Chapter 14, Problem 21P

a)

To determine

Determine the percentage increase in sales and prepare the pro forma income statement.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Compute the percentage of increase in sales:

$\begin{array}{c}\text{Percentage }\text{increase in sales}=\frac{\text{Projected sales}-\text{Current sales}}{\text{Current sales}}\times 100\\ =\frac{\$3,635,000\left(1\right)-\$3,200,000}{\$3,200,000}\times 100\\ =13.59\%\end{array}$

Hence, the percentage of increase in sales is 13.59%.

Prepare the pro forma income statement:

Company P
Income Statement
For the year ended
Particulars	Amount
Sales revenue (1)	$3,635,000
Cost of goods sold	$2,544,500
Gross profit	$1,090,500
Selling & administrative expenses (2)	$423,500
Net income	$ 667,000

Table (1)

Working note 1: Calculate the sales value:

The company expects net income to increase by 15%, so the increased net income is $667,000$\left(\text{\$580,000}+\left(\text{\$580,000}\times 15\%\right)\right)$ . The cost of goods sold is 70% or 0.70 and the selling and administrative expense is 10% or 0.10.

Consider sales as X:

$\begin{array}{c}\text{Net income}=\text{Sales}-\text{COGS}-\text{S\&A expenses}\\ \$667,000=\text{X}-0.70\text{X}-\left(\$60,000+0.10\text{X}\right)\\ \$667,000+\$60,000=\text{X}-0.70\text{X}+0.10\text{X}\\ \$727,000=0.2\text{X}\end{array}$

$\begin{array}{l}\text{X}=\frac{\$727,000}{0.2}\\ \text{X}=\$3,635,000\end{array}$

Hence, sales are $3,635,000.

Working note 2: Compute selling and administration expenses:

$\begin{array}{c}\text{Selling and administration expenses}=\text{10\% of sales revenue}+\text{Fixed cost}\\ =\left(\$3,635,000\times 0.10\right)+\$60,000\\ =\$363,500+\$60,000\\ =\$423,500\end{array}$

Hence, the selling and administration expenses are $423,500.

b)

To determine

Prepare the pro forma income statement and the other ideas to reach the Company P’s goal.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

The cost of goods sold could be reduced by 2% if production procedure is improved. So, the revised cost of goods sold is $2,195,200$\left(\$2,240,000\times 98\%\right)$.

The budgeted level of selling and administrative expenses is $337,800$\left(\$1,004,800–\$667,000\right)$.

Prepare the pro forma income statement:

Company P
Income Statement
For the year ended
Particulars	Amount
Sales revenue	$3,200,000
Less: Cost of goods sold	$2,195,200
Gross profit	$1,004,800
Less: Selling & administrative expenses	$337,800
Net income	$667,000

Table (2)

The management has to reduce the selling and administrative expenses by $42,200 $\left(\$380,000–\$337,800\right)$ in order to reach the president’s goal.

c)

To determine

Explain whether the company can reach the goal of Company P.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Compute projected sales:

$\begin{array}{c}\text{Projected sales}=\text{Current sales}\times 11\text{5\%}\\ =\$3,200,000\times \frac{\left(100+15\right)}{100}\\ =\$3,680,000\end{array}$

Hence, the projected sales are $3,680,000.

Compute the projected cost of goods sold:

$\begin{array}{c}\text{Projected cost of goods sold}=\text{Projected sales}\times \text{70\% }\\ =\text{\$3,680,000}\times \text{70\% }\\ =\text{\$2,576,000}\end{array}$

Hence, the projected cost of goods sold is $2,756,000.

Prepare a pro forma income statement:

Company P
Income Statement
For the year ended
Sales revenue	$3,680,000
Less: Cost of goods sold	$2,576,000
Gross profit	$1,104,000
Less: Selling & administrative expenses	$460,000
Net income	$644,000

Table (3)

Hence, the net income is $644,000.

The projected net income under this situation is $644,000 which is less than the actual income of $667,000. So, the company would not be able to reach its goal.