You are the chief financial officer for a small manufacturing company that has applied for a bank loan. In speaking with the bank loan officer, you are told that two minimum criteria for granting loans are (1) a 40 percent gross margin and (2) operating income of at least 15 percent of sales. Looking at the last four months’ income statements, you find that gross margin has been between 30 and 33 percent, and operating income ranged from 18 to 24 percent of sales. You discuss these relationships with the company president, who suggests that some of the product costs included in Cost of Goods Sold should be moved to the selling and administrative categories so that the income statement will conform to the bank’s criteria.
a. Which types of product costs might be most easily reassigned to 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 the rationale for your answer.
c. Write a short memo to convince the banker to loan funds to the company in spite of its noncompliance with the specified loan criteria.