Case study 2 Paul Smith, the new manager of manufacturing division of Garden Scapes, has just reviewed a draft of his year-end financial statements. Paul Smith receives a year-end bonus of 11.5% of the divisions operating profit. The year-end income statement provided by the divisions management accounting was disappointing, to say the least. After reviewing the numbers, Paul Smith demanded that his management accountant go back and work the numbers again. Paul Smith insisted that if he didnt see a better operating income number the next time around he would be forced to look for a new management accountant

Garden Scapes Manufacturing classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the product is sold. All other expenses, including finished goods warehousing costs of $3,640,000, are classified as period expenses. Paul Smith had suggested that warehousing costs be included as product costs because they are definitely related to our product. The company produced 260,000 units during the period and sold 240,000 units. As the management accountant reworked the numbers, he discovered that if he included warehousing costs as product costs, he could improve operating profit. He was also sure that these new numbers would make Howard happy.

Required: (1) Numerically illustrate how the operating profit would improve just by classifying the warehousing costs as product costs instead of period expenses. Also, specify the amount by which the operating profit would improve by reclassification of warehousing costs.

(2) Is Paul Smith correct in his justification that these costs are definitely related to our product? What is your position on this issue?

(3) By how much will Paul Smith profit personally if the management accountant makes the adjustments in requirement 1?

(4) Given the circumstances of the case study, what would you do if you were the management accountant at the manufacturing division of Garden Scapes?