Problem 11 - Accounting

Question

On March 31, 2010, the balances of the accounts appearing in the ledger of El Dorado Furnishings Company, a furniture wholesaler, are as follows: \(\begin{array}{lrlr}\text { Administrative Expenses } & \$ 250,000 & \text { Ricardo Cepeda, Capital } & \$ 1,137,600 \\ \text { Building } & 1,025,000 & \text { Ricardo Cepeda, Drawing } & 50,000 \\ \text { Cash } & 97,000 & \text { Salaries Payable } & 6,000 \\ \text { Cost of Merchandise Sold } & 1,400,000 & \text { Sales } & 2,550,000 \\ \text { Interest Expense } & 15,000 & \text { Sales Discounts } & 40,000 \\ \text { Merchandise Inventory } & 260,000 & \text { Sales Retums and Allowances } & 160,000 \\ \text { Notes Payable } & 59,000 & \text { Selling Expenses } & 410,000 \\ \text { Office Supplies } & 21,200 & \text { Store Supplies } & 15,400\end{array}\) a. Prepare a multiple-step income statement for the year ended March 31, 2010 . b. Compare the major advantages and disadvantages of the multiple-step and singlestep forms of income statements.

Step-by-Step Solution

Answer

Net Income: $275,000. The multiple-step income statement offers more detailed information compared to the single-step format.

Step 1: Calculate Gross Profit

To find the Gross Profit, follow this formula:\[ \text{Gross Profit} = \text{Net Sales} - \text{Cost of Merchandise Sold} \]First, determine Net Sales:\[ \text{Net Sales} = \text{Sales} - \text{Sales Returns and Allowances} - \text{Sales Discounts} \]Plug in the values:\[ \text{Net Sales} = 2,550,000 - 160,000 - 40,000 = 2,350,000 \]Now, calculate Gross Profit:\[ \text{Gross Profit} = 2,350,000 - 1,400,000 = 950,000 \]

Step 2: Calculate Operating Income

Operating Income is calculated by deducting operating expenses from Gross Profit. Operating Expenses include Selling, Administrative, and other Operating Expenses.We have:- Selling Expenses = 410,000 - Administrative Expenses = 250,000Total Operating Expenses:\[ \text{Total Operating Expenses} = 410,000 + 250,000 = 660,000 \]Calculate Operating Income:\[ \text{Operating Income} = \text{Gross Profit} - \text{Total Operating Expenses} \]\[ \text{Operating Income} = 950,000 - 660,000 = 290,000 \]

Step 3: Determine Other Income and Expenses

List other income and expenses:- Interest Expense = 15,000Since there is no other income provided, only consider the Interest Expense.Net Other Income/Expenses:\[ \text{Net Other Income/Expenses} = -15,000 \]

Step 4: Calculate Net Income

Net Income can be calculated by subtracting Net Other Income/Expenses from Operating Income.\[ \text{Net Income} = \text{Operating Income} + \text{Net Other Income/Expenses} \]\[ \text{Net Income} = 290,000 + (-15,000) = 275,000 \]

Step 5: Comparison of Income Statement Formats

The multiple-step income statement offers more detailed information because it separates operating activities from non-operating activities, facilitating detailed analysis of company performance. The single-step format is simpler but gives less insight as it doesn't categorize revenues and expenses, making it less useful for in-depth financial analysis.

Key Concepts

Gross Profit Calculation

Gross Profit is a critical figure that reflects a company's profitability from its core business activities. Calculating it involves subtracting the Cost of Merchandise Sold from Net Sales. This is a vital metric for understanding how efficiently a company is producing and selling its goods.
To determine Net Sales, you need to adjust the total revenue (sales) by subtracting any Sales Returns, Allowances, and Discounts. In this case, El Dorado Furnishings had Sales of $2,550,000. After taking into account Sales Returns and Allowances ($160,000) and Sales Discounts ($40,000), Net Sales come to $2,350,000.
With the Net Sales figure in hand, Gross Profit is calculated by deducting the Cost of Merchandise Sold, which was $1,400,000 for El Dorado. Thus, Gross Profit equals $950,000, indicating the amount left to cover other business expenses and generate a profit.

Operating Income

Operating Income is an important measure of company performance, showing how much money remains after accounting for operating expenses. These expenses include costs like Selling and Administrative Expenses, which are necessary for keeping the business running smoothly.
For El Dorado Furnishings, the Selling Expenses amounted to $410,000, while Administrative Expenses were $250,000. These two categories add up to Total Operating Expenses of $660,000.
To find Operating Income, we subtract these Total Operating Expenses from the Gross Profit of $950,000. The result is $290,000, which indicates how much profit is generated from core operations after covering the operational costs.

Net Income Analysis

Net Income is the final profit figure after accounting for all business expenses, including both operating and non-operating items. It gives a comprehensive view of profitability.
At El Dorado Furnishings, after calculating the Operating Income ($290,000), we need to consider other expenses. An Interest Expense of $15,000 is noted, which affects total profitability.
Net Income is derived by adjusting the Operating Income for these other financial items. Subtracting the Interest Expense from Operating Income gives us a Net Income of $275,000, demonstrating the company's overall profitability after all financial considerations.

Income Statement Formats Comparison

Different income statement formats serve different analysis purposes. The multiple-step format used by El Dorado Furnishings provides a clear separation of operating and non-operating activities, which offers a more detailed analysis of the company’s performance. It allows stakeholders to see how well the core business operations are performing, independent of other financial aspects.
In contrast, the single-step income statement aggregates revenues and expenses without distinction. While it is simpler and faster to prepare, it offers less insight, especially for stakeholders trying to understand the specific areas of profitability or loss.
In decision-making contexts, the detailed breakdown provided by a multiple-step format can facilitate better analysis and strategic planning, making it a preferred choice for in-depth financial review.