Question

Pro forma income statement-Scenario analysis Allen Products LP, wants to do a scenario analysis for the coming year. The pessimistic prediction for sales is $905,000; the most likely amount of sales is $1,120,000, and the optimistic prediction is $1,271,000 Allen's income statement for the most recent year is shown here 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 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 forma income statements prepared in part a. to incorporate the following assumptions about the 2019 costs: $271,115 of the cost of goods sold is fixed; the rest is variable. $160,498 of the operating expenses is fixed, the rest is variable. All the interest expense is fixed. (Please see: EES d. C 囲 pare your findings in part c. to your findings in part a. Do your observations confirm your explanation in part b?

Answer 1

	Cost of Goods Sold as percentage of sales = COGS/Sales*100
		= $443996/$936700
		47.40%
	Operating Expense as percentage of sales = Operating Exp/Sales*100
		= $211694/$936700
		22.60%
	Interest Expense as percentage of sales = Interest Exp/Sales*100
		= $29038/$936700
		3.10%
A	PROFORMA INCOME STATEMENT
		Pessimistic	Otpimistic	Most Likely
	Sales	$ 905,000.00	$      1,120,000.00	$ 1,271,000.00
	Less: COGS [47.40%*sales]	$ 428,970.00	$         530,880.00	$      602,454.00
	Gross Profit	$ 476,030.00	$         589,120.00	$      668,546.00
	Less: Operating Expense [22.60%*sales]	$ 204,530.00	$         253,120.00	$      287,246.00
	Operating Profits	$ 271,500.00	$         336,000.00	$      381,300.00
	Less: Interest Expense [3.10%*sales]	$    28,055.00	$            34,720.00	$        39,401.00
	Net Profit before taxes	$ 243,445.00	$         301,280.00	$      341,899.00
	Less: Income Tax (30% of Net Profit)	$    73,033.50	$            90,384.00	$      102,569.70
	Profit after tax	$ 170,411.50	$         210,896.00	$      239,329.30
B	The simple percent of sales method assumes that all cost are variable. But actually some
	of the expenses are fixed. In the pesssissmistic case this assumtion causes all cost to decrease
	wit thelower level of sales when in reality the fixed portion of the cost will not decrease
	The opposite occurs for the optimistic forecast since the percent of sales assumes all costs
	increase when in reality only the variable portion will increase. This pattern results in an
	understatement of costs in the pessismistic case and an overstatement of profit.
	The opposite occurs in the optimistic scenario
C	Cost of Goods Sold as percentage of sales = Variable COGS/Sales*100
		= $172881/$936700
		18.46%
	Operating Expense as percentage of sales = Variable Operating Exp/Sales*100
		= $51196/$936700
		5.47%
	PROFORMA INCOME STATEMENT
		Pessimistic	Otpimistic	Most Likely
	Sales	$ 905,000.00	$      1,120,000.00	$ 1,271,000.00
	Less: COGS
	Variable [18.46%*Sales]	$ 167,063.00	$         206,752.00	$      234,626.60
	Fixed	$ 271,115.00	$         271,115.00	$      271,115.00
	Gross Profit	$ 466,822.00	$         642,133.00	$      765,258.40
	Less: Operating Expense
	Variable [5.47%*Sales]	$    49,503.50	$            61,264.00	$        69,523.70
	Fixed	$ 160,498.00	$         160,498.00	$      160,498.00
	Operating Profits	$ 256,820.50	$         420,371.00	$      535,236.70
	Less: Interest Expense	$    29,038.00	$            29,038.00	$        29,038.00
	Net Profit before taxes	$ 227,782.50	$         391,333.00	$      506,198.70
	Less: Income Tax (30% of Net Profit)	$    68,334.75	$         117,399.90	$      151,859.61
	Profit after tax	$ 159,447.75	$         273,933.10	$      354,339.09
d	The profits for the pessimistic case are larger in part (a) than in part (c).
	The profits for the otimistic case are larger in part (c) than in part (a).
	This outcome confirms the result as stated in part (b)