Question

Three years ago, Karen Suez and her brother-in-law Reece Jones opened Gigasales Department Store. For the fi rst 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 $700,000

Cost of goods sold 560,000

Gross profi t 140,000

Operating expenses

Selling expenses $100,000

Administrative expenses 20,000

120,000

Net income $ 20,000

Karen believes the problem lies in the relatively low gross profi t rate of 20%. Reece believes the problem is that operating expenses are too high. Karen thinks the gross profi t 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 profi t 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 $60,000 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 $40,000 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.

Instructions With the class divided into groups, answer the following. (a) Prepare a condensed income statement for 2018 assuming (1) Karen’s changes are implemented and (2) Reece’s ideas are adopted. (b) What is your recommendation to Karen and Reece? (c) Prepare a condensed income statement for 2018 assuming both sets of proposed changes are made. (d) Discuss the impact that other factors might have. For example, would increasing the quantity of inventory increase costs? Would a salary cut affect employee morale? Would decreased morale affect sales? Would decreased store deliveries decrease customer satisfaction? What other suggestions might be considered?

Answer 1

computation of net income from karen point

	AMOUNT
sales (700,000*104%)	728,000
cost of goods sold(sales-gross profit)	546,000
gross profit (728000*25%) A	182,000
operating expenses
selling expenses	100,000
administration expenses	20,000
total selling and adminstration expenses B	120,000
NET INCOME(A-B)	62,000

NET INCOME FROM REECE POINT

	AMOUNT
sales	700,000
cost of goods sold	560,000
gross profit A	140,000
operating expenses
selling expenses(60,000/2+700.000*2%)+40000*60%	68000
administration expenses	20,000
total selling and adminstration expenses B	88,000
NET INCOME(A-B)	52,000

WHEN COMPAREDTO REECE POINT KAREN IS GETTING MORE NET INCOME BY 10,000 SO IT IS BETTER TO IMPLEMENT KAREN'S PLAN

NET INCOME BY IMPLEMENTING BOTH THE IDEAS

sales (700,000*104%)	728,000
cost of goods sold	546,000
gross profit (728000*25%) A	182,000
operating expenses
selling expenses(60000/2+700,000*2%)+40000*60%	68,000
administration expenses	20,000
total selling and adminstration expenses B	88,000
NET INCOME(A-B)	94,000

if we implement both ideas net income will be 94,000

d) if you implement the above, the impact will be on other factors like

already said if you increase sales price sales volume will effect

if you increase the quantity of inventory definetly inventory carrying and storage cost will increase by that whole inventory cost will increases so before that we need to analysis eoq analysis

if you cut down the salary definetly employee morale will effect and may leads to chance to loose of efficient employees recruting others will cost alot and if employees are not working in the favour of company it leads to droup in sales. these sales employees are only the people who represent the company directly to customers so it effect alot in droping the sales

decreasing stores delivery will definetly decreases the customers satifaction and leads to sales drop

impother impacts -like

already said,in question if you increase sales price sales volume will effect by that area covered by the company will decreases

and if you decrease deliveries by once in a week deliver cost per unit may increses with the increases in maintaenance of delivary channel for less deliveries delivery agencies cost more

other suggestions are

try to negotiate with the supplier to decrease the purchasing cost per uint it will definetly helps to increases the grosses profit in healthy manner try to avoid inventory cost

by increasing the sales persons salary, it helps to increases sales volume and try to avoid some administration cost

by increasing more deliveries, customer satisfactions will increases and it helps to increase sales volume and leads to more gross profit rate