Question

The comparative balance sheet of Cookie & Coffee Creations Inc. at October 31, 2020 for the years 2020 and 2019, and the income statements for the years ended October 31, 2019 and 2020, are presented below.

COOKIE & COFFEE CREATIONS INC.

Balance Sheet

October 31

Assets		2020		2019
Cash		$ 22,324		$ 5,550
Accounts receivable		3,250		2,710
Inventory		7,897		7,450
Prepaid expenses		5,800		6,050
Equipment		102,000		75,500
Accumulated depreciation		(25,200)		(9,100)
Total assets		$116,071		$88,160
Liabilities and Stockholders’ Equity
Accounts payable		$    1,150		$ 2,450
Income taxes payable		9,251		7,200
Dividends payable		27,000		27,000
Salaries and wages payable		7,250		1,280
Interest payable		188		0
Note payable—current portion		4,000		0
Note payable—long-term portion		6,000		0
Preferred stock, no par, $6 cumulative—
3,000 and 2,800 shares issued,
respectively		15,000		14,000
Common stock, $1 par—25,180
shares issued		25,180		25,180
Additional paid in capital—treasury stock		250		250
Retained earnings		20,802		10,800
Total liabilities and stockholders’ equity		$116,071		$88,160

COOKIE & COFFEE CREATIONS INC.

Income Statement

Year Ended October 31

	2020		2019
Sales	$485,625		$462,500
Cost of goods sold	222,694		208,125
Gross profit	262,931		254,375
Operating expenses    Salaries and wages expense	147,979		146,350
Depreciation expense	17,600		9,100
Other operating expenses	48,186		42,925
Total operating expenses	213,765		198,375
Income from operations	49,166		56,000
Other expenses    Interest expense	413		0
Loss on disposal of plant assets	2,500		0
Total other expenses	2,913		0
Income before income tax	46,253		56,000
Income tax expense	9,251		14,000
Net income	$ 37,002		$ 42,000

Additional information:

Natalie and Curtis are thinking about borrowing an additional $20,000 to buy more kitchen equipment. The loan would be repaid over a 4-year period. The terms of the loan provide for equal semi-annual payments of $2,500 on May 1 and November 1 of each year, plus interest of 5% on the outstanding balance.

1. Prepare a horizontal analysis of the income statement for Cookie & Coffee Creations Inc. using 2019 as a base year. Also, prepare a vertical analysis of the income statement for Cookie & Coffee Creations Inc. for 2020 and 2019.

2. Comment your findings.

3. What would justify a decision by Cookie & Coffee Creations Inc. to buy the additional equipment? What alternatives are there instead of bank financing?

Answer 1

COOKIE & COFFEE CREATIONS INC.
Income Statement Horizontal Analysis
Year Ended October 31	A	B
	2020	2019	% change 2020 from 2019 (A-B)/B*100
Sales	485625	462500	5.00%
Cost of goods sold	222694	208125	7.00%
Gross profit	262931	254375	3.36%
Operating expenses
Salaries and wages expense	147979	146350	1.11%
Depreciation expense	17600	9100	93.41%
Other operating expenses	48186	42925	12.26%
Total operating expenses	213765	198375	7.76%
Income from operations	49166	56000	-12.20%
Other expenses
Interest expense	413	0	100.00%
Loss on disposal of plant assets	2500	0	100.00%
Total other expenses	2913	0	100.00%
Income before income tax	46253	56000	-17.41%
Income tax expense	9251	14000	-33.92%
Net income	37002	42000	-11.90%
COOKIE & COFFEE CREATIONS INC.
Income Statement Vertical Analysis
Year Ended October 31
	2020		2019
Sales	485625	100.00%	462500	100.00%
Cost of goods sold	222694	45.86%	208125	45.00%
Gross profit	262931	54.14%	254375	55.00%
Operating expenses
Salaries and wages expense	147979	30.47%	146350	31.64%
Depreciation expense	17600	3.62%	9100	1.97%
Other operating expenses	48186	9.92%	42925	9.28%
Total operating expenses	213765	44.02%	198375	42.89%
Income from operations	49166	10.12%	56000	12.11%
Other expenses
Interest expense	413	0.09%	0	0.00%
Loss on disposal of plant assets	2500	0.51%	0	0.00%
Total other expenses	2913	0.60%	0	0.00%
Income before income tax	46253	9.52%	56000	12.11%
Income tax expense	9251	1.90%	14000	3.03%
Net income	37002	7.62%	42000	9.08%
2)
Comments
Net income for the year 2020 is decreased by 11.90% in comparison to 2019, primarily
because of increase in Operating expenses by 7.76 %
Sales have increased by 3.36% in 2020 in comparison to 2019
Operating expenses constitute 44% of total sales in 2020 which was 43 percent in 2019
Further, increase in interest expense, loss on disposal of assets and other expenses decreased the income for the year 2020
3)
No
Reason:
Buying of additional equipment through loan would further decrease the net income
by charging depreciation and interest if equipment is financed through bank
But if it is purchased out of its own funds like from its cash balance or
by issue of equity shares only depreciation expense would be charged the
interest expense wont be charged.
Additional equipment should be purchased by financing from sources other than bank
borrowing because since the sales are increasing in 2020 in comparison to previous year,
purchase of equipment might enhance the sales.