Question

Question 2

The Statement of Comprehensive Income provided below was obtained from the accounting records of Dreamonline Limited:

Statement of Comprehensive Income for the year ended 31 August 2018 (Extract)

	R
Sales	5 000 000
Cost of sales	(1 900 000)
Gross profit	3 100 000
Operating expenses	(700 000)
Operating profit	2 400 000
Interest income	50 000
Interest expense	?
Profit before tax	2 200 000
Income tax	(630 000)
Net profit	1 570 000

Required:

2.1 Explain six (6) reasons why shareholders and financial managers would be interested in the Statement of Comprehensive Income

2.2 Calculate the interest expense for the year ended 31 August 2018

2.3 Explain the accounting treatment of sales returns and allowances

2.4 Interest has been calculated at 8% per year on the amount invested. Assume that there was no change in investments during the year, determine the value of the investment

2.5 Which method of depreciation will result in lower net profit in the early years of the life of the asset?

2.6 Of what significance is the operating profit to investors?

Answer 1

2.1
Managers require Financial Statements to manage the affairs of the company by assessing its financial performance and position and taking important business decisions.
The purpose of the income statement is an account which gives the directors and the executive a very clear picture of the performance of the company during the period.
The income statement of the period serves as an indicator of how the strategy which was planned by the management of the company at the beginning of the period has paid off and where is the scope of improvement

Shareholders use Financial Statements to assess the risk and return of their investment in the company and take investment decisions based on their analysis.
It serves as a good source of analysis of the investors who are willing to invest their stake in the company.
The income statement serves as a good source to do fundamental analysis of the company.
The primary purpose of an income statement is to provide information on how a company is raising its revenue and the costs incurred in doing so.
The statements show the earnings per share or the net profit and how it’s distributed across the outstanding shares.

2.2
Profit before tax = Operating Income + Interest Income - Interest Expense
$2,200,000 = $2,400,000 + $50,000 - Interest Expense
Interest Expense = $250,000

2.3
Sales Returns and Allowances are shown as Deduction from total sales in income statement
Total Sales xxx
Less : Sales Return and allowance xxx
Net Sales xxx

2.4
Interest Income = $50,000
Interest = 8% of Investment
$50,000 = 8% of Investment
Investment = $50,000 / 8% = $625,000

2.5
Double Declining Balance method of depreciation provides Highest Depreciation in initial years, thereby causing the net profit to be lower during the early years of life of asset
Since name also suggests depreciation is charged at double rate

2.6
Operating profit is important because it is an indirect measure of efficiency. The higher the operating profit, the more profitable a company's core business is.