Question

MA18-46. Absorption Costing and Performance Evaluation On July 2, 2017 Maddon Financial acquired 90 percent of the outstanding stock of Kluber Industries in exchange for 2,000 shares of its own stocks. Maddon Financial has a reputation as a “high flier “company that commands a high price-to-earnings ratio because it's management team works wonders in improving the performance of ailing companies. At the time of the acquisitions, Kluber 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 and sold during the first half of 2017. Immediately after the acquisition Maddon Financial installed its own management team and increased production to practical capacity. One-hundred thousand units were produced during the second half of 2017. At the end of the year, the new management declared another dramatic turnaround and a $100,000 cash dividend when the following set of income statements were issued: KLUBER INDUSTRIES Income Statement For the first and second half-years of 2017 First Second Total Sales $1,400,000 $1,400,000 $2,800,000 Cost of goods sold* (1,200,000) (700,000) (1,900,000) Gross profit 200,000 700,00 900,000 Selling and administrative expenses (200,000) (400,000) (600,000) Net Income $0 $300,000 $300,000 Required As the only representative of the minority interest on the board of directors, evaluate the performance of the new management team. View comments (1) Expert Answer An expert answer will be posted here

Answer 1

	1st half of 2017	2nd half of 2017	Total
Total sales	1,400,000	1,400,000	2,800,000
Less: cost of goods sold	1,200,000	700,000	1,900,000
Gross profit	200,000	700,000	900,000
Gross margin (gross profit/total sales)	14.29%	50.00%	32.14%
Less: operating expenses
Selling & administrative expenses	200,000	400,000	600,000
Net income	0	300,000	300,000
Net margin (net income/total sales)	0.00%	21.43%	10.71%

The above table clearly shows that performance in the second half of the year, after the takeover by Maddon Financial, certainly did improve for Kluber Industries. As we can see that this was mainly on account of better cost management in the second half. Gross margin was 14.29% in the first half and this increased to 50% in the second half. For the entire year it was 32.14%. Net profit was nil in the first half but increased to $300,000 in the second half.

Thus the new management team was successful at controlling costs and increasing the profitability of Kluber.