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 EEB 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: ) d. Compare your findings in part c. to your findings in part a. Do your observations confirm your explanation in part b?

Answer 1

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Part a
		Actual of 2019	% of 2019 Sale	Pessimistic	Most Likely	Optimistic
Sales Revenue		$         936,700		$   905,000	$ 1,120,000	$1,271,000
Les: Cost of Goods Sold		$        -443,996	47.40%	$ -428,970	$   -530,880	$ -602,454
Gross Profit		$         492,704		$   476,030	$    589,120	$   668,546
Less: Operating Expense		$        -211,694	22.60%	$ -204,530	$   -253,120	$ -287,246
Operating Profit		$         281,010		$   271,500	$    336,000	$   381,300
Less: Interest Epxense		$          -29,038	3.10%	$    -28,055	$     -34,720	$    -39,401
Net Profit before tax		$         251,972		$   243,445	$    301,280	$   341,899
Less: Tax		$          -75,592	30% of Net Profit before tax	$    -73,033	$     -90,384	$ -102,570
Net Profit after tax		$         176,380		$   170,411	$    210,896	$   239,329
Part b
In percentage of sale method, it is assumed that all costs are varaible.
Event fixed cost will be increased in calculation based on increase in sale.
Hence, in Pessimistic case, even fixed cost will come down which is not the case in real
And prfot will go up
Same, in Optimistic case, even fixed cost will go up which is not the case in real
And profit will go down
Part c
				Pessimistic	Most Likely	Optimistic
Sales Revenue				$   905,000	$ 1,120,000	$1,271,000
Les: Cost of Goods Sold
Fixed				$ -271,115	$   -271,115	$ -271,115
Variable	172881/936700		18.46%	$ -167,030	$   -206,712	$ -234,581
Gross Profit				$   466,855	$    642,173	$   765,304
Less: Operating Expense
Fixed				$ -160,498	$   -160,498	$ -160,498
Variable	51196/936700		5.47%	$    -49,463	$     -61,214	$    -69,467
Operating Profit				$   256,893	$    420,461	$   535,339
Less: Interest Epxense				$    -29,038	$     -29,038	$    -29,038
Net Profit before tax				$   227,855	$    391,423	$   506,301
Less: Tax			30% of Net Profit before tax	$    -68,357	$   -117,427	$ -151,890
Net Profit after tax				$   159,499	$    273,996	$   354,411
Part d
As dicussed in part b, Profit is large in part a then part c in case of Pessimistic case
For optimistic, profit is lower in part a then part c
Which confirm out Part b Observations