Three years ago, Sue Kienholz and her brother-in-law Jeremy Reyes opened Megamart Department Store. For the first 2 years, business was good, but the following condensed income statement results for 2014 were disappointing.

Sue believes the problem lies in the relatively low gross profit rate of 20%. Jeremy believes the problem is that operating expenses are too high. Sue 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 are expected to increase the gross profit rate from 20% to 25%. Sue does not anticipate that these changes will have any effect on operating expenses. Jeremy thinks expenses can be cut by making these two changes. (1) Cut 2014 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 2014 delivery expenses of $40,000 by 40%. Jeremy feels that these changes will not have any effect on net sales. Sue and Jeremy 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 2015 assuming
(1) Sue’s changes are implemented and
(2) Jeremy’s ideas are adopted.
(b) What is your recommendation to Sue and Jeremy?
(c) Prepare a condensed income statement for 2015 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 beconsidered?

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MEGAMART DEPARTMENT STORE Income Statement For the Year Ended December 31, 2014 Net sales Cost of goods sold Gross profit Operating expenses $700,000 560,000 140,000 Selling expenses Administrative expenses $100,000 20,000 120,000 $20,000 Net income