Question

In its income statement for the year ended December 31, 2017, Darren Company reported the
following condensed data.
Salaries and wages expense $465,000 Loss on disposal of plant assets $83,500
Cost of goods sold 987,000 Sales revenue 2,210,000
Interest expense 71,000 Income tax expense 25,000
Interest revenue 65,000 Sales discounts 160,000
Depreciation expense 310,000 Utilities expense 110,000
Instructions
(a) Prepare a multi-step income statement.
(b) Calculate the profit margin and gross profit rate.
(c ) In 2016, Darren had a profit margin of 5%. Is the decline in 2017 a cause for concern?
(Ignore income tax effects.)
NOTE: Enter a number in cells requesting a value; enter either a number or a formula in cells with a "?" .
(a) DARREN COMPANY
Income Statement
For the Year Ended December 31, 2017
Sales
Sales revenue $2,210,000
Less: Sales discounts $160,000
Net Sales $2,050,000
Cost of goods sold $987,000
Gross profit $1,063,000
Operating expenses
Salaries and wages expense $465,000
Depreciation expense $310,000
Utilities expense $110,000
Total operating expenses $885,000
Income from operations $178,000
Other revenues and gains
Interest revenue $65,000
Other expenses and losses
Loss on disposal of plant assets 83,500
Interest expense 71,000 154,500
Income before income taxes 88,500
Income tax expense 25,000 28%
Net income $63,500
(b) Profit margin
Net income $63,500
Net Sales 2,050,000
3.10%
Gross profit rate
Gross profit $1,063,000
Net sales $2,050,000
51.9%
After you have completed E5-8 , consider the following additional question.
1. Assume that cost of goods changed to $1,015,000 and that the income tax rate is 28%.
What impact does this change have on the multi-step income statement and the
profitability ratios?

Answer 1

Answer:

Part a

Darren Company

Multi-step income statement

Sales

Sales revenue                                                                $2,210,000

Less: Sales discounts                                                     ($160,000)

Net Sales                                                                       $2,050,000

Cost of goods sold                                                         ($987,000)

Gross profit                                                                     $1,063,000

Operating expenses

Salaries and wages expense                 $465,000

Depreciation expense                             $310,000

Utilities expense                                       $110,000

Total operating expenses                                            ($885,000)

Income from operations                                                 $178,000

Other revenues and gains

Interest revenue                                     ($65,000)

Other expenses and losses

Loss on disposal of plant assets            $83,500

Interest expense                                      $71,000         ($89,500)

Income before income taxes                                          $88,500

Income tax expense 25,000 28%                                 ($25,000)

Net income                                                                       $63,500

Part b

Darren Company

Profit margin = 3.10 % and gross profit rate = 51.85 %

Part c

Change in profit margin : The Profit Margin has fallen from 5% to 3.10 % in 2017 by 2.10% . The cause of this decline is a concern and must be investigated. The Profit margin rate measure the success with respect of earnings on sales thus more investigations must be done on what caused the earnings to decline in 2017.

Part 1

Cost of Goods Sold has increased by $28,000 ($1,015,000 -$987,000). Income tax rate has not changed.

a. Impact of the change on multi-step income statement

The items of Gross Profit and Income from Operations will decline by $28,000.

b. Impact of the change on profitability ratios

The Profit ratios will decline. Profit margin will be 1.73 %. Gross Profit margin will be 50.49 %

Explanation:

Multiple Step Income Statement shows separately the Operating Income and the Net Income. Operating Income being Income derived from Primary Activities of the Company whilst the Net Income includes the Secondary Activities of the Company such as Income taxes or Sale of assets.

Other Workings :

Profit margin = Net Income / Net Sales x 100

                     =  $63,500 / $2,050,000 x 100

                     =  3.10 %

Gross Profit rate = Gross Profit / Net Sales x 100

                           = $1,063,000 / $2,050,000 x 100

                           =51.85 %

Answer 2

The Total Revenue and Net Earnings are shown individually on the Several Stage Financial Statements. Operating income comes from the company's main activities, whereas net earnings come from the industry's support functions, such as taxable income and divestments.

The income statement has been attached below.

Part. B.

Darren Company

Profit margin = 3.10 % and gross profit rate = 51.85 %

Part. C.

Profitability has dropped by 2.10 percent from 5 percent to 3.10 percent in the year 2017. The basis for this drop is a point of anxiety that needs to be questioned.

Because the gross margin rate evaluates achievement in terms of income on selling, more analysis into what prompted the profitability to drop in 2017 is required.  

Part 1

Cost of Goods Sold has boost up by $28,000 ($1,015,000 -$987,000).

The income tax rate has not changed.

a. Impact of the change on the multi-step income statement

The items of Gross Profit and Income from Operations will reduce by $28,000.

b. Impact of the change on profitability ratios

The Profit ratios will decline.

The profit margin will be 1.73 %.

The Gross Profit margin will be 50.49 %

Working Notes:

Profit margin = $\frac{ \text{Net Income}}{ \text{Net Sales}} \times 100$  

                    =  $\frac{ \ 63,500}{ \ 2,050,000}\times 100$  

                    =  3.10 %

Gross Profit rate = $\frac{\text{Gross Profit}}{\text{Net Sales}} \times 100$  

                          = $\frac{ \ 1,063,000 }{ \ 2,050,000}\times 100$  

                          =51.85 %

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