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hanhan2008
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Posted: 26 Nov 2009 at 08:11 \| IP Logged

Able co. provides an incentive compensation plan under which its president receives a bonus equal to 10% of the corporation's income before income tax but after deduction of the bonus. If the tax rate is 40% and net income after bonus and income tax was $360,000, what was the amount of the bonus?

Answer is $60000. The explanation is:

If net income after bonus and tax is 4360000 and the tax rate is 40%, net income after bonus can be calculated as follows:

$360000/0.6=$600000 (.6=100%-40% tax rate)

if net income after bonus (but before tax) is $600000; the bonus is 10% of the $600000 or $60000.

My confusion is: in the situation, it tells you "If the tax rate is 40% and net income after bonus and income tax was $360,000", but how the answer tells you "net income after bonus (but before tax) is $600000"?

I think becker is wrong on this question. Any thoughts? Thanks!

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roswellpodsquad
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Posted: 26 Nov 2009 at 12:06 \| IP Logged

I think the Becker solution is fine.

I usually set it up like this

Bonus = 10% * (Pretax Income - Bonus)

In this question net income already accounts for the deduction of the
bonus, so we just have to convert net of tax income to pretax income.

Bonus = 10% *(360,000/.6)
Bonus = 10% * (600,000)
Bonus = 60,000

The 600,000 net income still accounts for the deduction of the bonus,
which is exactly what we want. So, all you have to do now is take the 10%.

Hope that all makes sense.

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lovethepirk
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Posted: 26 Nov 2009 at 12:31 \| IP Logged

As rosewell is saying you need to visualize these questions...learn how to do this fast and it will save you valuable time during the exam!!!

The following is your typical income statement very simplified:

Revenue.........................xxxx
Expenses.......................(xxxx)
Bonus Expense................(xxxx)
___________________________
Pretax income................xxxx
Taxes(40%).....................(xxxx)
____________________________
Net income.....................360,000

The bonus = the following:
"a bonus equal to 10% of the corporation's income before income tax but after deduction of the bonus."

What line in my example would equate to "before income tax but after deduction of the bonus"?
---Easy it is pretax income!!! We deducted the bonus to get that number and it is prior to removing tax expense

FIND that number and multiply it by 10% and your DONE!

360,000 + the taxes we removed= pretax income
10% x pretax income = bonus

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passfirsttime
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Posted: 26 Nov 2009 at 13:08 \| IP Logged

It might help you to think of the becker question as asking what the bonus EQUALS, and not how it is CALCULATED. When you first read their question, it might make your mind run in circles trying to figure out how to calculate a bonus based on a net number that includes the bonus we are calculating. That is done through an iterative calculation, but is not really what Becker is emphasizing.

All they are asking is for is what the bonus is EQUIVALENT too. So, if net income is 360K, the tax rate is 40%, then as you say pretax income is $600K. If the bonus is EQUAL to 10% of pretax income, then it must be $60K.

Again, to actually CALCULATE a bonus payment equivalent to 10% of pretax income, but taking into account the bonus payment, would require an iterative calculation which is beyond the scope of their question.

hanhan2008
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Posted: 26 Nov 2009 at 15:18 \| IP Logged

Got it! Very explained by all of you. Thanks!!!

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