Question

Three years ago, Karen Suez and her brother-in-law Reece Jones opened Gigasales Department Store. For the first 2 years, business was good, but the following condensed income statement results for 2017 were disappointing.

GIGASALES DEPARTMENT STORE

Income Statement

For the Year Ended December 31, 2017

Net sales

$518,000

Cost of goods sold

414,400

Gross profit

103,600

Operating expenses

Selling expenses

$74,000

Administrative expenses

14,800

88,800

Net income

$14,800

Karen believes the problem lies in the relatively low gross profit rate of 20%. Reece believes the problem is that operating expenses are too high. Karen thinks the gross profit rate can be improved by making two changes. (1) Increase average selling prices by 15%; this increase is expected to lower sales volume so that total sales dollars will increase only 4%. (2) Buy merchandise in larger quantities and take all purchase discounts. These changes to purchasing practices are expected to increase the gross profit rate from its current rate of 20% to a new rate of 25%. Karen does not anticipate that these changes will have any effect on operating expenses.

Reece thinks expenses can be cut by making these two changes. (1) Cut 2018 sales salaries of $44,400 in half and give sales personnel a commission of 2% of net sales. (2) Reduce store deliveries to one day per week rather than twice a week; this change will reduce 2018 delivery expenses of $29,600 by 40%. Reece feels that these changes will not have any effect on net sales.

Karen and Reece come to you for help in deciding the best way to improve net income.

Answer the following.

Answer 1

GIGASALES DEPARTMENT STORE Current and Proposed Income Statements
	Last Year	Karen's Proposal	Reece's Proposal
Net Sales	$ 518,000	$ 538,720	$ 518,000
Cost of Goods Sold	414,400	404,040	414,400
Gross Profit	103,600	134,680	103,600
Operating Expenses
Selling Expenses	74,000	74,000	50,520 *
Administrative Expenses	14,800	14,800	14,800
Total Selling and Administrative Expenses	88,800	88,800	65,320
Net Income	$ 14,800	$ 45,880	$ 38,280

As can be seen for the above, Karen's proposal will lead to higher net income, but at the cost of loss of market share. Also, purchasing merchandise in bulk to avail of quantity discount may entail higher investment and higher cost of storing the merchandise.

On the other hand, Reece's proposal also leads to a net income higher than last year. But he proposes to reduce fixed sales salaries, which might cause resentment among the salespeople, resulting in lower net sales.

* Reece's Proposal : New Selling Expenses:

Last year's selling expenses	$ 74,000
Reduction in sales salaries	(22,200)
Add: sales commission expense	10,360
Reduction in delivery expense	(11,840)
Expected Selling Expense	50,520