Donna and her friend Luke opened Share Department Store three years ago. For the

Question

Donna and her friend Luke opened Share Department Store three years ago. For the first two years, business was good, but the following condensed income results for 2011 were disappointing. Donna believes the problem lies in the relatively low gross profit rate (gross profit divided by net sales) of 21%. Luke believes the problem is that operating expenses are too high. Donna thinks the gross profit rate can be improved by making both the flowing changes. She does not anticipate that these changes will have any effect on operating expenses. Increase average selling prices by 17%. This increase is expected to lower sales volume so that total sales will increase only 6%. Buy merchandise in larger quantities and take all purchase discounts. These changes are expected to increase the gross profit rate by 3 percentage points. Luke thinks expenses can be cut by making both of the following changes. He feels that these changes will not have any effect on net sales. Cut 2011 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales. Reduce store deliveries to one day per week rather than twice a week; this change will reduce 2011 delivery expenses of $30,000 by 40%. Donna and Luke come to you for help in deciding the best way to improve net income. Required: Prepare a condensed income statement for 2012, assuming Donna's changes are implemented; Prepare a condensed income statement for 2012, assuming Luke's changes are implemented; What is your recommendation to Donna and Luke? Prepare a condensed income statement for 2012, assuming both sets of proposed changes are made.

Explanation / Answer

Donnas proposal has give higher net income as compared to other Proposal

Condensed Income Statement 2012(based on Donnas recommendation) Net sales (net effect 6% increase in total sales) 742000 Cost Of Goods sold(76% of sales ie 100-24% GP) 563920 Gross Profit (21%+3% =24% of sales) 178080 Selling Expense 100000 Administrative Expenses 2000 102000 Net Income 76080

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