1. As a result of the changes the new president has implemented, it appears as though net income is now positive rather than negative which looks good from an investors standpoint. However, what’s really important for us to look at is the arrival of this endpoint rather than the endpoint itself. His decision to increase production from 17,000,000 units to 30,000,000 was quite a bold one considering sales and production were exactly even at the time of hire. What would happen if B.E. wasn’t able to sell all of the 30,000,000 units? They would get stockpiled into ending inventory and allocated expense which would increase costs of goods sold and therefore net income. Since the presidents bonus is based off of net income and the amount he can make appear on paper, there was incentive for him to over stock inventory and inflate net income. In reference to the schedule below, if B.E. were to produce 25,000,000 units instead of 30,000,000 and have 0 left in ending inventory, net income would amount to $0 and the newly appointed president would receive no bonus. Now where’s the incentive in that?
2010 – production and sale of 25,000,000 units
Sales 25,000,000 x $2.00 50,000,000
Variable 25,000,000 x $1.00 $ 25,000,000
Ending Inventory, 0 units 0
Cost of Goods Sold 33,400,000
Gross Margin $ 16,600,000
Marketing, distribution, customer service costs:
Variable $ 12,500,000
Fixed 4,100,000 16,600,000
Operating Income $ 0
2. Would you change your remarks in (1) if?
a. If the sales outlook for the coming three years was only 20,000,000 and B.E. continued producing at the rate of 30,000,000 units, a total of 10,000,000 units would be dumped into ending inventory at the end of each year once again reducing costs of goods sold and falsely increasing income. By the end of year 2013, B.E. Company would...