Absorption Costing And Performance Evaluation – Speech or Presentation Example

Topic: Absorption Costing and Performance Evaluation On July 2, 2008 Go Go Incorporated acquired 90 percent of the outstanding stock of Medioker Industries in exchange for 2,000 shares of its own stock. Go Go Incorporated has a reputation as a “high-flier” company that commands a high price-to-earnings ratio because its management team works wonders in improving the performance of ailing companies.
At the time of the acquisition, Medioker was producing and selling at an annual rate of 100,000 units per year. This is in line with the firm’s average annual activity. Fifty thousand units were produced during the first half of 2008.
Immediately after the acquisition Go Go installed its own management team and increased production to practical capacity. One-hundred thousand units were produced during the second half of 2008.
At the end of the year, the new management declared another dramatic turnaround and a $500,000 cash dividend when the following set of income statements was issued:
Medioker Industries: Income Statement: For the first and second half-years of 2008
Sales:
First $1,500,000 Second $1,500,000 Total $3,000,000
Cost of Goods Sold:
First ($1,200,000) Second (700,000) Total (1,900,000)
Gross Profit:
First $300,000 Second $800,000 Total $1,100,000
Selling & Admin Expenses:
First (200,000) Second (400,000) Total (600,000)
Net Income:
First $100,000 Second $400,000 Total $500,000
*Absorption costing with any under-absorbed or over-absorbed overhead written off as an adjustment to cost of goods sold. Medioker applies manufacturing overhead using a predetermined overhead rate based on annual production of 100,000 units.
Required: As the only representative of the minority interest on the board of directors, evaluate the performance of the new management team.
As the representative of the minority interest on the board, I like what I see in terms of operations but not in payouts. New management has maintained the volume of sales seen in the previous period, demonstrating that the changes in efficiency have not adversely affected production or sales. What has changed dramatically is the turnaround in COGS. In the second period, the new management has been able to sustain the same revenue base at a ~40% reduction in costs of production. This has doubled—almost tripled—the Gross Profit of the firm between the periods, making a major impact on the value of the firm. Further, this efficiency has been extended into the G&A expense categories—even though the actual expenses have doubled, their ratio to Gross Profit demonstrates significant efficiencies; G&A has been reduced from 66% of Gross Profit to 50%. Thus, it is taking less non-direct sales support to accomplish significantly higher profits. Finally, the effectiveness of new management is most fully appreciated in the Net Profit category; 4X earnings between the periods under review, with 80% of the profit coming during the second period. As far as operational efficiency, this management team is great.
That said, however, I am not in favor of declaring the $ 500,000 cash dividend. This is the entirety of the profits achieved by the company in a full year. Who does this? Not prudent managers who might issue a small dividend on a profitable year and put the rest of the profits back into the working capital or infrastructure of the company. A 100% profit declaration as a cash dividend can only be used by one group—managers that are short-term and looking to move on. This team is a group of raiders. While my minority share certainly made money, if I cared about this company, I would not be pleased by giving away the profits.