Gross profit does not appear
- to be relevant in analyzing the operation of a merchandising company.
- on the income statement if the periodic inventory system is used because it cannot be calculated.
- on a service company income statement.
- on a merchandising company income statement.
The Correct Answer and Explanation is :
Correct Answer:
Gross profit does not appear on a service company income statement.
Explanation:
Gross profit is a key metric in analyzing the financial performance of a merchandising or manufacturing company but is not relevant to service companies. Service companies do not sell physical goods; instead, they provide services such as consulting, legal assistance, healthcare, or accounting. Since there is no cost of goods sold (COGS) in a service-based business, there is no gross profit calculation on their income statement.
Why Gross Profit is Relevant for Merchandising Companies
Merchandising companies buy and sell goods. Their income statement includes:
- Revenue (or Sales): Total sales made.
- Cost of Goods Sold (COGS): The direct costs of purchasing or producing goods.
- Gross Profit: Revenue minus COGS. This represents the profit before deducting operating expenses.
Why Gross Profit is Not on a Service Company’s Income Statement
A service company’s income statement typically starts with Revenue, followed by Operating Expenses such as salaries, rent, and utilities. Since they do not have inventory, there is no COGS to deduct from revenue. Instead, net income is calculated directly after deducting operating expenses.
Example:
- A retail store sells products and reports gross profit.
- A law firm provides services and does not report gross profit.
Since gross profit is directly tied to inventory and cost of goods sold, it is only relevant for businesses that sell tangible products. That’s why it does not appear on a service company’s income statement.
Now, I will generate an image to illustrate this concept.
I’ve generated an image comparing the income statements of a merchandising company and a service company. The image highlights the presence of Gross Profit in the merchandising company’s statement while showing its absence in the service company’s statement. Let me know if you need any modifications!
