You are working as a loan officer at TransPacific Bank and are analyzing a loan request for a client when you come across the following footnote in the client’s annual report:
Inventories are priced at the lower of cost or market of materials plus other direct (variable) costs. Fixed overheads of $ 4.2 million this year and $ 3.0 million last year are excluded from inventories. Omitting such overhead resulted in a reduction in net income (after taxes) of $ 720,000 for this year. Our tax rate is 40 percent.
In preparing to present the loan application to the bank’s loan committee, write a brief para graph in nontechnical terms describing what this footnote means and how it affects the bank’s evaluation of the financial condition of the borrower.