Questions on Overhead Allocation
Jack owns a small factory that produces buttons for garment industry. Jack wants to buy a new machine and has applied to a bank for financing. The loan officer has asked for operating statements for the past year. The company’s net income has not been very good over the last year, and inventory has grown substantially. Jack is concerned that the bank will not loan the money as they will not be as optimistic as he is about Jack’s future sales and the company’s ability to reduce its inventory. Yesterday Jack had the following conversation with the company’s controller.
Jack: You know that I have applied for a bank loan and that the bank wants copies of our operating statements for the last 12 months.
Controller: I can have those ready for you today.
Jack: I would like you to make some changes before you prepare those statements.
Controller: what changes?
Jack: I want you to increase our predetermined overhead rate by 25% and then recalculate the inventory figures and last year’s income statement using the new rate. Also, move my salary and our office rent into the manufacturing overhead pool. I will need those statements in the morning.
1.What effect would the change in predetermined overhead rate have on the company’s inventory values?
2.What effect would the reclassification of Jack’s salary and the office rent have on the company’s product costs?
3.What parts of a financial statement would reveal Jack’s changes to the loan officer?