Solved: The board of directors of Mesa Verde Tool

Company set
The board of directors of Mesa Verde Tool Company set

The board of directors of Mesa Verde Tool Company set the profit goal for calendar year 2016
at $2,200,000. It also established a bonus plan in which the top five officers of the company will
share $150,000 if the profit goal is met or exceeded. If the goal is not met, there is no bonus. T.
J. Elias, the chief financial officer and one of the top five executives, prepared the following
budgeted income statement for 2016, based on the board’s profit directive:

By late September, it became apparent that sales were running below fore- cast and that annual
sales would approximate 450,000 units, for an estimated net income of $1,230,000 and no
bonus. In an executive committee strategy meeting, Bob Wrangell, vice president of
Manufacturing, suggested that the production capacity was available to produce the entire
500,000 units or more, even if that sales level could not be reached. He remembered a
presenter, from a seminar that he recently attended, describing how net income could be
increased by producing more than can be sold. He urged Elias to determine how many extra
units they would need to produce to achieve the profit goal and, thus, earn the bonus.

Required:

1. If sales only reach 450,000 units for the year, how many additional units would have to be
produced, given the current selling price and cost structure, to meet the budgeted profit of
$2,200,000?

2. Prepare an absorption costing income statement to prove your answer above.

3. What ethical responsibility, if any, does Elias have in this situation?

4. What is there about the bonus plan that potentially encourages unethical behavior?

The board of directors of Mesa Verde Tool Company set

ANSWER
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