Question

Party-Time T-Shirts sells T-shirts for parties at the local college. The company completed the first year of operations, and the shareholders are generally pleased with operating results as shown by the following income statement:

PARTY-TIME T-SHIRTS

Income Statement

Year Ended December 31, 2017

Net Sales Revenue \(350,000

Cost of Goods Sold 210,000

Gross Profit 140,000

Operating Expenses:

Selling Expense 40,000

Administrative Expense 25,000

Net Income \)75,000

Bill Hildebrand, the controller, is considering how to expand the business. He proposes two ways to increase profits to \(100,000 during 2018.

a. Hildebrand believes he should advertise more heavily. He believes additional advertising costing \)20,000 will increase net sales by 30% and leave administrative expense unchanged. Assume that Cost of Goods Sold will remain at the same percentage of net sales as in 2017, so if net sales increase in 2018, Cost of Goods Sold will increase proportionately.

b. Hildebrand proposes selling higher-margin merchandise, such as party dresses, in addition to the existing product line. An importer can supply a minimum of 1,000 dresses for \(40 each; Party-Time can mark these dresses up 100% and sell them for \)80. Hildebrand realizes he will have to advertise the new merchandise, and this advertising will cost $5,000. Party-Time can expect to sell only 80% of these dresses during the coming year.

Help Hildebrand determine which plan to pursue. Prepare a multi-step income statement for 2018 to show the expected net income under each plan.

Short answer

The net income under plan a is$97,000.

The net income under plan b is$102,000.

Step-by-step solution

Types of Income Statement

The major purpose of drafting an income statement is to determine the profits generated or losses incurred by a business.Single-step and multi-step are two main forms of income statements; though both reflect the samenet income, the presentation of events differs in both formats.

Preparation of multi-step income statement under plan a

PARTY-TIME T-SHIRTS
Multi-step Income Statement
For the year ended 2018
Particulars	Amounts ($)
Net sales revenue (WN-1)	455,000
Less: Cost of goods sold (WN-2)	(273,000)
Gross profit	182,000
Less: Operating expenses
Selling expenses 40,000
Add: Advertising expense 20,000	(60,000)
Administrative expense	(25,000)
Net income	$97,000

Working Notes:

1. Computation of net sales revenue:

Net sales increased by 30%, hence net sales for the year 2018 is:

$$\begin{gathered} \text{Net sales revenue}=\text{Sales for 2017}+30\%\text{of 2017's sale} \\ =\$350,000+\frac{30}{100}\times \$350,000 \\ =\$455,000 \end{gathered}$$

2. Computation of cost of goods sold:

The cost of goods sold is computed as follows:

$$\begin{gathered} \text{Cost of goods sold}=\frac{\text{Cost of goods sold for 2017}}{\text{Net sales revenue for 2017}}\times 100 \\ =\frac{\$210,000}{\$350,000}\times 100 \\ =60\% \\ \text{Hence, the cost of goods sold for 2018 is as follows:} \\ \text{Cost of goods sold}=\text{Net sales of 2018}\times 60\% \\ =\$455,000\times \frac{60}{100} \\ =\$273,000 \end{gathered}$$

Preparation of multi-step income statement under plan b

PARTY-TIME T-SHIRTS
Multi-step Income Statement
For the year ended 2018
Particulars	Amounts ($)
Net sales revenue (WN-1)	414,000
Less: Cost of goods sold (WN-2)	(242,000)
Gross profit	172,000
Less: Operating expenses
Selling expenses 40,000
Add: Advertising expense 5,000	(45,000)
Administrative expenses	(25,000)
Net income	$102,000

Working Notes:

1. Computation of net sales revenue:

$$\begin{gathered} \text{New Sales revenue}=\left(\text{Number of dresses}\times \text{expected sales percentage}\right)\times \text{Selling price} \\ =\left(1,000\times 80\%\right)\times \$80 \\ =\$64,000 \end{gathered}$$

$$\begin{gathered} \text{Total net sales revenue for 2018}= \text{Sales revenue for 2017 + New sales revenue} \\ =\$350,000+\$64,000 \\ =\$414,000 \end{gathered}$$

2. Computation of cost of goods sold:

$$\begin{gathered} \text{Cost of new sales revenue}=\left(\text{Number of dresses}\times \text{Expected sales percentage}\right)\times \text{Cost per dress} \\ =\left(1,000\times 80\%\right)\times \$40 \\ =\$32,000 \end{gathered}$$

$$\begin{gathered} \text{Total increase in cost of goods sold}=\text{Cost of goods sold for 2017 + New cost of goods sold} \\ =\$210,000+\$32,000 \\ =\$242,000 \end{gathered}$$

Comment:The net income under plan b is more than plan a. Hence, the company should pursue with plan b.