ACC 203 Lecture Notes - Lecture 17: Earnings Before Interest And Taxes, Income Statement, Financial Statement
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3-44.
Comprehensive CVP analysis
(LO 1, 2, 3, 5) âI'll never understand this accounting stuff,â Blake Dunn yelled, waving the income statement he had just received from his accountant in the morning mail. âLast month, we sold 1,000 stuffed State University mascots and earned $6,850 in operating income. This month, when we sold 1,500, I thought we'd make $10,275. But this income statement shows an operating income of $12,100! How can I ever make plans if I can't predict my income? I'm going to give Janice one last chance to explain this to me,â he declared as he picked up the phone to call Janice Miller, his accountant.
âWill you try to explain this operating income thing to me one more time?â Blake asked Janice. âAfter I saw last month's income statement, I thought each mascot we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each mascot, so I don't understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line.â
Taking a deep breath, Janice replied, âSure, Blake. I'd be happy to explain how you made so much more operating income than you were expecting.â
Required
(a)
Assume Janice's role. Explain to Blake why his use of operating income per mascot was in error.
(b) Using the following income statements, prepare a contribution margin income statement for March.
Februaryâ | Marchâ | |
---|---|---|
Sales revenue | $25,000 | $37,500 |
Cost of goods sold | 10,000 | 15,000 |
Gross profit | 15,000 | 22,500 |
Rent expense | 1,500 | 1,500 |
Wages expense | 3,500 | 5,000 |
Shipping expense | 1,250 | 1,875 |
Utilities expense | 750 | 750 |
Advertising expense | 750 | 875 |
Insurance expense | 400 | 400 |
Operating income | $â6,850 | $12,100 |
(c)
Blake plans to sell 500 stuffed mascots next month. How much operating income can Blake expect to earn next month if he realizes his planned sales?
(d)
Blake wasn't happy with the projected income statement you showed him for a sales level of 500 stuffed mascots. He wants to know how many stuffed mascots he will need to sell to earn $3,700 in operating income. As a safety net, he also wants to know how many stuffed mascots he will need to sell to break even.
(e)
Blake is evaluating two options to increase the number of mascots sold next month. First, he believes he can increase sales by advertising in the university newspaper. Blake can purchase a package of 12 ads over the next month for a total of $1,200. He believes the ads will increase the number of stuffed mascots sold from 500 to 960. A second option would be to reduce the selling price. Blake believes a 10% decrease in the price will result in 1,000 mascots sold. Which plan should Blake implement? At what level of sales would he be indifferent between the two plans?
(f)
Just after Blake completed an income projection for 1,200 stuffed mascots, his supplier called to inform him of a 20% increase in cost of goods sold, effective immediately. Blake knows that he cannot pass the entire increase on to his customers, but thinks he can pass on half of the 20% increase while suffering only a 5% decrease in units sold. Should Blake respond to the increase in cost of goods sold with an increase in price?
(g)
Refer back to the original information. Blake has decided to add stadium blankets to his product line. He has found a supplier who will provide the blankets for $32, and he plans to sell them for $55. All other variable costs currently incurred for selling mascots will be incurred for selling blankets at the same rate. Additional fixed costs of $350 per month will be incurred. He believes he can sell one blanket for every three stuffed mascots. How many blankets and stuffed mascots will Blake need to sell each month in order to break even?
Style, Inc. operates three stores in a large metropolitan area. The companyâs segmented absorption costing income statement for the last quarter follows:
Style, Inc. | ||||
Income Statement | ||||
For the Quarter Ended March 31 | ||||
Total | Uptown Store | Downtown Store | Eastpark Store | |
Sales | $ 2,500,000 | $ 900,000 | $ 750,000 | $ 1,000,000 |
Cost of goods sold | 1,450,000 | 513,000 | 522,000 | 565,000 |
Gross margin | $ 1,050,000 | $ 387,000 | $ 228,000 | $ 435,000 |
Selling and administrative expenses: | ||||
Selling expenses: | ||||
Direct advertising | 118,500 | 40,000 | 36,000 | 42,500 |
General advertising | 20,000 | 7,200 | 4,800 | 8,000 |
Sales salaries | 157,000 | 52,000 | 45,000 | 60,000 |
Delivery salaries | 30,000 | 10,000 | 10,000 | 10,000 |
Store rent | 215,000 | 70,000 | 60,000 | 80,000 |
Depreciation of store fixtures | 46,950 | 18,300 | 8,800 | 19,850 |
Depreciation of delivery equipment | 27,000 | 9,000 | 9,000 | 9,000 |
Total selling expenses | 614,450 | 206,500 | 173,600 | 229,350 |
Administrative expenses: | ||||
Store management salaries | 63,000 | 20,000 | 18,000 | 25,000 |
General office salaries | 50,000 | 18,000 | 12,000 | 20,000 |
Utilities | 89,800 | 31,000 | 27,200 | 31,600 |
Insurance on fixtures and inventory | 25,500 | 8,000 | 9,000 | 8,500 |
Employment taxes | 36,000 | 12,000 | 10,200 | 13,800 |
General office expenses-other | 25,000 | 9,000 | 6,000 | 10,000 |
Total administrative expenses | 289,300 | 98,000 | 82,400 | 108,900 |
Total operating expenses | 903,750 | 304,500 | 261,000 | 338,250 |
Net operating income (loss) | $ 146,250 | $ 82,500 | $ (28,000) | $ 96,750 |
Additional Data: | ||||
Manager's salary per quarter | $ 18,000 | |||
New employee's salary per month | $ 5,000 | |||
Employment tax as a percentage of salaries | 12% | |||
Delivery person's salary per quarter | $ 7,000 | |||
Insurance related to downtown fixtures | 1/3 | |||
Discharged employee's salary per quarter | $ 8,000 | |||
Assumed sales transferred to Uptown store | $ 200,000 | |||
Uptown store gross margin percentage | 43% |
Management is very concerned about the Downtown storeâs inability to show a profit, and consideration is being given to closing the store. The company has asked you to make a recommendation as to what course of action should be taken. The following additional information is available about the store:
a. The manager of the store has been with the company for many years, he would be retained and transferred to another position in the company if the store were closed. His salary is $6,000 per month, or $18,000 per quarter. If the store were not closed, a new employee would be hired to fill the other position at a salary of $5,000 per month.
b. The lease on the building housing the Downtown Store can be broken with no penalty.
c. The fixtures being used in the Downtown Store would be transferred to the other two stores if the Downtown Store were closed.
d. The companyâs employment taxes are 12% of salaries.
e. A single delivery crew serves all three stores. One delivery person could be discharged if the Downtown Store were closed; this personâs salary amounts to $7,000 per quarter. The delivery equipment would be distributed to the other stores. The equipment does not wear out through use, but it does eventually become obsolete.
f. One-third of the Downtown Storeâs insurance relates to its fixtures.
g. The general office salaries and other expenses relate to the general management of Style, Inc. The employee in the general office who is responsible for the Downtown Store would be discharged if the store were closed. This employeeâs compensation is $8,000 per quarter.
Required (USE EXCEL):
1. Prepare a schedule showing the change in revenues and expenses and the impact on the overall company net operating income that would result if the Downtown Store were closed.
2. Based on your computations in (1) above, what recommendation would you make to the management of Style, Inc.?
3. Assume that if the Downtown Store were closed, sales in the Uptown Store would increase by $200,000 per quarter due to loyal customers shifting their buying to the Uptown Store. The Uptown Store has ample capacity to handle the increased sales, and its grow margin is 43% of sales. What effect would these factors have on your recommendation concerning the Downtown Store? Show computations in Excel.