Question

P4-15 Pro forma income statement The marketing department of Metroline Manufactur ing estimates that its sales in 2016 will be $1.5 million. Interest expense is expected to remain unchanged at $35,000, and the firm plans to pay $70,000 in cash divi dends during 2016. Metroline Manufacturing’s income statement for the year ended December 31, 2015, and a breakdown of the firm’s cost of goods sold and operating expenses into their fixed and variable components are given below. a. Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31, 2016. b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2016. c. Compare and contrast the statements developed in parts a and b. Which state ment probably provides the better estimate of 2016 income? Explain why. Metroline Manufacturing Metroline Manufacturing Breakdown of Costs and Expenses Income Statement for the Year Ended December 31, 2015 Sales revenue $1,400,000 Cost of goods sold Less: Cost of goods sold 910,000 Fixed cost $210,000 Gross profits $ 490,000 Variable cost 700,000 Less: Operating expenses 120,000 Total costs $910,000 Operating profits $ 370,000 Operating expenses Less: Interest expense 35,000 Fixed expenses $ 36,000 Net profits before taxes $ 335,000 Variable expenses 84,000 134,000 Less: Taxes (rate = 40%) Total expenses $120,000 Net profits after taxes $ 201,000 Less: Cash dividends 66,000 To retained earnings $ 135,000 ***Please provide response in excel formatting*** Thank you.

Answer 1

(a) Preparation of the proforma income statement for the year ended December 31, 2016 using percent-of-sales mehtod.

Particulars	December 31,2015	Percent-of-sales	December 31,2016
Sales Revenue	$ 1,400,000		$ 1,500,000
Less: Cost of goods Sold	910,000	910,000/1,400,000 = 65 %	975,000
Gross profit	490,000		525,000
Less: Operating Expenses	120,000	120,000/1,400,000 = 8.57 %	128,550
Operating Profit	370,000		396,450
Less: Interest Expenses	35,000		35,000
Net Profit before taxes	335,000		361,450
Less: Tax rate @40%	134,000		144,580
Net Profit	201,000		216,870
Less: Cash Dividend	66,000		70,000
Retained Earning	$ 135,000		$ 146,870

(b) Preparation of the proforma income statement for the year ended December 31, 2016 using fixed and variable cost data.We have,

Particulars	December 31,2015	Percent-of-sales	December 31,2016
Sales Revenue	$ 1,400,000		$ 1,500,000
Less: Variable Cost	700,000	700,000/1,400,000 =50 %	750,000
Less: Variable Expenses	84,000	84,000/1,400,000 = 6 %	90,000
Contribution	616,000		660,000
Less: Fixed Cost	210,000		210,000
Less: Fixed expenses	36,000		36,000
Operationg Profit	370,000		414,000
Less: Interest expenses	35,000		35,000
Net Profit before taxes	335,000		379,000
Less: Tax @ 40%	134,000		151,600
Net Profit	201,000		227,400
Less: Cash Dividend	66,000		70,000
Retained Earings	$ 135,000		$ 157,400

Note: Fixed expenses are not changes with changes in sales level to a certain period.So, here fixed cost is not changes with change in sales level.

(c) The income calculated by fixed and variable cost data is better estimate than percent-to-sales method. It is beacause, in the percent-to-sales method cost of goods sold is change with any changes in sales revenue. But, in the cost of goods sold, there are variable and fixed component available and fixed cost is not change with any changes in sales revenue. This is why, income is reduced by any changes in fixed cost in the percent-to-sales method.

In the question, Net profit under percent-of-sales method is $ 216,870 and net profit under contribution margin method is $ 227,400.Net profit reduced by $ 10,530 in percent-of-sales method from contribution margin.