On 1 January, Bob Earl set up Earl's Gyms Ltd to manufacture and sell children's outdoor play gyms. He was an engineer by profession but he understood the importance of accounting information and kept his accounting records meticulously throughout the year. At the end of the year he prepared the following income statement for the year:

Sales

$540 000

LessOperating expenses:

Purchases of raw material

$ 240 000

Purchases of factory supplies

12 000

Wages for factory employees who work directly on the play gyms

90 000

Wages for other factory employees

12 000

Manager's salary

48 000

Office staff salaries

12 000

Sales staff salaries

26 400

Advertising

6 000

Administrative expenses

9 600

Cleaning costs

6 000

Rent

30 000

Electricity

5 400

Purchases of factory equipment

168 000

Purchases of office equipment

12 000

Purchases of sales vehicles

18 000

Total operating expenses

695 400

Net loss

$(155 400)

Although disappointed, Earl was not surprised. He knew that expenses were higher than sales because, throughout the year, he had been unable to generate a cash surplus. His bank overdraft had blown out and his bank manager has asked him to present his financial statements for the year to the bank.

Required:

You are the bank's accountant and the bank manager has asked you to:

Review the performance of Earl's Gyms Ltd for the current year and make a recommendation as to whether Earl's overdraft facility should be cancelled.

Prepare a report for Earl explaining the errors he made in his income statement.

To perform thisanalysisyou will need to update Earl's income statement. The following information may be useful:

The factory occupies 80 per cent of the rented building, the sales area 15 per cent and the administration area 5 per cent.

All the company's non-current assets are estimated to have a useful life of five years and no salvage value at the end of their life.

Earl spends 50 per cent of his time as factory manager and spends the remaining time equally on sales and general administration.

Electricity costs are consumed almost entirely by the factory.

At 31 December, the following inventories existed:

Raw material

$24 000

Work in process

48 000

Finished goods

1 800