Jordan Brothers recently instituted a bonus plan to pay its executives. The plan specifies that net income must exceed $200,000 before any bonus payments are made. Cash in the amount of 10 percent of net income in excess of $200,000 is placed in a bonus pool, which is to be shared evenly by each of the executives. Ignore income taxes, and assume that the bonus payment is not included as an expense in the calculation of net income.
a. Briefly describe why a company would institute a bonus plan, and compute the amount in the bonus pool if Jordan Brothers shows net income of $300,000. Prepare the journal entry that would be recorded to reflect the bonus liability at the end of the year.
b. How much is in the bonus pool if Jordan Brothers shows net income of $180,000? Assume that Jordan Brothers is being sued for $60,000 as of the end of the year. The company's legal counsel believes that there is an 80 percent chance that Jordan will lose the suit and that the entire $60,000 will have to be paid. Assume also that the suit was ignored when the $180,000 net income was computed. Why might Jordan's management wish to accrue the loss from the suit in the current year instead of simply disclosing it?