Express the following comparative income statements in common-size percents. Using the common-size percentages, which item is most responsible for the decline in net income?
Express the following comparative income statements in common-size percents. (Round your percentage answers to 1 decimal place.)
GOMEZ CORPORATION Comparative Income Statements For Years Ended December 31 Current Year Prior Year $ % $ % $ 735,000 $680,000 568,100 297,600 166,900 382,400 Sales Cost of goods sold Gross profit Operating expenses Net income 130,400 36,500 222,800 $ 159,600 $
The Correct Answer and Explanation is :
The common-size income statement reveals that the most significant factor contributing to the decline in net income is the “Gross Profit” line item.
Here’s why:
- Sales have increased by approximately 8.1% (from $680,000 in the prior year to $735,000 in the current year), which suggests that revenue growth occurred.
- Cost of goods sold (COGS) also saw a significant rise in the current year, increasing from $297,600 to $568,100, representing an increase of 90.8%. This is a larger increase than the sales growth, meaning that the company has spent more on producing goods without a proportional increase in sales.
- Gross Profit dropped dramatically from $382,400 (56.2% of sales) to $166,900 (22.7% of sales), indicating that the company’s cost of goods sold is consuming a much larger portion of its sales revenue. This drop in gross profit is the most significant change in the income statement and is the primary reason for the decrease in net income.
- While Operating Expenses increased from $159,600 (23.5% of sales) to $382,400 (52.0% of sales), this was a smaller increase compared to the rise in COGS, which means that the most significant decline in profitability occurred due to higher costs of production rather than operational inefficiencies.
- Net Income also experienced a sharp decline from $222,800 (32.8% of sales) to $130,400 (17.7% of sales), which is a direct result of the much lower gross profit and higher operating expenses.
In summary, the item most responsible for the decline in net income is the increase in Cost of Goods Sold (COGS), which outpaced sales growth and led to a significant reduction in gross profit.