MacGiver Brass is a brass plating firm with sales of $8 million and profits befo

Question

MacGiver Brass is a brass plating firm with sales of $8 million and profits before taxes of $625,000. MacGiver has a loan outstanding at its local bank for working capital purposes. As the loan officer reviewing MacGiver's loan application, you are charged with making a recommendation as to whether the $608,000 loan should be renewed for another year.
Upon reviewing MacGiver's most recent annual report, you find the following footnote: Under-absorbed overhead of $462,000 was prorated to inventories (2/3) and cost of goods sold (1/3).
Required:
a. How should you evaluate MacGiver's annual report in light of this footnote? In particular, how does this footnote affect your recommendation regarding the loan?
b. In preparing for your meeting with MacGiver's president and chief financial officer, what questions do you want to ask regarding this footnote?

Explanation / Answer

(a) Upon reviewing MacGiver's most recent annual report, you find the following footnote: Under-absorbed overhead of $462,000 was prorated to inventories (2/3) and cost of goods sold (1/3). This mean that profit for the current year has been inflated to the amount of 462000*2/3 = 308000 So the actual profit for the current year = 625000-308000 = 317000 Has correct amount of overhead been allocated to correct accounts, the profit would have been around 317000 instead of 625000. He should discus with the management the reason for not allocating the overhead to the current year, rather than charging it off to the inventory. (b) I would want to ask him the reason for allocating such overheads to inventory I would also ask him that does he expect higher realisation from the inventories in the next year. Happy to help

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