Question

The Canton Corporation shows the following income statement. The firm uses FIFO inventory accounting.

CANTON CORPORATION Income Statement for 20X1
Sales	$	239,400	(12,600 units at $19.00)
Cost of goods sold		126,000	(12,600 units at $10.00)
Gross profit	$	113,400
Selling and administrative expense		11,970
Depreciation		14,600
Operating profit	$	86,830
Taxes (30%)		26,049
Aftertax income	$	60,781

a. Assume in 20X2 the same 12,600-unit volume is maintained, but that the sales price increases by 10 percent. Because of FIFO inventory policy, old inventory will still be charged off at $10.00 per unit. Also assume selling and administrative expense will be 5 percent of sales and depreciation will be unchanged. The tax rate is 30 percent. Compute aftertax income for 20X2. (Do not round intermediate calculations. Round your answer to the nearest whole number.)

b. In part a, by what percent did aftertax income increase as a result of a 10 percent increase in the sales price? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

c. Now assume that in 20X3 the volume remains constant at 12,600 units, but the sales price decreases by 15 percent from its year 20X2 level. Also, because of FIFO inventory policy, cost of goods sold reflects the inflationary conditions of the prior year and is $10.50 per unit. Further, assume selling and administrative expense will be 5 percent of sales and depreciation will be unchanged. The tax rate is 30 percent. Compute the aftertax income. (Round the sales price per unit to 2 decimal places but do not round any other intermediate calculations. Round your final answer to the nearest whole dollar amount.)

Answer 1

a. Sale price per unit in 20x1 = $19 , Increase in sales price per unit from 20X1 = 10%, Units Volume in 20X2 = 12600

Sale price per unit in 20X2 = Sale price per unit in 20x1 (1 + Increase in sales price per unit ) = 19(1 + 10%) = 19 x 1.1 = 20.90

Sales in 20X2 = Sale price per unit in 20X2 x Units Volume in 20X2 = 12600 x 20.9 = 263340

Cost per unit in 20X2 = 10

Cost of goods sold in 20X2 = Units volume in 20X2 x Cost per unit in 20X2 = 12600 x 10 = 126000

Gross profit in 20X2 = Sales - Cost of goods sold = 263340 - 126000 = 137340

Selling and administrative expenses in 20X2 = 5% of sales in 20X2 = 5% x 263340 = 13167

Depreciation in 20X2 = 14600

Operating profit in 20X2 = Gross profit - Selling and administrative expenses in 20X2 - Depreciation in 20X2 = 137340 - 13167 - 14600 = 109573

Taxes = 30% of operating profit = 30% x 109573 = 32871.90

After tax income for 20X2 = Operating profit in 20X2 - Taxes = 109573 - 32871.90 = $76701.10 = $76701 ( rounded to nearest whole number)

Hence After tax income for 20X2 = $76701

b. Percent increase in after tax income = (After tax income for 20X2 / After tax income for 20X1) - 1 = (76701 / 60781) - 1

= 1.261924 - 1 = 0.261924 = 26.1924% = 26.19% (rounded to two places off decimal)

After tax income increased by 26.19%

c. Sale price per unit in 20x2 = $20.9 , decrease in sales price per unit from 20X2 = 15%, Units Volume in 20X3 = 12600

Sale price per unit in 20X3 = Sale price per unit in 20x2 (1 - decrease in sales price) = 20.9(1 - 15%) = 20.9 x 0.85 = 17.765 = 17.77 (rounded sales price to two places off decimal)

Sales in 20X3 = Sale price per unit in 20X3 x Units Volume in 20X3 = 12600 x 17.77 = 223902

Cost per unit in 20X3 = 10.5

Cost of goods sold in 20X3 = Units volume in 20X3 x Cost per unit in 20X3 = 12600 x10.5 = 132300

Gross profit in 20X3 = Sales - Cost of goods sold = 223902 - 132300 = 91602

Selling and administrative expenses in 20X3 = 5% of sales in 20X3 = 5% x 223902 = 11195.10

Depreciation in 20X3 = 14600

Operating profit in 20X3 = Gross profit - Selling and administrative expenses in 20X3 - Depreciation in 20X3 = 91602 - 11195.10 - 14600 = 65806.90

Taxes = 30% of operating profit = 30% x 65806.90 = 19742.07

After tax income for 20X3 = Operating profit in 20X3 - Taxes = 65806.90 - 19742.07 = $46064.83 = $46065 (rounded to nearest whole dollar amount)

Hence after income for 20X3 = $46065