Learning Goal 5
P4-17 Pro forma income statement: Scenario analysis Allen Products Inc. wants to do a scenario analysis for the coming year. The pessimistic prediction for sales is $900,000; the most likely amount of sales is $1,125,000; and the optimistic prediction is $1,280,000. Allen’s income statement for the most recent year follows.
Allen Products Inc. Income Statement for the Year Ended December 31, 2019
Sales revenue | $937,500 |
Less: Cost of goods sold | 421,875 |
Gross profits | $515,625 |
Less: Operating expenses | 234,375 |
Operating profits | $281,250 |
Less: Interest expense | 30,000 |
Net profits before taxes | $251,250 |
Less: Taxes (rate = 25%) | 62, 813 |
Net profits after taxes | $188,437 |
- a. Use the percent-of-sales method, the income statement for December 31, 2019, and the sales revenue estimates to develop pessimistic, most likely, and optimistic pro forma income statements for the coming year.
- b. Explain how the percent-of-sales method could result in an overstatement of profits for the pessimistic case and an understatement of profits for the most likely and optimistic cases.
- c. Restate the pro forma income statements prepared in part a to incorporate the following assumptions about the 2019 costs:
$250,000 of the cost of goods sold is fixed; the rest is variable.
$180,000 of the operating expenses is fixed; the rest is variable.
All the interest expense is fixed.
- d. Compare your findings in part c to your findings in part a. Do your observations confirm your explanation in part b?
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