MacGiver Brass is a brass plating firm with sales of $8 million and profits before taxes of $625,000. MacGiver has a loan outstanding at its local bank for working capital purposes. As the loan officer reviewing MacGiver's loan application, you are charged with making a recommendation as to whether the $608,000 loan should be renewed for another year.
Upon reviewing MacGiver's most recent annual report, you find the following footnote: Under-absorbed overhead of $462,000 was prorated to inventories (2/3) and cost of goods sold (1/3).
a. How should you evaluate MacGiver's annual report in light of this footnote? In particular, how does this footnote affect your recommendation regarding the loan?
b. In preparing for your meeting with MacGiver's president and chief financial officer, what questions do you want to ask regarding this footnote?
The solution explains the impact of pro rating the under absorbed overhead on financial statements