Table 4.6
Income Statement
Ace Manufacturing, Inc.
For the Year Ended December 31, 2015
44) Ace Manufacturing, Inc., is preparing pro forma financial statements for 2016. The firm
utilized the percent-of-sales method to estimate costs for the next year. Sales in 2015 were $2
million and are expected to increase to $2.4 million in 2016. The firm has a 40 percent tax rate.
(a) Given the 2015 income statement in Table 4.6, estimate net profit and retained earnings for
2016.
(b) If $200,000 of the cost of goods sold and $40,000 of selling expense are fixed costs; and the
interest expense and dividends are not expected to change, what is he dollar effect on net income
and retained earnings? What is the significance of this effect?
(a)
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Table 4.7
The income statement and balance sheet for the ZZZ Mattress Co. for the year ended December
31, 2015 follow.
Balance Sheet
ZZZ Mattress Company
December 31, 2015
45) The ZZZ Mattress Co. has been requested by the 1st National Bank, a major creditor, to
prepare a pro forma balance sheet for the year ending, December 31, 2016. Using the percent-of-
sales method and the following financial data, prepare the pro forma income statement and
balance sheet and discuss the resulting external financing required. (See Table 4.7)
• 2016 sales are estimated at $330,000.
• Accounts receivable represent 20 percent of sales.
• A minimum cash balance of $1,650 is maintained.
• Inventory represents 32 percent of sales.
• Fixed-asset outlays in 2006 are $20,000. Total depreciation expense for 2016 will be $15,000.
• Accounts payable represents 15 percent of sales.
• Notes payable and accruals will remain the same.
• No long-term debt will be retired in 2016.
• No common stock will be repurchased in 2016.
• The firm will pay dividends equal to 50 percent of its earnings after taxes.
77
Table 4.8
Balance Sheet
Wirl Wind Company
46) The Wirl-Wind Company of America is trying to plan for the next year. Using the current
income statement and balance sheet given in Table 4.8, and the additional information provided,
prepare the company’s pro forma statements.
• Sales are projected to increase by 15 percent.
• Total of $75,000 in dividend will be paid.
• A minimum cash balance of $650,000 is desired.
• A new asset for $50,000 will be purchased.
• Depreciation expense for next year is $50,000.
• Marketable securities will remain the same.
• Accounts receivable, inventory, accounts payable, notes payable, and accruals will increase by
15 percent.
• $30,000 new issue of bond will be sold.
• No new stock will be issued.
79
4.6 Evaluate the simplified approaches to pro forma financial statement preparation and the
common uses of pro forma statements.
1) One basic weakness of the simplified pro forma approaches lies in the assumption that certain
variables, such as cash, accounts receivable, and inventories, can be forced to take on certain
“desired” values.
2) One basic weakness of the simplified pro forma approaches lies in the assumption that the
firm’s past financial condition is an accurate indicator of its future.
3) A weakness of the percent-of-sales method of preparing a pro forma income statement is
________.
A) that it forecasts income and then expresses the various income statement items as percentages
of projected income
B) the assumption that the firm faces linear total revenue and total operating cost functions
C) the assumption that the firm’s past financial condition is an accurate predictor of its future
D) the difficulty faced in calculation and preparation of such statements
4) Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to ________.
A) understate profits when sales are decreasing
B) understate profits when sales are increasing
C) overstate profits when sales are increasing
D) neither understate nor overstate profits
5) Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma
financial statements will tend to ________.
A) understate profits when sales are decreasing and overstate profits when sales are increasing
B) understate profits, no matter what the change in sales, as long as fixed costs are present
C) understate profits when sales are increasing and overstate profits when sales are decreasing
D) overstate profits, no matter what the change in sales, as long as fixed costs are present
6) The weakness of the judgmental approach to preparing a pro forma balance sheet is ________.
A) the assumption that the values of certain accounts can be forced to take on desired levels
B) the assumption that the firm faces linear total revenue and total operating cost functions
C) the assumption that the firm’s past financial condition is an accurate predictor of its future
D) ease of calculation and preparation
7) If transportation costs were a huge portion of a firm’s expenses and the firm expected gas
prices to increase greatly in the next year, then in preparing its pro forma income statement the
firm should ________.
A) use the percentage of transportation costs from last year’s sales
B) decrease the percentage of transportation costs from the percentage of last year’s sales
C) increase the percentage of transportation costs from the percentage of last year’s sales
D) double the percentage of transportation costs from the percentage of last year’s sales