Chapter 5, Problem 5.4AP

(a)

To determine

A financial statement is the complete record of financial transactions that take place in a company, at a particular period of time. It provides important financial information like assets, liabilities, revenues and expenses of the company to its internal and external users. It helps them to know the exact financial position of the company.

Profitability ratios are the metrics used to measure the profit generating ability of a company for a specific period of time.

To Prepare: The multi-step income statement, retained earnings statement, and classified balance sheet of W Departmental Store, for the year ended November 30, 2017.

Explanation of Solution

Prepare the multi-step income statement of W Departmental Store.

Multi-step Income Statement: A multiple step income statement refers to the income statement that shows the operating, and non-operating activities of the business, under separate head. In different steps of the multi-step income statement, principal operating activities are reported that starts from the record of sales revenue with all contra sales revenue account like sales returns, allowances and sales discounts.

W Departmental Store
Income Statement
For the Year Ended November 30, 2017
Particulars	Amount($)	Amount($)
Sales revenue		904,000
Less: Sales returns and allowances		(20,000)
Net sales		884,000
Less: Cost of goods sold		(614,300)
Gross profit		269,700
Less: Operating expenses:
Salaries and wages expenses	117,000
Depreciation expenses	13,500
Advertising expense	33,500
Freight-out	6,200
Insurance expense	9,000
Rent expense	34,000
Utilities expense	10,600
Total operating expenses		(223,800)
Income from operations		45,900
Add: Other revenues and gain:
Gain on disposal of plant assets		2,000
Less: Other expenses and losses:
Interest expense		(5,000)
Income before income taxes		42,900
Less: Income tax expense		(10,000)
Net income		32,900

Table (1)

Prepare the retained earnings statement of W Departmental Store.

Retained Earnings Statement: This is a financial statement that shows the amount of net income retained by a company at a particular point of time for reinvestment, and to pay its debts, and obligations. It shows the amount of retained earnings that is not paid as dividends to shareholders.

W Departmental Store
Retained Earnings Statement
For the Year Ended November 30, 2017
Details	Amount ($)
Beginning Balance of Retained earnings	14,200
Add: Net Income for the year	32,900
Total Retained Earnings	47,100
Less: Dividends	(12,000)
Ending balance of Retained Earnings	35,100

Table (2)

Prepare the classified balance sheet of W Departmental Store.

Classified Balance Sheet: This is a financial statement where the assets, liabilities, and stockholders’ equity are organized and reported as different groups, and sub-groups on the basis of the nature of the classification made by a company at a particular point of time. It reveals the financial health of a company. Thus, this statement is also called as the Statement of Financial Position. It helps the users to know about the creditworthiness of a company as to whether the company has enough assets to pay off its liabilities.

W Departmental Store
Classified Balance Sheet
As of November 30, 2017
Particulars	Amount ($)	Amount ($)
Current assets:
Cash		8,000
Accounts receivable		17,200
Inventory		26,200
Prepaid Insurance		6,000
Total current assets		57,400
Plant assets:
Equipment	157,000
Less: Accumulated depreciation	-68,000
Total plant assets		89,000
Total assets		146,400
Liabilities and Stockholders’ equity
Current liabilities:
Accounts payable		26,800
Salaries and wages  payable		6,000
Total current liabilities		32,800
Long-term liabilities:
Notes payable		43,500
Total liabilities		76,300
Stockholders’ Equity:
Common stock	35,000
Retained earnings	35,100
Total stockholders’ equity		70,100
Total liabilities and stockholders’ equity		146,400

Table (3)

(b)

To determine

The gross profit rate and profit margin of W Departmental Store for 2017.

Explanation of Solution

Gross profit rate is the financial ratio that shows the relationship between the gross profit and net sales. Gross profit is the difference between the total revenues and cost of goods sold. It is calculated by using the following formula:

$\text{Gross profit rate}=\frac{\text{Gross profit}}{\text{Net sales}}\times 100$

Calculate the gross profit rate.

Gross profit = $269,700 (Refer Table 1)

Net sales = $884,000 (Refer Table 1)

$\begin{array}{c}\text{Gross profit rate}=\frac{\text{Gross profit}}{\text{Net sales}}\times 100\\ =\frac{\$269,700}{\$884,000}\times 100\\ =30.51\%\end{array}$

Profit margin measures the amount of net income earned from each dollar of sales revenue generated by a company. Thus, it shows the relationship between the net income and net sales. It is calculated by using the following formula:

$\text{Profit Margin}=\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\times 100$

Calculate the profit margin.

Net income = $32,900 (Refer Table 1)

Net sales = $884,000 (Refer Table 1)

$\begin{array}{c}\text{Profit margin}=\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\times 100\\ =\frac{\$32,900}{\$884,000}\times 100\\ =3.72\%\end{array}$

Conclusion

Therefore, the gross profit rate and profit margin of W Departmental Store is 30.51% and 3.72% respectively.

(c)

To determine

To Calculate: The expected new net income, revised gross profit rate, and profit margin of W Departmental Store for 2017 if net sales are increased 15%, gross profit is increased by $40,443 and expenses are increased by $58,600.

Answer to Problem 5.4AP

Calculate the expected new net income.

New gross profit = $310,143 (1)

New expenses = $274,400 (2)

$\begin{array}{c}\text{Expected new net income = New gross profit}-\text{New}\text{expenses}\\ \text{= }\left(\text{\$269,700 + \$40,443}\right)-\left(\$223,800+\$50,600\right)\\ =\$310,143-\$274,400\\ =\$35,743\end{array}$ (a)

Calculate the revised gross profit rate.

New gross profit = $310,143 (1)

Expected net sales = $1,016,600 (3)

$\begin{array}{c}\text{Revised gross profit rate}=\frac{\text{New gross profit }}{\text{Expected net sales}}\times 100\\ =\frac{\$310,143}{\$1,016,600}\times 100\\ =30.51\%\end{array}$

Calculate the revised profit margin.

Expected net income = $35,743 (a)

Expected net sales = $1,016,600 (3)

$\begin{array}{c}\text{Revised profit margin}=\frac{\text{Expected net}\text{income}}{\text{Expected net}\text{sales}}\times 100\\ =\frac{\$35,743}{\$1,016,600}\times 100\\ =3.52\%\end{array}$

Working Notes:

Calculate the new gross profit.

Old gross profit = $269,700 (Refer Table 1)

Increased gross profit = $40,443

$\begin{array}{c}\text{New gross profit = Old gross profit}\text{+}\text{Increased gross profit}\\ \text{= \$269,700 + \$40,443}\\ \text{=}\text{\$310,143}\end{array}$ (1)

Calculate the new expenses.

Old expenses = $223,800 (Refer Table 1)

Increased expenses = $50,600

$\begin{array}{c}\text{New expenses = Old expenses}\text{+}\text{Increased expenses}\\ \text{= }\$223,800+\$50,600\\ =\$274,400\end{array}$ (2)

Calculate expected net sales.

Net sales = $884,000

Percentage increased = 15%

$\begin{array}{c}\text{Expected net sales = \$884,000 + }\left(\text{\$884,000}\times \text{15\%}\right)\\ =\$884,000+\$132,600\\ =\$1,016,600\end{array}$ (3)

Therefore, the expected new net income, revised gross profit rate, and profit margin of W Departmental Store for 2017 are $35,743, 30.51% and 3.52% respectively.

Explanation of Solution

After increase in net sales by 15%, gross profit by $40,443 and expenses by $58,600 the profit margin decreased from 3.72% to 3.52%.  However, the gross profit rate remain same in both of the cases.

Conclusion

The second plan presented by the marketing department, and human resource department of W Departmental Store has a merit in higher net sales, that results in higher net income of the company.