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Pro-forma income statements under two ideas

BYP5-6
Zoe and Tom opened of MallMart three years ago. For the first 2yrs business was good but the following condensed income statement results for 2007 were disappointing.

MallMart Department Store
Income Statement
For the Year Ended December 31, 2007

Net sales $700,000
Cost of goods sold 560,000
Gross profit 140,000

Operating expenses
Selling expenses $100,000
Administrative expenses 15,000
115,000

Net Income $25,000

Zoe believes the problem lies in the relatively low gross profit rate of 20%. Tom believes the problem is that operating expenses are too high. Zoe 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 volumes so that total sales dollars will increase only 5%.
(2) Buy merchandise in larger quantities and take all purchase discounts; these changes are expected to increase the gross profit rate by 4%. Zoe does not anticipate that these changes will have any effect on operating expenses.

Tom thinks expenses can be cut by making these two changes:

(1) cut 2007 sales salaries of $60,000 in half and gives sales personnel a commission of 2% of net sales.
(2) Reduce store delivers to one day per week rather than twice a week; this change will reduce 2007 delivery expenses of $30,000 by 40%.

Tom feels that these changes will not have any effect on net sales.
Zoe and Tom come to you for help in deciding the best way to improve net income.

1. Prepare a condensed income statement for 2008 assuming (1) Zoe's changes are implemented and (2) Tom's ideas are adopted
2. What is your recommendation to Zoe and Tom?
3. Prepare a condensed income statement for 2008 assuming both sets of proposed changes are made.

Solution Preview

Current Condensed Income statement

MallMart Department Store
Income Statement
For the Year Ended December 31, 2007
Current GP margin
Net sales $700,000
Cost of goods sold 560,000
Gross profit 140,000 20.00%

Operating expenses
Selling expenses $100,000
Administrative expenses 15,000
115,000

Net Income $25,000

Income Statement as per Zoe's recommendations

MallMart Department Store
Income Statement
For the Year Ended December 31, 2007
Current GP margin
Net sales $764,750 ...

Solution Summary

This provides the steps to prepare pro-forma income statements under two ideas

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