Question
The marketing department of Metroline Manufacturing estimates that its sales in 2013 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 dividends during 2013. Metroline Manufacturing’s income statement for the year ended December 31, 2012, is given on page 152, 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, 2013.
b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2013.
c. Compare and contrast the statements developed in parts a and b. Which statement probably provides the better estimate of 2013 income? Explain why.
a. Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31, 2013.
b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2013.
c. Compare and contrast the statements developed in parts a and b. Which statement probably provides the better estimate of 2013 income? Explain why.
Answers
GPT-4o mini
To prepare pro forma income statements using both the percent-of-sales method and the fixed and variable cost approach, we first need to examine the information provided. Given the 2012 income statement and the estimates for 2013, let's assume we have the following breakdown for the 2012 income statement:
### 2012 Income Statement (Dummy Data Example)
| Item | Amount |
|-------------------------------|----------|
| Sales | \$1,200,000 |
| Cost of Goods Sold (COGS) | \$720,000 |
| Operating Expenses | \$360,000 |
| Earnings Before Interest & Tax | \$120,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$85,000 |
| Income Tax (assumed 20%) | \$17,000 |
| Net Income | \$68,000 |
Let's assume that COGS is 60% of sales and Operating Expenses are broken down into fixed and variable components, where:
- Fixed Operating Expenses: \$120,000
- Variable Operating Expenses: 20% of Sales
1. **Percent-of-Sales Method**
Based on the 2012 data, we can estimate expenses as a percentage of sales for 2013.
- **Sales for 2013**: \$1,500,000
- **COGS (60% of Sales)**: \$1,500,000 * 60% = \$900,000
- **Operating Expenses (Fixed + Variable)**:
- Fixed: \$120,000 (unchanged)
- Variable: 20% of \$1,500,000 = \$300,000
- **Total Operating Expenses**: \$120,000 (fixed) + \$300,000 (variable) = \$420,000
- **Earnings Before Interest & Tax**: Sales - COGS - Operating Expenses = \$1,500,000 - \$900,000 - \$420,000 = \$180,000
- **Interest Expense**: Remains at \$35,000
- **Earnings Before Tax**: \$180,000 - \$35,000 = \$145,000
- **Income Tax (assumed 20%)**: \$145,000 * 20% = \$29,000
- **Net Income**: \$145,000 - \$29,000 = \$116,000
**Pro Forma Income Statement (Percent-of-Sales Method)**
| Item | Amount |
|-------------------------------|-------------|
| Sales | \$1,500,000 |
| Cost of Goods Sold | \$900,000 |
| Operating Expenses | \$420,000 |
| Earnings Before Interest & Tax| \$180,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$145,000 |
| Income Tax | \$29,000 |
| Net Income | \$116,000 |
2. **Fixed and Variable Cost Data Method**
Using fixed and variable components:
- **Sales for 2013**: \$1,500,000
- **COGS**: Total COGS remains at 60% = \$900,000
- **Fixed Operating Expenses**: \$120,000 (unchanged)
- **Variable Operating Expenses**: Remains at 20% = \$300,000
- **Total Operating Expenses**: Also \$420,000, same as the previous calculation.
- **Earnings Before Interest & Tax**: Still \(Sales - COGS - Operating Expenses\)= \$1,500,000 - \$900,000 - \$420,000 = \$180,000
- **Interest Expense**: Remains \$35,000
- **Earnings Before Tax**: Still \$145,000
- **Income Tax**: \$29,000 (same)
- **Net Income**: \$116,000
**Pro Forma Income Statement (Fixed and Variable Cost Data Method)**
| Item | Amount |
|-------------------------------|-------------|
| Sales | \$1,500,000 |
| Cost of Goods Sold | \$900,000 |
| Operating Expenses | \$420,000 |
| Earnings Before Interest & Tax| \$180,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$145,000 |
| Income Tax | \$29,000 |
| Net Income | \$116,000 |
3. **Comparison of the Statements**
In this case, both the percent-of-sales method and the fixed/variable cost data method produced the same pro forma income statement due to the nature of costs structured in the original data.
- **Comparison**:
- Both methods yield the same sales, cost of goods sold, expenses, and ultimately net income.
- The percent-of-sales method is useful for quick estimates, especially when past data is available showing consistent percentages.
- The fixed and variable approach gives a clearer picture of the behavior of costs, particularly in the context of changes in sales levels.
**Conclusion**: In cases where costs and revenue patterns are stable and well-defined, both methods can yield similar results. However, situations with more variable cost structures or nonlinear relationships may favor the fixed and variable method for better estimations. It might provide a better analytical framework for understanding business performance by isolating fixed versus variable costs, especially useful for decision-making and forecasting beyond mere estimates.
### 2012 Income Statement (Dummy Data Example)
| Item | Amount |
|-------------------------------|----------|
| Sales | \$1,200,000 |
| Cost of Goods Sold (COGS) | \$720,000 |
| Operating Expenses | \$360,000 |
| Earnings Before Interest & Tax | \$120,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$85,000 |
| Income Tax (assumed 20%) | \$17,000 |
| Net Income | \$68,000 |
Let's assume that COGS is 60% of sales and Operating Expenses are broken down into fixed and variable components, where:
- Fixed Operating Expenses: \$120,000
- Variable Operating Expenses: 20% of Sales
1. **Percent-of-Sales Method**
Based on the 2012 data, we can estimate expenses as a percentage of sales for 2013.
- **Sales for 2013**: \$1,500,000
- **COGS (60% of Sales)**: \$1,500,000 * 60% = \$900,000
- **Operating Expenses (Fixed + Variable)**:
- Fixed: \$120,000 (unchanged)
- Variable: 20% of \$1,500,000 = \$300,000
- **Total Operating Expenses**: \$120,000 (fixed) + \$300,000 (variable) = \$420,000
- **Earnings Before Interest & Tax**: Sales - COGS - Operating Expenses = \$1,500,000 - \$900,000 - \$420,000 = \$180,000
- **Interest Expense**: Remains at \$35,000
- **Earnings Before Tax**: \$180,000 - \$35,000 = \$145,000
- **Income Tax (assumed 20%)**: \$145,000 * 20% = \$29,000
- **Net Income**: \$145,000 - \$29,000 = \$116,000
**Pro Forma Income Statement (Percent-of-Sales Method)**
| Item | Amount |
|-------------------------------|-------------|
| Sales | \$1,500,000 |
| Cost of Goods Sold | \$900,000 |
| Operating Expenses | \$420,000 |
| Earnings Before Interest & Tax| \$180,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$145,000 |
| Income Tax | \$29,000 |
| Net Income | \$116,000 |
2. **Fixed and Variable Cost Data Method**
Using fixed and variable components:
- **Sales for 2013**: \$1,500,000
- **COGS**: Total COGS remains at 60% = \$900,000
- **Fixed Operating Expenses**: \$120,000 (unchanged)
- **Variable Operating Expenses**: Remains at 20% = \$300,000
- **Total Operating Expenses**: Also \$420,000, same as the previous calculation.
- **Earnings Before Interest & Tax**: Still \(Sales - COGS - Operating Expenses\)= \$1,500,000 - \$900,000 - \$420,000 = \$180,000
- **Interest Expense**: Remains \$35,000
- **Earnings Before Tax**: Still \$145,000
- **Income Tax**: \$29,000 (same)
- **Net Income**: \$116,000
**Pro Forma Income Statement (Fixed and Variable Cost Data Method)**
| Item | Amount |
|-------------------------------|-------------|
| Sales | \$1,500,000 |
| Cost of Goods Sold | \$900,000 |
| Operating Expenses | \$420,000 |
| Earnings Before Interest & Tax| \$180,000 |
| Interest Expense | \$35,000 |
| Earnings Before Tax | \$145,000 |
| Income Tax | \$29,000 |
| Net Income | \$116,000 |
3. **Comparison of the Statements**
In this case, both the percent-of-sales method and the fixed/variable cost data method produced the same pro forma income statement due to the nature of costs structured in the original data.
- **Comparison**:
- Both methods yield the same sales, cost of goods sold, expenses, and ultimately net income.
- The percent-of-sales method is useful for quick estimates, especially when past data is available showing consistent percentages.
- The fixed and variable approach gives a clearer picture of the behavior of costs, particularly in the context of changes in sales levels.
**Conclusion**: In cases where costs and revenue patterns are stable and well-defined, both methods can yield similar results. However, situations with more variable cost structures or nonlinear relationships may favor the fixed and variable method for better estimations. It might provide a better analytical framework for understanding business performance by isolating fixed versus variable costs, especially useful for decision-making and forecasting beyond mere estimates.