If a firm’s common size income statement shows that the earnings after tax perce

ID: 2653152 • Letter: I

Question

If a firm’s common size income statement shows that the earnings after tax percentage is too low, the firm may have spent too much money:

on cost of goods sold as a percentage of sales.

on taxes paid as a percentage of stockholders’ equity.

on total assets as a percentage of long-term liabilities.

on expenses as a percentage of current assets.

on cost of goods sold as a percentage of sales.

on taxes paid as a percentage of stockholders’ equity.

on total assets as a percentage of long-term liabilities.

on expenses as a percentage of current assets.

Explanation / Answer

If a firm’s common size income statement shows that the earnings after tax percentage is too low, the firm may have spent too much money:

a. on cost of goods sold as a percentage of sales.

Earnings after tax percentage is a ratio of net profit and total sales. The increase in cost of goods sold will reduce the gross profit of the firm, which has a direct impact on net profit (or earnings after tax).

Also find a basic format of Income Statement below, which will help you in understanding the effect of cost of goods sold on earnings after tax.

Particulars

Amount

Sales

(-) Cost of Goods Sold

Gross Profit

(-) Operating Expenses

Operating Profit

(-) Interest Expense

Earnings before tax

(-) Tax

Earnings after tax