Question

BTN 4-7 Refer to the opening feature about Sword & Plough. Assume that Emily and Betsy report current annual sales at approximately \(1 million and prepare the following income statement.

Sword and Plough
Income statement
For year ended Jan 31, 2016
Net sales	\)1,000,000
Cost of sales	610,000
Expenses (Other than cost of sales)	200,000
Net income	$190,000

Emily and Betsy sell to individuals and retailers, ranging from small shops to large chains. Assume that they currently offer credit terms of 1∕15, n∕60, and ship FOB destination. To improve their cash flow, they are considering changing credit terms to 3∕10, n∕30. In addition, they propose to change shipping terms to FOB shipping point. They expect that the increase in discount rate will increase net sales by 9%, but the gross margin ratio (and ratio of cost of sales divided by net sales) is expected to remain unchanged. They also expect that delivery expenses will be zero under this proposal; thus, expenses other than cost of sales are expected to increase only 6%.

Required

1. Prepare a forecasted income statement for the year ended January 31, 2017, based on the proposal.

2. Based on the forecasted income statement alone (from your part 1 solution), do you recommend that Emily and Betsy implement the new sales policies? Explain.

3. What else should Emily and Betsy consider before deciding whether or not to implement the new policies? Explain.

Short answer

1. Net income of the business entity is$213,100.
2. The business entity must implement the new sales policy.
3. The business entity must considersales return and inventory shrinkage before implementing the new strategy.

Step-by-step solution

Step-by-Step SolutionStep 1: Definition of Income Statement

A statement prepared by an accountant that represents the net benefits generated by a business entity by reporting the expenses and revenue of the business is known as an income statement.

Forecasted income statement

Particulars	Amount $
Sales$(\$1,000,000\times 109\%)$	$1,090,000
Less: Cost of sales$\left(\frac{\$610,000}{\$1,000,000}\times \$1,090,000\right)$	(664,900)
Less: expenses other than cost of sales$(\$200,000\times 106\%)$	(212,000)
Net income	$213,100

Decision on new sales policy

Based on the forecasted income statement, the new sales policy of the business entity must be implemented because it reflects an increase in the net income of the business entity.

Points to be considered while deciding whether the new sales policy should be implemented

Sales returns and inventory shrinkage are two points to be considered while deciding whether the new sales policy should be implemented.

1. Sales returns.
2. Inventory shrinkage.