Problem:
A firm with sales of $8 million and profits before taxes of $625,000 has a loan outstanding at its bank for working capital purposes. As the loan officer reviewing the loan application, you are charged with making a recommendation as to whether the $608,000 loan should be renewed for another year.
Upon reviewing the firm’s most recent annual report, you find the following footnote:
Underabsorbed overheard of $462,000 was prorated to inventories (2/3) and cost of goods sold (1/3).
Required:
Q1. How should you evaluate the firm’s annual report in light of this footnote? In particular, how does this footnote affect your recommendation regarding the loan? Be very specific.
Q2. In preparing for your meeting with the firm’s president and CFO, what questions do you want to ask regarding this footnote? Be very detailed.