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 10% of the division's net income. Division income in 2018 before the bonus and income tax was $160,000. The tax rate is 30% Required: 2. Calculate the amount of the bonus. 3. Prepare the adjusting entry to record the bonus compensation. 4. Bonus arrangements take many forms. Suppose the bonus specifies that the bonus is 10% of the division's income before tax, but after the bonus itself. Calculate the amount of the bonus. Complete this question by entering your answers in the tabs below Required 2 Required 3 Required 4 Calculate the amount of the bonus. (Do not round intermediate calculations and round your answers to the nearest whole dollar amount.) Amount of the bonus Required 2 Required 3

Explanation / Answer

Regalia Fashions

Division income before bonus and income tax = $160,000

Bonus = 10% of division income

Tax rate = 30%

Bonus = 10% (160,000 – bonus – tax)

Tax = 30% of (160,000 – bonus)

Assume bonus = B and Tax = T

Substituting the value of tax in equation for bonus we have,

B = 10% of [160,000 – B – 30% of (160,000 –B]

B = 10% x [160,000 – B – 48,000 + 0.30B]

B = 10% x [112,000 – 0.70B]

B = 11,200 – 0.07B

1.07B = $11,200

B = $11,200/1.07

B = $10,467

Hence, bonus = $10,467

Account Titles and Explanation

Debit

Credit

Bonus Compensation Expense

$10,467

Bonus Compensation Payable

$10,467

(Adjusting entry to record bonus compensation payable)

B = 10% (160,000 – B)

B = 16,000 -0.1B

1.1B = 16,000

Bonus = $16,000/1.1

Bonus = $14,545

Account Titles and Explanation

Debit

Credit

Bonus Compensation Expense

$10,467

Bonus Compensation Payable

$10,467

(Adjusting entry to record bonus compensation payable)

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