Suppose you are the cost accountant for Palm Producers. Turn in your answers to the following — expecting sales growth and built nearly identical automated plants San Jose

Palm Producers (PP) is expecting sales growth, and so it built nearly identical automated plants in San Jose, California, and in Singapore to produce its new Palm Powerhouse. Each plant manager is responsible for producing adequate inventories to meet sales orders and for maintaining quality while producing the Palm Powerhouse at the lowest possible cost.

Under PP’s decentralized organization, each plant maintains its own accounting records. Quarterly reports are filed with the corporate controller’s office and are then reviewed by corporate management. The following reports were filed for the third and fourth quarter by the two plants.

ANALYZE INFORMATION

The following questions will help you analyze the information for this problem. Do not turn in your answers to these questions unless your professor asks you to do so.

A. Suppose each plant manager receives a bonus based on absorption costing operating income that is 5% of operating income. Calculate the fourth quarter bonus for each manager. Explain how this bonus plan might affect the managers’ production decisions.

B. Examine changes in sales relative to cost of goods sold between the two quarters. What are two possible explanations for the San Jose plant’s profit increase during the fourth quarter?

C. Assume that variable costs in this industry are an immaterial part of cost of goods sold. Recast the fourth quarter financial statements using the variable costing approach.

D. What would you conclude about the relative performances of the two plant managers in the fourth quarter?

REQUIRED

Suppose you are the cost accountant for Palm Producers. Turn in your answers to the following.

E. Write a memo to the CFO recommending the type of income statement that would be best for monitoring divisional performance. Attach to the memo a schedule showing any computations that might be useful to the CFO. As appropriate, refer to the schedule in the memo.

SOLUTION:

San Jose plant manager’s bonus = 5% × $12,646 = $632.30

Singapore plant manager’s bonus = 5% × $5,791 = $289.55

The plant managers have incentives to overproduce inventory, so that more fixed overhead is allocated to inventory on the balance sheet rather than to COGS on the income statement.

For the San Jose plant, sales increase but cost of goods sold decreases. Either cost reductions were instituted or there was a build-up of inventory over the period, which would reduce the amount of fixed overhead in cost of goods sold.

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If variable costs are immaterial, the difference in inventory amounts between the last two quarters is assumed to be expense that is on the balance sheet instead of on the income statement.

San Jose Plant Singapore Plant

Fourth quarter income $12,646 $5,791

Change in inventory (18,100) (2,508)

Variable costing income $ (5,454) $3,283

I would conclude that the San Jose plant manager’s performance was poor during the last quarter of the year, and certainly not as good as the performance of the Singapore plant manager.

However, a high-quality memo would do all of the following:

Briefly identify and then describe the major pros and cons of alternative income statements (absorption costing and variable costing, and possibly also throughput costing) for monitoring divisional performance at Palm Producers

Use the quarterly financial results to illustrate the potential problems under absorption costing (i.e., discuss possible explanations for the San Jose plant’s profit increase, including a possible inventory build-up in light of the incentives under absorption costing)

Discuss ways in which variable costing would improve performance measurement, highlighting the fact that the relative profitability of the two plants would be reversed under variable costing, and that the San Jose plant would show a loss instead of income during the fourth quarter

Present relevant numerical calculations in an attachment to the memo and refer to the attachment in the memo

Focus the managers’ attention on the best way to measure and monitor divisional performance

Provide a recommendation for the best income statement, including how factors were prioritized in making the recommendation

Provide at least one major limitation and/or drawback of the recommendation (such as possible negative reactions of the managers to a change)

Use language and degree of detail that is appropriate when communicating with the CFO, who should be familiar with accounting methods and terminology

Demonstrate a tone of giving objective advice, with management as the ultimate decision maker

Be written as a cohesive document that does NOT read like a mere list of answers to Parts A-D