Question

Top executive officers of Tildon Company, a merchandising firm, are preparing the next year’s budget. The controller has provided everyone with the current year’s projected income statement.

	Current Year
Sales revenue	$	1,600,000
Cost of goods sold		1,120,000
Gross profit		480,000
Selling & administrative expenses		190,000
Net income	$	290,000

Cost of goods sold is usually 70 percent of sales revenue, and selling and administrative expenses are usually 10 percent of sales plus a fixed cost of $30,000. The president has announced that the company’s goal is to increase net income by 15 percent.

Required

The following items are independent of each other:

A. Prepare a pro forma income statement. What percentage increase in sales would enable the company to reach its goal?

B. The market may become stagnant next year, and the company does not expect an increase in sales revenue. The production manager believes that an improved production procedure can cut cost of goods sold by 2 percent. Prepare a pro forma income statement still assuming the President's goal to increase net income by 15 percent. Calculate the required reduction in selling & administrative expenses to achieve the budgeted net income.

C. The company decides to escalate its advertising campaign to boost consumer recognition, which will increase selling and administrative expenses to $230,000. With the increased advertising, the company expects sales revenue to increase by 15 percent. Assume that cost of goods sold remains a constant proportion of sales. Prepare a pro forma income statement. Will the company reach its goal?

Answer 1

Current years' income statement is as below:

PV Ratio: Contribution / Sales = 320,000/1,600,000 X 100 = 20%

A. as the company targets to increase increase the net income by 15%, amount of increased net income is as below:

290,000 X 15% = 43,500

Therefore, amount of additional sales required: Additional profit required / PV Ratio = 43,500/20% = 217,500

Therefore,% increase in sales required: 217,500/1,600,000 = 13.59%

On this basis, revised pro forma income statement is as below:

B. If cost of goods sold is cut by 2%, revised cost of goods sold for same amount of sale is: 1,600,000 X 68% = 1,088,000 and gross profit is : 1,600,000-1,088,000 = 512,000

Target Net Income of company = 290,000 + 15% = 333,500

Therefore, amount left for selling and adm. Exp. = 512,000 - 333,500 = 178,500

Current amount of selling and adm. Exp. is 190,000. Therefore, reduction in selling in adm. exp. required = 190,000 - 178500 = 11,500. Pro forma statement will look as below:

C. Revised proforma statement shall be as below:

Revised Net Income is 322,000 whereas company's goal is 333,500. Therefore, company will not reach to its goal.