Posted: April 24th, 2016

What factors might cause the difference in the gross profit ratios of the two companies?

EXERCISE 4-26: Revenue Recognition, Cash and Accrual Basis

Hathaway Health Club sold three-year memberships at a reduced rate during its opening promotion. It sold 1,000 three-year nonrefundable memberships for $366 each. The club expects to sell 100 additional three-year memberships for $900 each over each of the next two years. Membership fees are paid when clients sign-up. The club’s bookkeeper has prepared the following income statement for the first year of business and projected income statements for Years 2 and 3. Cash-basis income statements:

Year 1 Year 2 Year 3
Sales 366000 90000 90000
Equipment* 100000 0 0
Salaries and wages 50000 50000 50000
Advertising 5000 5000 5000
Rent and utilities 36000 36000 36000
Net income (loss) 175000 -1000 -1000
*Equipment was purchased at the beginning of Year 1 for $100,000 and is expected to last for three years and then be worth $1,000.

1. Convert the income statements for each of the three years to the accrual basis.

2. Describe how the revenue recognition principle applies. Do you believe that the cash-basis or the accrual-basis income statements are more useful to management? To investors? Why?

PROBLEM 5-2: Calculation of Gross Profit Ratio for Wal-Mart and Target

The following information was summarized from the consolidated statements of income of Wal-Mart Stores, Inc. and Subsidiaries for the years ended January 31, 2011 and 2010, and the consolidated statements of operations of Target Corporation for the years ended January 29, 2011, and January 30, 2010. (For each company, years are labeled as 2010 and 2009, respectively, although Wal-Mart labels these as the 2011 and 2010 fiscal years.)

[see the attached file for the table]

1. Calculate the gross profit ratios for Wal-Mart and Target for 2010 and 2009.

2. Which company appears to be performing better? What factors might cause the difference in the gross profit ratios of the two companies? What other information should you consider to determine how these companies are performing in this regard?


The following condensed income statements and balance sheets are available for Planter Stores for a two-year period. (All amounts are stated in thousands of dollars.)

Income Statements FY2012 FY2011
Revenues $35,982 $26,890
Cost of goods sold 12,594 9,912
Gross profit $23,388 $16,978
Operating expenses 13,488 10,578
Net income $9,900 $6,400

Balance Sheets December 31, 2012 December 31, 2011
Cash $9,400 $4,100
Inventory 4,500 5,400
Other current assets 1,600 1,250
Long-term assets, net 24,500 24,600
Total assets $40,000 $35,350

Current liabilities 9,380 10,600
Capital stock 18,000 18,000
Retained earnings 12,620 6,750
Total liabilities and stockholders’ equity $40,000 $35,350

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