Costing Methods and Earnings Management

Managerial Accounting

Project 3 Costing Methods and Earnings Management

Team 2: Kaitlyn Bright, JE Doerr, Bill Abad, Jonathan Needham & Janine Menasakanian

Map Machines manufactures GPS systems that are used in motor vehicles. They are a publicly traded company and must report GAAP financial statements accordingly. In 2016, Map Machines received a commitment for 300,000 GPS units over the 2017 and 2018 fiscal years. While the commitment looks solid, the buyer has the right to purchase fewer units should they receive fewer orders for cars with the GPS option. Although the volume per year is also not guaranteed under the contract, Map Machines management, as well as stock market analysts, expect the contract to yield sales of 150,000 units per year.

Below is Map Machines financial information and projected income statement based on 150,000 units of production and sales (i.e. production = sales).

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Additional Information:

• Map Machines current production capacity is 160,000 units.
• The company has very little warehouse space and prefers to produce and sell the same amount of units to eliminate inventory costs.
• Map Machines CEO receives a salary plus a bonus of 50% of salary if the company meets or beats its projected GAAP income.
• The company keeps variable costing income records for management decision purposes, but does not currently use them for compensation purposes since the income from these methods have been typically very similar in the past. 
• R&D expenses are treated as fixed costs for variable costing purposes, but the amount spent on R&D is 100% at management discretion.

As of mid-2017, management has been notified by their buyer that GPS orders for the year will total 145,000 units rather than the 150,000 expected. The CEO is worried about the prospects of not meeting expected financial targets and has called on you, his financial planning team, to calculate GAAP and Variable Costing income under various scenarios and to make suggestions.

Assignment

Instructions: Please embed your answers inside the document after each question. If you are unsure about something, feel free to email me for guidance.

1.          Using the income statements from the previous page as templates, calculate the GAAP (absorption costing) and variable costing income statements under 145,000 units of sales and production. How much will Map Machines miss their target earnings by?