MBA 607 Financial Accounting - Case Study

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A case presented in Winter 2007 about a fictitious company dealing with the difference between FIFO and LIFO inventory accounting.

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MBA 607 Financial Accounting - Case Study

  1. 1. Morgan Manufacturing<br />Presented by:<br />Mark Bundang, B.Sc<br />and <br />Mohammed Abdo, B.Eng, M.Eng, PhD, CSSA, PMP <br />
  2. 2. Morgan Manufacturing<br />Agenda <br />Introduction<br />Situation Analysis<br />Conclusion<br />
  3. 3. Morgan Manufacturing<br />Agenda <br />Introduction<br />Situation Analysis<br />Conclusion<br />
  4. 4. Morgan Manufacturing<br />Key Players<br />Morgan Manufacturing<br />Westwood Inc.<br />Charles Crutchfield<br /><ul><li> Manager of manufacturing operations at Morgan.
  5. 5. Primarily concerned with the health of the operating aspects of the business.</li></ul>Edward Drewery<br /><ul><li> Controller for Morgan Manufacturing</li></ul>Competitor of Morgan Manufacturing <br />
  6. 6. Morgan Manufacturing<br />Morgan Manufacturing uses LIFO as its inventory costing method and provides the LIFO reserve.<br />Westwood uses FIFO as its inventory costing method.<br />Events and Facts: Morgan Operations<br />Productivity Improvements<br />Financial Statements<br />Comparison of Operating Performance<br />Over 2006, Morgan Manufacturing implemented significant productivity improvements over Westwood.<br />Morgan feels that these improvements in efficiency should be reflected in the financial statements.<br />Morgan feels that the comparison of 3 key ratios are good indicators of the relative efficiencies between the competitors.<br /><ul><li> Gross Margin Percentage
  7. 7. Pre-tax Return on Sales
  8. 8. Pre-tax Return on Assets </li></ul> Key Fact<br />
  9. 9. Morgan Manufacturing<br />Agenda <br />Introduction<br />Situation Analysis<br />Conclusion<br />
  10. 10. Morgan Manufacturing<br />Inventory Costing Methods<br />EInv = BInv + Purchases – COGS<br />
  11. 11. Morgan Manufacturing<br />Inventory Costing Methods: FIFO and LIFO<br />
  12. 12. Morgan Manufacturing<br />FIFO and LIFO: Goods Available for Sale<br />Current year purchases<br />Beg. Inventory cost<br />COGS<br />FIFO<br />(Pipe)<br /> (Bin)<br />LIFO<br />
  13. 13. Morgan Manufacturing<br />The LIFO Reserve: What‘s Left in Inventory ?<br />Current year purchases<br />Beg. Inventory cost<br />End. Inventory<br />(Bin)<br />LIFO<br />FIFO<br />(Pipe)<br />Ending Inventory (FIFO)<br />Ending Inventory (LIFO)<br />“LIFO Reserve” = EInvFIFO – EInvLIFO<br />
  14. 14. Morgan Manufacturing<br />Using the LIFO Reserve: Income Statement<br />EInvFIFO = BInvFIFO + Purchases – COGSFIFO<br />EInvLIFO = BInvLIFO + Purchases – COGSLIFO<br />Subtracting these two equations yields:<br />EInvFIFO – EInvLIFO = BInvFIFO–BInvLIFO– (COGSFIFO–COGSLIFO)<br />EInvFIFO– EInvLIFO– (BInvFIFO–BInvLIFO) = COGSLIFO–COGSFIFO<br />End LIFO Reserve – Beg. LIFO Reserve = COGSLIFO–COGSFIFO<br /> Change in LIFO Reserve = LIFO-FIFO difference in COGS<br />
  15. 15. Morgan Manufacturing<br />Accounts Affected by the Inventory Costing Method<br />Income Statement<br />Cost of Goods Sold<br />Income<br />Gross Margin<br />Change in LIFO Reserve<br />Inventory<br />Retained Earnings<br />Balance Sheet<br />
  16. 16. Morgan Manufacturing<br />Key Parameters to Assess Operating Efficiency<br />Calculation<br />Meaning<br />Ratio<br />Gross Margin Percentage<br />How well is the business’ ability to generate a return at the Gross Profit level. <br />1<br />Pre-tax Return on Sales (ROS)<br />How well the business is managing its operating expenses.<br />2<br />Pre-tax Return on Assets (ROA)<br />How much income (before taxes) is derived from every 1 dollar in assets.<br />3<br />Inventory Turnover<br />How quickly inventory turns over in a given period of time.<br />4<br />Days’ Inventory<br />How many days needed to turn inventory over completely.<br />5<br />
  17. 17. Morgan Manufacturing<br />Financial Statements: Morgan and Westwood<br />Based on LIFO<br />Based on FIFO<br />**All figures are in $ millions<br />
  18. 18. Morgan Manufacturing<br />Initial Comparison Before LIFO/FIFO Conversion<br />Based on LIFO<br />Based on FIFO<br />2006 Comparison: <br />Difference<br />Westwood Inc.<br />Morgan Manufacturing<br />Ratio<br />-0.5%<br />45.0%<br />Gross Margin Percentage<br />44.5%<br />1<br />-0.5%<br />15.0%<br />Pre-tax Return on Sales (ROS)<br />14.5%<br />2<br />-0.03%<br />13.39%<br />Pre-tax Return on Assets (ROA)<br />13.36%<br />3<br />+4.6 times<br />6.5 times<br />Inventory Turnover<br />11.1 times<br />4<br />-23.5 days<br />56.4 days<br />Days’ Inventory<br />32.9 days<br />5<br />
  19. 19. Morgan Manufacturing<br />Inventory<br />Gross Margin<br />EInvLIFO=$100<br />LIFO Reserve (2006)=$70<br />EInvFIFO=EInvLIFO+ LIFO Reserve<br />EInvFIFO= $170<br />$950<br />(Increase from $890 LIFO amount)<br />Income Before Tax<br />$350<br />(Increase from $290 LIFO amount)<br />Conversion of Accounts from LIFO to FIFO<br />Morgan year ended<br />December 31, 2006<br />COGS<br />COGSFIFO=COGSLIFO+ ΔLIFORes<br />ΔLIFORes= - $60<br />COGSFIFO=$1,110 + ($10-$70)<br />COGSFIFO=$1,050<br />LIFO to FIFO Comparison enabled<br />
  20. 20. Morgan Manufacturing<br />Effect of Inventory Method: Morgan Manufacturing<br />COGS<br />GM<br />IBT<br />TaxesLIFO &lt; TaxesFIFO<br />Inventory<br />Assets<br />R/E<br />**All figures are in $ millions<br />
  21. 21. Morgan Manufacturing<br />Financial Statements: After LIFO to FIFO Conversion<br />COGSM &lt; COGSW<br />GMM &gt; GMW<br />IBTM &gt; IBTW<br />InvM = InvW<br />AssetsM = AssetsW<br />REM &gt; REW<br />**All figures are in $ millions<br />
  22. 22. Morgan Manufacturing<br />Comparison After LIFO to FIFO Conversion<br />2006 Comparison: <br />Difference<br />Westwood Inc.<br />Morgan Manufacturing<br />Ratio<br />+2.5%<br />45.0%<br />Gross Margin Percentage<br />47.5%<br />1<br />+2.5%<br />15.0%<br />Pre-tax Return on Sales (ROS)<br />17.5%<br />2<br />+2.2%<br />13.39%<br />Pre-tax Return on Assets (ROA)<br />15.6%<br />3<br />-0.3 times<br />6.5 times<br />Inventory Turnover<br />6.2 times<br />4<br />+2.5 days<br />56.4 days<br />Days’ Inventory<br />58.9 days<br />5<br />
  23. 23. Morgan Manufacturing<br />Profit After LIFO to FIFO Conversion<br />Calculation<br />Meaning<br />Ratio<br />Profit Margin Percentage<br />How well is the business’ ability to generate profit. <br />2006 Comparison: <br />Difference<br />Westwood Inc.<br />Morgan Manufacturing<br />Ratio<br />+1.5%<br />9.0%<br />Profit Margin Percentage<br />10.5%<br />
  24. 24. Morgan Manufacturing<br />Agenda <br />Introduction<br />Situation Analysis<br />Conclusion<br />
  25. 25. Morgan Manufacturing<br />Conclusion<br /><ul><li> The choice of different inventory methods affects one’s ability to directly compare the financial results of different companies
  26. 26. Based on the operating efficiency parameters calculated after conversion of LIFO figures into FIFO, comparison of Morgan Manufacturing ratios to those of Westwood Inc. was made possible.
  27. 27. This comparison demonstrates that Morgan Manufacturing’s operations are relatively more efficient than those of Westwood, Inc.</li></li></ul><li>Morgan Manufacturing<br />Any questions?<br />

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