Sometimes compensation packages include bonuses designed to provide performance

Question

Sometimes compensation packages include bonuses designed to provide performance incentives to employees. The difficulty a bonus can cause accountants is not an accounting problem, but a math problem. The complication is that the bonus formula sometimes specifies that the calculation of the bonus is based in part on the bonus itself. This occurs anytime the bonus is a percentage of income because expenses are components of income, and the bonus is an expense.

     Regalia Fashions has an incentive compensation plan through which a division manager receives a bonus equal to 15% of the division’s net income. Division income in 2016 before the bonus and income tax was $125,000. The tax rate is 30%.

Calculate the amount of the bonus. (Do not round intermediate calculations.)

Prepare the adjusting entry to record the bonus compensation. (Do not round intermediate calculations. If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

** Record the bonus compensation.

Bonus arrangements take many forms. Suppose the bonus specifies that the bonus is 15% of the division’s income before tax, but after the bonus itself. Calculate the amount of the bonus.

Sometimes compensation packages include bonuses designed to provide performance incentives to employees. The difficulty a bonus can cause accountants is not an accounting problem, but a math problem. The complication is that the bonus formula sometimes specifies that the calculation of the bonus is based in part on the bonus itself. This occurs anytime the bonus is a percentage of income because expenses are components of income, and the bonus is an expense.

     Regalia Fashions has an incentive compensation plan through which a division manager receives a bonus equal to 15% of the division’s net income. Division income in 2016 before the bonus and income tax was $125,000. The tax rate is 30%.

Explanation / Answer

Assume bonus=X

so net income before tax =$125,000-X

tax on that=30%($125,000-X)=$37,500-0.3X

Net Income after tax= Net income before tax -Tax=$125,000-X-($37,500-0.3X)

=$125,000-$37,500-X+0.3X=$87,500-0.7X

bonus is 15% net income after tax=15%($87,500-0.7X)=$13,125-0.105X

so X=$13,125-0.105X

X+0.105X=$13,125

1.105X=$13,125

X=$13,125/1.105=$11,878

amount of bonus=$11,878

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