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    Johnson Inc: Compute correct amount of operating income....

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    1. Johnson, Inc. is a manufacturer with a calendar accounting year. A physical inventory is taken on January 1, and any items not in inventory are charged to cost of goods sold. The current year is 2010 and all transaction occur in 2010 unless otherwise specified.

    a. In late September, Johnson signed a $3,500,000 contract with Smith, Inc. for production and installation of custom machinery at Smith's plant. On December 22, Johnson shipped Smith the completed machinery, and billed Smith $3,500,000, debiting a receivable and crediting revenue. Johnson also debited COGS and credited inventory for $2,550,000, the cost of producing the machinery. The machinery is of no use to Smith without installation and calibration by Johnson employees. This work had not been begun as of December 31.

    b. In August, Johnson signed a lease on an office building to be used for administrative (not manufacturing) purposes. An advance rent payment of $1,000,000 was made and debited to Prepaid Rent. The controller forgot to make the year-end adjusting entry to record the expiration of $450,000 of this prepayment during 2010.

    c. In December, Johnson shipped goods on consignment to a dealer, booking revenue and an account receivable of $350,000 and cost of goods sold of $235,000. None of these goods had actually been sold to customers by year-end.

    d. Two years ago, Johnson acquired another manufacturing company whose operations have been integrated with Johnson's. The acquisition price included $5,000,000 for goodwill, which has not been amortized. An appraiser with expertise in this industry estimates that the goodwill has lost 45% of its original value due to changes in the industry. Johnson's management disregarded this appraisal in preparing the financial statements.

    e. Johnson sells its products with a one-year warranty. Estimated cost of servicing warranties on products sold in 2010 is $893,000. During the year, Johnson actually incurred warranty service costs of $842,000, of which half related to products sold in 2010 and half to those sold in 2009. Johnson's accountant charged the actual costs of $842,000 to product warranty expense, and made no other entries to that account.


    For 2010, Johnson reported operating income (before interest and taxes) of $20,000,000. Compute the correct amount of operating income/loss, showing any necessary calculations and explaining your reasoning.

    2. Jerry Manufacturing is a decentralized corporation. Divisions are treated as investment centers. In recent years, Jerry has been running about 11% ROA for the corporation as a whole, and has a cost of capital of 9%. One of their most profitable divisions is Salem Products, which last year had ROA of 17% ($1,700,000 operating income on assets of $10,000,000). Salem has an opportunity to expand one of its plants to produce a promising new product. The expansion will cost two million dollars, and is expected to increase operating earnings to $2,100,000. What factors should Jerry's manager and her supervisor, the VP of operations, consider in deciding whether to go forward with the expansion? Show any necessary calculations.

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    Solution Summary

    Your tutorial (see Excel attached, click in cells to see calculations) gives you the five adjustments to operating income and eight factors to consider for the plant expansion.