Following are income statements for Hossa Corporation for 2017 and 2016. Percent
ID: 2556186 • Letter: F
Question
Following are income statements for Hossa Corporation for 2017 and 2016. Percentage of sales amounts are also shown for each operating expense item. Hossa’s income tax rate was 38% in 2016 and 40% in 2017.
Hossa's management was pleased that 2017 net income was up 5.8% from the prior year. Although you are also happy with the increase in net income, you are not so sure the news is all positive. You have modeled Hossa’s income as follows:
NET INCOME = SALES × (1 ? COGS% ? OPEX%) × (1 ? TAX RATE)
Using this model, net income in 2016 is computed as $5,500 × (1 ? 45% ? 15%) × (1 ? 38%) = $1,364. Net income in 2017 is computed as $6,500 × (1 ? 47% ? 16%) × (1 ? 40%) = $1,443.
Required:
Prepare a cause-of-change analysis to show the extent to which each of the following items contributed to the $79 million increase in Hossa’s net income from 2016 to 2017: (Enter your answers in millions of dollars. Negative amounts should be indicated by a minus sign. Round your answer to 1 decimal place.)
-Increase in sales (SALES)
-Increase in cost of sales as a percent of sales (COGS%)
-Increase in other operating expenses as a percent of sales (OPEX%)
-Increase in income tax rate (TAX RATE)
Need to know the causes of change in net income,
Net Income - 2016 -
Effect of increase in sales-
Effect of increase in COGS-
Effect of increase in OPEX-
Effect of increase in tax rate-
Increase in net income-
Net income - 2017 -
2016 2017 ($ in millions) $ in millions % of sales $ in millions % of sales Sales $ 5,500 $ 6,500 Cost of sales (2,475 ) 45 % (3,055 ) 47 % Other operating expenses (825 ) 15 % (1,040 ) 16 % Operating income 2,200 2,405 Provision for income taxes (836 ) (962 ) Net income $ 1,364 $ 1,443 Income tax rate 38 % 40 %Explanation / Answer
Note 1:
Operating Income at 2016 rates = 6500*(1-45%-15%) = 2,600
Effect of Increase in tax rate on 2,600 = 2,600*2% = 52
Tax savings due to increase in cost of sales and Opex as a % of sales = (130+65)*40% = 78
Net tax savings - 78-52 = 26
2016 2017 Increase Increase in Sales 5500 6500 1000 Increase in cost of sales as a % of Sales 45% 47% 2% Increase in Other operating expenses as a % of Sales 15% 16% 1% Increase in Income tax rate 38% 40% 2% Net Income in 2016 1,364 Effect of Increase in Sales 248 =1000*(1-45%-15%)*(1-38%) Effect of Increase in cost of sales as a % of Sales (130) =6,500*2% Effect of Increase in Other operating expenses as a % of Sales (65) =6,500*1% Effect of Increase in Income tax rate 26 See note 1 Increase in Net Income 79 Net Income in 2017 1,443 Net Income as a % of Sales in 2016 =1364/5500 24.80%