Question

P4-20: Integrative: Pro forma statements Red Queen Restaurants wishes to prepare financial plans. Use the financial statements and the other information provided below to prepare the financial plans.

The following financial data are also available:

1. The firm has estimated that its sales for 2020 will be $900,000.
2. The firm expects to pay $35,000 in cash dividends in 2020.
3. The firm wishes to maintain a minimum cash balance of $30,000.
4. Accounts receivable represent approximately 18% of annual sales.
5. The firm’s ending inventory will change directly with changes in sales in 2020.
6. A new machine costing $42,000 will be purchased in 2020. Total depreciation for 2020 will be $17,000.
7. Accounts payable will change directly in response to changes in sales in 2020.
8. Taxes payable will equal one-fourth of the tax liability on the pro forma income statement.
9. Marketable securities, other current liabilities, long-term debt, and common stock will remain unchanged.

1. Prepare a pro forma income statement for the year ended December 31, 2020, using the percent-of-sales method.
2. Prepare a pro forma balance sheet dated December 31, 2020, using the judgmental approach.
3. Analyze these statements, and discuss the resulting external financing required.

Assets		Liabilities and stockholders’ equity
Red Queen Restaurants Income Statement for the Year Ended December 31, 2019
Sales revenue			$800,000
Less: Cost of goods sold			600,000
Gross profits			$200,000
Less: Operating expenses			100,000
Net profits before taxes			$100,000
Less: Taxes (rate = 21%)			21,000
Net profits after taxes			$ 79,000
Less: Cash dividends			20,000
To retained earnings			$ 59,000
Red Queen Restaurants Balance Sheet December 31, 2019
Cash	$ 32,000	Accounts payable		$100,000
Marketable securities	18,000	Taxes payable		20,000
Accounts receivable	150,000	Other current liabilities		5,000
Inventories	100,000	Total current liabilities		$125,000
Total current assets	$300,000	Long-term debt		200,000
Net fixed assets	350,000	Total liabilities		$325,000
Total assets	$650,000	Common stock		150,000
		Retained earnings		175,000
		Total liabilities and stockholders’ equity		$650,000

Please show your work. It does not help me if you just provide the answers.

Answer 1

Assuming that the depreciation of 17,000 is already included in the operating expenses of 2020,

Income statement using percentage of sales method :

Income Statement	Dec-19	%	%	Dec-20	Dec-20
Sales revenue	$8,00,000	$800,000/$800,000	100%	$9,00,000	$9,00,000
Less: Cost of goods sold	$6,00,000	$600,000/$800,000	75%	75% of $900,000	$6,75,000
Gross profits	$2,00,000			Sales - COGS	$2,25,000
Less: Operating expenses	$1,00,000	$100,000/$800,000	13%	13% of $900,000	$1,12,500
Net profits before taxes	$1,00,000			Gross Profits - Operating exp	$1,12,500
Less: Taxes (rate = 21%)	$21,000			21% tax on Net profit before taxes	$23,625
Net profits after taxes	$79,000			Net profit before tax - Tax	$88,875
Less: Cash dividends	$20,000			Cash dividend as per statement	$35,000
To retained earnings	$59,000			Net profit after tax - Cash dividend	$53,875

The income statement for year ended Dec 31,2020 is as below:

Change in sales = ($900,000 - $800,000)/$800,000 *100 = 12.5%

So, Inventory and Accounts payable will increase by 12.5% as they change directly in response to change in sales.

For balance sheet,

Balance Sheet	Dec'19	Dec '20	Dec '20	Balance Sheet	Dec'19	Dec '20
Cash	$32,000	Minimum cash as per statement	$30,000	Accounts payable	$1,00,000	Same as change in Sales	$1,12,500
Marketable securities	$18,000	Same	$18,000	Taxes payable	$20,000	1/4th of tax in income statement	$5,906
Accounts receivable	$1,50,000	18% of sales	$1,62,000	Other current liabilities	$5,000	Same	$5,000
Inventories	$1,00,000	Same as change in Sales	$1,12,500	Total current liabilities	$1,25,000	Sum of Payables and other current liabilities	$1,23,406
Total current assets	$3,00,000	Sum of Cash, Securities and Receivables	$3,22,500	Long-term debt	$2,00,000	Same	$2,00,000
Net fixed assets	$3,50,000	Addition of new machinery and reduction of depreciation	$3,75,000	Total liabilities	$3,25,000	Sum of current liabilitues and Long term debt	$3,23,406
Total assets	$6,50,000	Current Assets + Fixed assets	$6,97,500	Common stock	$1,50,000	Same	$1,50,000
				Retained earnings	$1,75,000	Profits of 2020 added in retained earnings of 2019	$2,28,875
				Total liabilities and stockholders’ equity	$6,50,000	Sum of Total Liabilities, common stock and Retained earnings	$7,02,281

Since the Total Liabilities, common stock and retained earnings are greater than Total Assets by $702,281 - $697,500 = $4781

The deficit of $4,781 will be added in cash to tally the Total assets

New Cash will be $32,000 + $4,781 = $36,781

So, the balance sheet as on Dec 31,2020 will be as below:

Since the total liabilities were more than total assets, there is no need of any external financing.

Please note that we have assumed that the depreciation of 17,000 is already included in the operating expenses of 2020. The answer will change in case of different assumption.