Beth Bledsoe joined Baker Brothers, Inc. as controller in October 2019. Baker Brothers manufactures and installs custom
Beth Bledsoe joined Baker Brothers, Inc. as controller in October 2019. Baker Brothers manufactures and installs custom kitchen countertops. The company uses a normal-costing system with two direct-cost pools, direct materials and direct manufacturing labor, and one indirect-cost pool, manufacturing overhead. In 2019, manufacturing overhead was allocated to jobs at 150% of direct manufacturing labor cost. At the end of 2019, an immaterial amount of underallocated overhead was closed out to cost of goods sold, and the company showed a small loss. Bledsoe is eager to impress her new employer, and she knows that in 2020, Baker Brothers’ upper management is under pressure to show a profit in a challenging competitive environment because they are hoping to be acquired by a large private equity firm sometime in 2021. At the end of 2019, Bledsoe decides to adjust the manufacturing overhead rate to 160% of direct labor cost. She explains to the company president that, because overhead was underallocated in 2019, this adjustment is necessary. Information for 2020 follows:
The ending balances (before proration of under- or overallocated overhead) in each account are as follows:
Baker Brothers’ revenue for 2020 was $5,580,000, and the company’s selling and administrative expenses were $2,790,000.
1. Calculate the amount of under- or overallocated manufacturing overhead in 2020.
2. Calculate Baker Brothers’ net operating income for 2020 under the following:
a. Under- or overallocated manufacturing overhead is written off to cost of goods sold.
b. Under- or overallocated manufacturing overhead is prorated based on the ending balances in work in process, finished goods, and cost of goods sold.
3. In your own words, describe how you expect net operating income in future periods to compare under scenarios 2a and 2b above.
4. Bledsoe chooses option 2a above, stating that the amount is immaterial. Comment on the ethical implications of her choice. Do you think that there were any ethical issues when she established the manufacturing overhead rate for 2020 back in late 2019? Refer to the IMA Statement of Ethical Professional Practice.
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