Question

Word has gotten around that you know accounting and can explain it well. Jim, another of your friends has a unique business. During the summer he buys hats that cost $5.00 each and sells them at the beach for $12.00 each. Other than the cost of the hat, his only other expense last summer was $120 for parking. He sold 78 hats last summer. His accountant prepared a financial statement for him and he has several questions about the income statement. He asks:

What does the cost of goods sold and gross profit mean?

How much gross profit do I make on each hat?

Why show both gross profit and net income?

If I have hats returned or a give a discount, how will that be shown on the income statement?

Answer 1

1. Cost of goods sold means the cost that is directly applied for the sale of hats .

That means the cost of purchasing the hat

Gross profit means the profit on sale of goods after deducting the direct cost

Gross profit = Sales revenue - Cost of goods sold

2.

Gross profit = 12 - 5 = $7 per hat

3.

Gross profit is profit on sale after deducting the direct expense , where as to find the net income indirect expense is also deducted from gross profit , As gross profit shows direct expense applied on the goods and net income shows the indirect expesne , so to compare the profits on direct and indirect expense we need both

4.

If the goods are returned the it will be considered as sales return and discount will be considered as sales discount

Both sales return and sales discount is deducted from the gross sales in the income statement