Problem Solving Survival Guide to accompany Financial Accounting, 8th Edition

SOLUTION TO EXERCISE 14-1

(c) Although the dollar amounts for sales, gross profit, and net income showed improvement from 2013 to 2014, the vertical analysis shows that improvements were not made in all areas. The cost of goods sold as a percentage of sales improved as it declined from 55% to 54%. This is probably favorable unless there was a cut in the quality of goods (to get a lower cost per unit) or an increase in the unit sales price which may prove later to work in favor of competition. In light of the significant increase in total sales, the cutback in the cost of goods sold percentage is most likely from favorable reasons. A significant area that worsened from 2013 to 2014 is the operating expenses. They were 25% of sales in 2013 and increased to 28% of sales in 2014. Further investigation in this area would be warranted to determine if corrective action could be taken to reduce this cost percentage. Taxes are a lesser percentage of sales in 2014 because of the lower percentage of income subject to tax in 2014. The net income as a percent of sales was lower in 2014 because the higher operating expense percentage more than offset the lower cost of goods sold percentage. (The horizontal analysis confirms these observations.)