You are a CFO for a small manufacturing company that has applied for a bank loan
ID: 2372096 • Letter: Y
Question
You are a CFO for a small manufacturing company that has applied for a bank loan. In speaking with the bank loan officer, you are told the two minimum criteria for granting loans are (1) a 40 percent gross margin and (2) operating income of 15 percent of sales. Looking into the last four month's income statements, you find that gross margin has been between 30-33 percent, and operating income ranged from 18-24 percent of sales. You discuss there relationships with the company president, who suggests tha some of the product costs included in the COGS should be moved to the selling and administrative categories so that income statement will conform to the bank's criteria.
a. Which Types of product costs might be most easily reassigned to the period cost classifications?
b. Because the president is not suggesting that any expenses be kept off the income statement, do you see any ethical problems with the request? Discuss rationale for your answer.
C. WRITE A SHORT MEMO TO CONVICE THE BANKER TO LOAN FUNDS TO THE COMPANY IN SPITE OF ITS NONCOMPLIANCE WITH THE SPECIFIED LOAN CRITERIA.
Explanation / Answer
In addition to classifying costs as manufacturing or nonmanufacturing costs, there are other ways to look at costs. For instance, they can also be classified as either product costs or period costs. To understand the difference between product costs and period costs, we must first discuss the matching principle from financial accounting. Generally, costs are recognized as expenses on the income statement in the period that benefits from the cost. For example, if a company pays for liability insurance in advance for two years, the entire amount is not considered an expense of the year in which the payment is made. Instead, one-half of the cost would be recognized as an expense each year. The reason is that both years
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