Question

Following are income statements for Hossa Corporation for 2017 and 2016. Percentage of sales amounts are also shown for each operating expense item. Hossa’s income tax rate was 38% in 2016 and 40% in 2017.

	2016								2017
($ in millions)	$ in millions				% of sales				$ in millions				% of sales
Sales	$	5,500							$	6,500
Cost of sales		(2,475	)			45	%			(3,055	)			47	%
Other operating expenses		(825	)			15	%			(1,040	)			16	%
Operating income		2,200								2,405
Provision for income taxes		(836	)							(962	)
Net income	$	1,364							$	1,443
Income tax rate		38	%							40	%

Hossa's management was pleased that 2017 net income was up 5.8% from the prior year. Although you are also happy with the increase in net income, you are not so sure the news is all positive. You have modeled Hossa’s income as follows:

NET INCOME = SALES × (1 − COGS% − OPEX%) × (1 − TAX RATE)

Using this model, net income in 2016 is computed as $5,500 × (1 − 45% − 15%) × (1 − 38%) = $1,364. Net income in 2017 is computed as $6,500 × (1 − 47% − 16%) × (1 − 40%) = $1,443.

Prepare a cause-of-change analysis to show the extent to which each of the following items contributed to the $79 million increase in Hossa’s net income from 2016 to 2017: (Enter your answers in millions of dollars. Negative amounts should be indicated by a minus sign (no space between a minus sign and numbers). Round your answer to 1 decimal place.)

• Increase in sales (SALES)
• Increase in cost of sales as a percent of sales (COGS%)
• Increase in other operating expenses as a percent of sales (OPEX%)
• Increase in income tax rate (TAX RATE)

Cause of change in	net income
Net income in Year 2016	1,364
Effect of increases in Sales
Effect of increases in COGS
Effect of increases in operating expenses
Effect of increases in tax rate
Increases in net income
Net income of Year 2017	1,443

Answer 1

Cause of change in	How we get	net income	How we get	% Increase
Net income in Year 2016		1,364		Base
Effect of increases in Sales	6500-5500	1000	(6500-5500)/5500*100	18.18%
Effect of increases in COGS	2475-3055	-580	-580/2475*100	-23.43%
Effect of increases in operating expenses	825-1040	-215	-215/2200*100	-9.77%
Effect of increases in tax rates	2200*(38-40)/100	-44	-(44+82)/836*100	-15.07%
Effect of Increase in Taxes	(2200 - 2405)*40/100	-82
Increases in net income		1,443		5.79%

Note: (in yellow) Effect of increase in taxes have been split into Increase in rate ie from 38% to 40% and Overall tax on the increased value of Net Operating Income ie 205 million (2405-2200). If such provision is not available, Please take the Overall increase of $ -126 million (ie -44 -82) as Effect of increase in taxes.

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