Chapter 4, Problem 11QP

Summary Introduction

To determine: Pro forma balance sheet and external financing needed.

Introduction:

The pro forma income statement can be determined after adjusting 15% of increase in the sales. The dividends are maintained in constant payout ratio. The required external financing can be computed by calculating the difference of total assets and total liabilities.

Answer to Problem 11QP

External financing needed is −$1,009.

Explanation of Solution

Given information:

The dividend are maintained in constant payout ratio and there is no external equity financing. The increased sales percentage is 15%. Refer text book QP 10 for the balance sheet items.

Formulae:

The formula to calculate the external financing needed:

$\text{External financing needed}=\text{Total assets}-\text{Total liabilities and Owner's equity}$

The formula to calculate the dividend:

$\text{Dividend}=\frac{\text{Current year's dividend}}{\text{Current Sales}}\times \text{Projected sales}$

The formula to calculate the additional retained earnings:

$\text{Additional retained earnings}=\text{Net income}-\text{Dividend}$

The formula to calculate the accumulated retained earnings:

$\text{Accumulated retained earnings}=\text{Existing retained earnings}+\text{Additional retained}$

Pro forma income statement:

H corporation Pro forma income statement
Particulars	Amount ($)
Sales	$54,050
Costs	$35,995
Taxable income	$18,055
Taxes (35%)	$6,319.25
Net income	$11,736

Compute the changes in the balance sheet by 15%:

$\begin{array}{c}\text{Increase in account receivables}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Existing account receivables}\\ \times \text{Percentage of increase in sales}\end{array}\right)+\\ \text{Exsiting account receivables}\end{array}\right]\\ =\left(\$4,100\times \frac{15}{100}\right)+\$4,100\\ =\$615+\$4,100\\ =\$4,715\end{array}$

Hence, the increase in account receivables is $4,715.

$\begin{array}{c}\text{Increase in cash}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Existing cash}\times \text{Percentage of}\\ \text{increase in sales}\end{array}\right)\\ +\text{Existing}\text{cash}\end{array}\right]\\ =\left(\text{\$2,950}\times \frac{15}{100}\right)+\$2,950\\ =\$443+\$2,950\\ =\$3,393\end{array}$

Hence, the increase in cashis $3,393.

$\begin{array}{c}\text{Increase in account payables}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Existing account payable}\\ \times \text{Percentage of increase in sales}\end{array}\right)+\\ \text{Existing}\text{account payables}\end{array}\right]\\ =\left(\$2,400\times \frac{15}{100}\right)+\$2,400\\ =\$360+\$2,400\\ =\$2,760\end{array}$

Hence, the increase in account payables is $2,760.

Note: The same method of calculation is needed for the rest of the accounts recorded in the balance sheet .

Compute the dividend and additional retained earnings:

$\begin{array}{c}\text{Dividend}=\frac{\text{Current year's dividend}}{\text{Current net income}}\times \text{Projected net income}\\ =\left(\frac{\$2,500}{\$10,205}\right)\times \$11,736\\ =0.2449\times \$11,736\\ =\$2,874\end{array}$

Hence, the dividend is $2,874.

$\begin{array}{c}\text{Additional retained earnings}=\text{Net income}-\text{Dividend}\\ =\$11,736-\text{\$2,874}\\ =\text{\$8,862}\end{array}$

Hence, the additional retained earnings are $8,862.

Compute the accumulated retained earnings:

$\begin{array}{c}\text{Accumulated retained earnings}=\left(\begin{array}{l}\text{Existing retained earnings}+\\ \text{Additional retained earnings}\end{array}\right)\\ =\$3,950+\$8,862\\ =\$12,812\end{array}$

Hence, the total retained earnings are $12,812.

Pro forma balance sheet:

H corporation Pro forma balance Sheet
Assets	Amount ($)	Liabilities and Owner's equity	Amount ($)
Current asset		Current liabilities
Cash	$3,393	Account payable	$2,760
Accounts receivable	$4,715	Notes payable	$5,400
Inventory	$7,360	Total	$8,160
Total	$15,468	Long term debt	$28,000
Fixed assets		Owner's equity
Net plant and equipment	$47,495	Common stock and paid in surplus	$15,000
		Retained earnings	$12,812
		Total	$27,812
Total Assets	$62,963	Total liabilities and owner's equity	$63,972

Compute the external financing needed:

The difference of total assets and total liabilities and owner’s equity is known as external financing need.

$\begin{array}{c}\text{External financing needed}=\text{Total assets}-\text{Total liabilities and Owner's equity}\\ =\text{\$62,963}-\text{\$63,972}\\ =-\text{\$1,009}\end{array}$

Hence, the external financing needed is −$1,009.