Question

Using the below information: Sales revenue $937,600 Less: cost of good sold Fixed 257,205 Variable 171,278 Gross profits $509,117 Less: operating expenses Fixed 202,533 Variable 54,369 Operating profits $252,215 Less: interest expense 29,066 Net profit before taxes $223,149 Less: taxes (rate 25%) 55,787 Net profits after taxes $167,362 Allen Products LP, wants to do a scenario analysis for the coming year. The pessimistic prediction for sales is $894,000; the most likely amount of sales is $1,124,000; and the optimistic prediction is $1,270,000. Allen's income statement for the most recent year is shown above, a. Use the percent-of-sales method, the income statement for December 31, 2019 and the sales revenue estimates to developpessimistic, most likely, and optimistic pro forma income statements for the coming year. b. Explain how this method could result in overstatement of profits for the pessimistic case and understatement of profits for the most likely and optimistic cases. c. Restate the pro foma income statement in prepared to part a. to incorporate assumptions about 2019 costs $257,205 of the cost of goods sold is fixed, the rest is variable. 202,533 of the operating expense is fixed rest is variable. All interest is fixed

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020 Sales: Less: Cost of goods sold:_____ Gross profits: ___ / _____% Less: Operating expense:______/____% Operating profits:_______ Less: Interest expense:_____/______% Net profits before taxes:_______ Taxes (25%):_______ Net profits after taxes:________

Answer 1

Part A

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Pessimistic
Sales	894000
Less: cost of goods sold	408558	45.7%
Gross profits	485442
Less: operating expenses	244956	27.4%
Operating profits	240486
Less: interest expense	27714	3.1%
Net profit before taxes	212772
Taxes (25%)	53193
Net profit after taxes	$159579

Cost of goods sold = (257205+171278)/937600 = 45.7%

Operating expenses = (202533+54369)/937600 = 27.4%

Interest expense = 29066/937600 = 3.1%

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Most Likely
Sales	1124000
Less: cost of goods sold	513668	45.7%
Gross profits	610332
Less: operating expenses	307976	27.4%
Operating profits	302356
Less: interest expense	34844	3.1%
Net profit before taxes	267512
Taxes (25%)	66878
Net profit after taxes	$200634

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Optimistic
Sales	1270000
Less: cost of goods sold	580390	45.7%
Gross profits	689610
Less: operating expenses	347980	27.4%
Operating profits	341630
Less: interest expense	39370	3.1%
Net profit before taxes	302260
Taxes (25%)	75565
Net profit after taxes	$226695

Part B

According to the simple percent-of-sales method it is assumed that all costs are variable. In reality environment there are some of the expenses which are fixed in nature. In the pessimistic case, there is decrease in all costs due to decrease in sales level but in real environment there is decrease in fixed costs. On the contrary, all costs increases in case of optimistic but in real situation only variable costs increases. In case of pessimistic case there is understatement of costs and overstatement of profits whereas the opposite happens in the case of optimistic scenario.

Part C

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Pessimistic
Sales	894000
Less: cost of goods sold
Fixed	257205
Variable	163602	18.30%
Gross profits	473193
Less: operating expenses
Fixed	202533
Variable	51852	5.80%
Operating profits	218808
Less: interest expense	29066
Net profit before taxes	189742
Taxes (25%)	47436
Net profit after taxes	$142306

Cost of goods sold = 171278/937600 = 18.3%

Operating expenses = 54369/937600 = 5.8%

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Most Likely
Sales	1124000
Less: cost of goods sold
Fixed	257205
Variable	205692	18.30%
Gross profits	661103
Less: operating expenses
Fixed	202533
Variable	65192	5.80%
Operating profits	393378
Less: interest expense	29066
Net profit before taxes	364312
Taxes (25%)	91078
Net profit after taxes	$273234

Pro Forma Income Statement Allen Products, Inc. for the Year Ended December 31, 2020
	Optimistic
Sales	1270000
Less: cost of goods sold
Fixed	257205
Variable	232410	18.30%
Gross profits	780385
Less: operating expenses
Fixed	202533
Variable	73660	5.80%
Operating profits	504192
Less: interest expense	29066
Net profit before taxes	475126
Taxes (25%)	118782
Net profit after taxes	$356344