Da = merrimack tractors -_analysis

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  • 1. Case Study – Merrimack Tractors and Mowers Inc. Case Study Merrimack Tractors and Mowers Inc. Submission Date 13-Sep-2009 Class EPGP– 09-10 Subject Financial Reporting and Analysis Submitted by  Abhishek Pangaria  Mandeepak Singh  Rajendra Inani  Saravanan Logu  Tarandeep Singh  Vivek Edlabadkar Table of contents Objectives............................................................................................................................2 Case Background.................................................................................................................2 About the Company.........................................................................................................2 Company’s need...............................................................................................................2 Analysis of current Business Scenario.................................................................................4 Conclusion...........................................................................................................................6 Take the FIFO way..........................................................................................................6 Page 1 of 6
  • 2. Case Study – Merrimack Tractors and Mowers Inc. Objectives To suggest suitable revenue recognition methods to Trans-share Inc for its fractional interest programs and other offered services. The recommendation should be an appropriate revenue recognition practices to EITF, based on the model suggested to Trans-share Inc. Case Background About the Company Name of the company Trans-Share Inc. Line of Business Buy-Sale of aircrafts, maintenance and operational support Products Offered: Partial / full ownership of aircrafts Services Offered: Maintenance of aircrafts Aircraft operations support - Pilot & Crew - Flight planning Purchasing & selling aircrafts in secondary market Brokerage & Marketing of aircrafts to 3rd party buyers Company’ s need Trans-share is preparing for IPO and wanted to ensure that its prospectus reflects the real picture of the company by implementing the right revenue recognition methods. In addition, Trans-share wants to be proactive by planning for the impending revenue recognition guidelines from Financial EITF (Emerging Issues Task Force), to be followed in its financial accounting. About EITF A professional financial reporting control group of 13 members, associated with SEC, Financial Accounting Standards Board and the American institute of Certified Public Accountants. This group is focused on early identification of emerging issues affecting the financial reporting and problems in implementing the corrective measures. Page 2 of 6
  • 3. Case Study – Merrimack Tractors and Mowers Inc. Page 3 of 6
  • 4. Case Study – Merrimack Tractors and Mowers Inc. Analysis of current Business Scenario Until 2007, Merrimack has accumulated a LIFO reserve of $5.5 million. Considering the current trend of rising prices, LIFO is a suitable method for computation but as evident from the discussions between the board members, Merrimack is facing huge challenges in meeting up with the cost and keeping the margins intact. This is primarily because of the rising cost of imports. Possible Solutions 1. Continuing with LIFO 2. Moving to FIFO from 2008 As evidenced by Colburn, moving to FIFO will cost the company $2 million on account of additional taxes. But this tax is unavoidable if the company were ever to liquidate. Moving into FIFO in 2008 will plug in additional $3.5 million into the financial system and hence bloat the profit margin for the year. However, moving to FIFO in times of rising costs is going to be counterproductive in following years. This is because the company would be incurring higher taxes as the cost of goods in transaction would be lower than what would have been in LIFO. Assumptions in analysis 1. Sales remain consistent at 40,000 units each year 2. Selling and administrative expenses remain constant 3. Sales Price increases YoY at a rate of 5% LIFO Analysis Figure 1 Page 4 of 6
  • 5. Case Study – Merrimack Tractors and Mowers Inc. Income Statement 2007 - LIFO 2008 - LIFO 2009 - LIFO Sales $67,000,000 $70,350,000 $73,867,500 Cost of Goods Sold $46,000,000 $62,000,000 $78,000,000 Gross Margin $21,000,000 $8,350,000 -$4,132,500 Selling and admin exp. $10,000,000 $10,000,000 $10,000,000 Income before taxes $11,000,000 -$1,650,000 -$14,132,500 Income Tax (35%) $3,850,000 $0 $0 Net Income $7,150,000 -$1,650,000 -$14,132,500 Profitability Margin 10.67 (2.35) (19.13) Figure 2 From Figure 1 and 2, we may conclude the following 1. Despite the rise in costs, the inventory holding remains unchanged. 2. YoY, the net income is depleting at a rapid rate. The main contributor for this change is the increasing COGS. FIFO Conversion Figure 3 Income Statement 2007 - LIFO 2008 - FIFO 2009 - FIFO 2009 - FIFO** Sales $67,000,000 $70,350,000 $73,867,500 $73,867,500 Cost of Goods Sold $46,000,000 $50,500,000 $72,000,000 $63,750,000 Gross Margin $21,000,000 $19,850,000 $1,867,500 $10,117,500 Selling and admin exp. $10,000,000 $10,000,000 $10,000,000 $10,000,000 Income before taxes $11,000,000 $9,850,000 -$8,132,500 $117,500 Income Tax (35%) $3,850,000 $3,447,500 $0 $41,125 Net Income $7,150,000 $6,402,500 -$8,132,500 $76,375 Profitability Margin 10.67 9.10 (11.01) 0.10 ** - Indicates the values with curtailed COGS Figure 4 Page 5 of 6
  • 6. Case Study – Merrimack Tractors and Mowers Inc. From figure 3 and 4 above, we can conclude the following: 1. As we move from LIFO to FIFO in 2008, the COGS does not increase substantially despite the rise in costs. This is primarily due to the use of inventory with cost of $900. 2. We are able to maintain profitability which is comparable to figures from 2007. 3. As the prices keep increasing from 2007 to 2009, the effect of move from LIFO to FIFO (i.e. LIFO reserve liquidation) is seen in 2008. However, the effect is counterproductive in 2009 as FIFO is not a good practice when prices are rising. Conclusion Take the FIFO way Considering available options it is evident that the business will run unviable in 2008 if the company does not move to FIFO method of accounting for inventory. This however is not the gospel to move company from RED to green. The move will prove to be extremely wrong if the company does not plan to reduce cost of production/purchase. Hence this move is to be seen only as a measure to keep the business running under “viable” status for another year. Page 6 of 6