South Chemicals 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 2010 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 2010 income before taxes as reported in the issued to the public.
2. Compute 2010 income before taxes as reported in the statements prepared for the tax authorities.
