South Chemicals Corporation
was adversely affected by a tax ruling that certain selling and administrative
expenses must be treated as product costs instead of period costs for reporting to
the tax authorities. (Recall that period costs are charged as expenses in the period
they are incurred. Product costs are added to the inventory value of the products
and are charged as expenses when the products are sold.)
South is a maker of wax compounds with annual sales of more than
$15 million. The company keeps large inventories to be able to respond quickly
to customer demands. Suppose in 2007 South’s financial reporting system measured
the revenue at $15 million, cost of goods sold (a product cost) at $10 million,
and selling and administrative expenses (all period costs) at $3 million. Now
suppose the tax ruling required $2 million of the $3 million selling and administrative
costs to be product, not period, costs. (The remaining $1 million is still a period cost for tax reporting as well as financial reporting.) Of the $2 million
additional product cost, $1.5 million was allocated to products that were sold and
$0.5 million to products remaining in inventory.
1. Compute 2007 income before taxes as reported in the financial statements
issued to the public.
2. Compute 2007 income.before taxes as reported in the statements prepared
for the tax authorities.