Question

Pro forma income statement   The marketing department of Metroline Manufacturing estimates that its sales in 2020 will be $1.63 million. Interest expense is expected to remain unchanged at $32,000​,and the firm plans to pay $72,000 in cash dividends during 2020.

Metroline​ Manufacturing's income statement for the year ended December​ 31, 2019​, is given​, along with a breakdown of the​ firm's cost of goods sold and operating expenses into their fixed and variable components.

a. Use the ​percent-of-sales method to prepare a pro forma income statement for the year ended December​ 31,2020.

b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December​ 31,2020.

c. Compare and contrast the statements developed in parts a. and b. Which statement probably provides the better estimate of 2020 ​income? Explain why.

Metroline Manufacturing Income Statement for the Year Ended December 31, 2012
Sales revenue	$1,394,000
Less: Cost of goods sold	913000
Gross profits	$481,000					Cost of goods sold
Less: Operating expenses	120000					Fixed cost	$202,000
Operating profits	$361,000					Variable cost	711000
Less: Interest expense	32000					Total cost	$913,000
Net profits before taxes	$329,000					Operating expenses
Less: Taxes (rate = 40%)	131600					Fixed expenses	$33,000
Net profits after taxes	$197,400					Variable expenses	87000
Less: Cash dividends	63000					Total expenses	$120,000
To retained earnings	$134,400

Answer 1

a). Proforma Income Statement FY2020 using percentage of sales method:

First calculate each line item as a percentage of sales for FY2019:

Apply the percentages obtained to get estimates for COGS and operating expenses for FY2020. Interest expense remains the same as in FY2019:

b). Proforma Income Statement FY2020 using breakup of fixed and variable costs/expenses method:

In this method, the fixed costs/expenses are assumed to be the same as for the given latest year (in this case, FY2019). Variable costs/expenses are estimated as a percentage of sales for FY2019 and that percentage is applied to the proforma sales of FY2020.

These %ages of variable components are applied to FY2020 sales to calculate these line items for FY2020. Fixed components are assumed to be same, as in FY2019:

c). As is seen by comparing the income statements in parts a) and b), the proforma income statement in part a). provides a lower estimate of net income compared to the net income calculated in the proforma income statement in part b). This happens because the percentage of sales method calculation is conservative in terms of net income when sales are increasing and aggressive in terms of net income when sales are decreasing. For this reason, the fixed and variable costs/expenses method provides a better estimate of the proforma income statement.