Question

Sales revenue Cost of goods sold Gross profit Selling and administrative expenses Operating income Interest expense Income before tax Income tax expense Net income 2018 R 70,000 42,000 R 28,000 20,000 R8,000 2,000 R6,000 2,000 R 4,000 2017 R 60,000 30,000 R 30,000 14,000 R16,000 2,000 R14,000 3,000 R11,000 Required: 1. Prepare common-size comparative income statements for the two years for Beach Motors (Pty) Ltd (11) 2. What observations can you make about the common-size statements? List at least four observations. (8) 3. Prepare comparative income statements for Beach motors including columns for the Rands s and for the percentage increase or decrease in each item on the statement. (9) 4. Assume that you are interested in identifying reasons for the changes in selling and administrative expenses and income tax expense. Explain where you would look to find additional information about the change. (2)

Answer 1

Answer-1:

BREACH MOTORS COMMON-SIZE COMPARATIVE INCOME STATEMENT 2017 % 2018 Sales revenue R 70000 100% R 60000 Cost of goods sold 42000 60% 30000 Gross Profit 28000 40% 30000 Selling and adminstrative expense 20000 28.57% 14000 Operating income 8000 11.43% 16000 Interest expense 2000 2.86% 2000 Income before tax 6000 8.57% 14000 Income tax expense 2000 2.86% 3000 Net income IR 4000 5.71% R 11000 100% 50% 50% 23.33% 26.67% 3% 23.33% 5% 18.33%

Answer-2

(i) First, we see that sales dereased from 2017 to 2018, which appears not to be a good sign for Breach Motors. It would be necessary to know how much the sales figure has changed. By looking at the income statement, we can see that sales changed by R10,000, from R70,000 to R60,000.

(ii) The cost of goods sold (COGS) for the business has decreased from 2017 to 2018. One reason the cost of goods sold has gone down is that sales have also gone down. The common size income statement shows that the percentage of COGS has also gone down.

(iii) The next point on the common size income statement is to analyze the operating profit or earnings before interest and taxes (EBIT). Operating profit is one of the most important numbers to analyze because it shows the health of the business firm's core business. In Breach Motors case, the operating income has doubled even if sales has gone down which has happened due drastic decrease in selling and administrative expense.

(iv) Next, we look at the firm's net profit. Net profit increased from 5.71 percent of sales to 18.33 percent of sales. It is a good sign for the business. Interest cost has remained intact.

Answer-3

BREACH MOTORS COMPARATIVE INCOME STATEMENT Absolute 2017 2018 change Sales revenue R 70000 R 60000 (10,000) Cost of goods sold 42000 30000 (12,000)| Gross Profit 28000 30000 2,000 Selling and adminstrative expense 20000 14000 (6,000) Operating income 8000 16000 8,000 Interest expense 2000 2000 Income before tax 6000 14000 8,000 Income tax expense 2000 3000 1,000 Net income R 4000 R 11000 7,000 Percentage change (14.29) % (28.57) % 7.14 % (30.00) % 100.00 % 0.00 % 133.33% 50.00 % 175.00 %