significant economic consequences