Question: Three years ago, Karen Suez and her brother-in-law Reece Jones opened Gigasales Department Store. For the first 2 years, business was good, but the following condensed income statement results for 2017 were disappointing.
Karen believes the problem lies in the relatively low gross profit rate of 20%. Reece believes the problem is that operating expenses are too high. Karen thinks the gross profit rate can be improved by making two changes.
(1) Increase average selling prices by 15%; this increase is expected to lower sales volume so that total sales dollars will increase only 4%.
(2) Buy merchandise in larger quantities and take all purchase discounts. These changes to purchasing practices are expected to increase the gross profit rate from its current rate of 20% to a new rate of 25%. Karen does not anticipate that these changes will have any effect on operating expenses. Reece thinks expenses can be cut by making these two changes.
(1) Cut 2018 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales. (2) Reduce store deliveries to one day per week rather than twice a week; this change will reduce 2018 delivery expenses of $40,000 by 40%. Reece feels that these changes will not have any effect on net sales. Karen and Reece come to you for help in deciding the best way to improve net income.
Instructions With the class divided into groups, answer the following. (a) Prepare a condensed income statement for 2018 assuming
(1) Karen's changes are implemented and
(2) Reece's ideas are adopted.
(b) What is your recommendation to Karen and Reece?
(c) Prepare a condensed income statement for 2018 assuming both sets of proposed changes are made. (d) Discuss the impact that other factors might have. For example, would increasing the quantity of inventory increase costs? Would a salary cut affect employee morale? Would decreased morale affect sales? Would decreased store deliveries decrease customer satisfaction? What other suggestions might be considered?