Problem:
The Canton Corporation shows the following income statement. The firm uses FIFO inventory accounting.
CANTON CORPORATION
Income Statement for 2010
| Sales |
$100,000(10,000 units at $10 |
| Cost of goods sold |
50,000(10,000 units at $5) |
| Gross profit |
$50,000 |
| Selling and administration expense |
5,000 |
| Depericiation |
10,000 |
| Operating Profit |
35,000 |
| Taxes (30%) |
10,500 |
| Aftertax income |
$24,500 |
a. Assume in 2011 the same 10,000-unit volume is maintained, but the sales price increases by 10 percent. Because of FIFO inventory policy, old inventory will still be charged off at $5 per unit. Also assume selling and administrative expense will be 5 percent of sales and depreciation will be unchanged. The tax rate is 30 percent. Compute after tax income for 2011.
b. In part a, by what percent did after tax income increase as a result of a 10 percent increase in the sales price? Explain why this impact took place.
c. Now assume that in 2012 the volume remains constant at 10,000 units, but the sales price decreases by 15 percent from its year 2011 level. Also, because of FIFO inventory policy, cost of goods sold reflects the inflationary conditions of the prior year and is $5.50 per unit. Further, assume selling and administrative expense will be 5 percent of sales and depreciation will be unchanged. The tax rate is 30 percent. Compute the after tax income.