Friend Vicki wrote again, nice to hear from you Vicki, with this: Happy new year to you, I hope you had a good break. Sorry to bother you, I just wondered if you could explain how profit is calculated. I have sat my exam for the piece of coursework I spoke to you about before, however I ended up with a few odd numbers on my spreadsheet, the reason for this is that I needed to alter the profit to be calculated. The profit was to be assumed 20%, so I had this: costs * 1.2 however, my friend (on the same course) advised me that what I should do was: (costs/80)*100 The two give different answers but using his formula gave me what should be the correct figures. (The selling price was discussed in a tutorial where my tutor had said that they were the correct figures, at the same time as telling us about the problem with hours for the interpretation). I understand how my friends calculation works but I do not understand why this way is to be used because mathematically, it is not straight forward being increased by 20%. I hope I haven't confused you, and I would be grateful if you could advise me the correct way to calculate profit. Although the exam is now gone I want to know and understand how to do this properly. Thank you for your time, Vicki Not confused, I replied as follows: Hi Vicki, I had a good but all too short holiday thanks. Your problem is a typical problem both to solve and to get confused by. Here’s the explanation! If someone says that the selling price is Cost plus 20% of cost, then the following is true Cost = 100% of Cost Profit = 20% of Cost Selling Price = 120% of Cost In this case, the method for getting from Cost to Selling Price is Selling Price = Cost * 1.2 So far so good; and I can see that you understand that! Now, let’s assume that we are told that the Profit is to be 20% of Selling Price when the Cost is known to be £100. Aagh! What’s the Selling Price … what’s the Profit … ? Keep calm and use the same layout and apply the same logic: fill in what we know and then derive what we don’t know: This is what we know: Cost = £100 Profit = 20% of Selling Price Selling Price = £x This is the logic; Cost = £100 = 80% of Selling Price … can you see why? Profit = 20% of Selling Price Selling Price = £x = 100% of Selling Price Hence, the Cost MUST be £100/80% = £100/0.8 = £125 Hence, the Selling Price MUST be £125/80*100 = £156.25 Hence, the Profit MUST be 20% of the Selling price = 20% * £125 = £31.25 Does this all work out? Cost = £125.00 Profit = 31.25 Selling Price = £156.25 So, is Cost of £125 equal to 80% of £156.25 … YES! You might need to think about that a bit Vicki: it’s a cheap trick, of course, but such questions are very commonly asked at ALL levels of accounting education. Let me know of any more bother! Best wishes HTH DW