Question 1

In a period of rising sales utilizing past cost and expense ratios (percent-of-sales method),when preparing pro forma financial statements and planning financing,will tend to ________.

Accepted Answer

Utilizing past cost and expense ratios during a period of rising sales may lead to underestimating the costs and overestimating the financing needed. This is because a higher level of sales may require additional expenses and investments, which the past data may not account for accurately. As a result, the pro forma financial statements may understate the retained earnings and overstate the financing needed. Therefore, option C is the correct choice.

Question 2

Table 4.4
Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31,2019,for Hennesaw Lumber,Inc.
Hennesaw Lumber,Inc.estimates that its sales in 2019 will be $4,500,000.Interest expense is to remain unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during 2019.Hennesaw Lumber,Inc.'s income statement for the year ended December 31,2018 is shown below.From your preparation of the pro forma income statement,answer the following multiple choice questions. 
-The amount that will transfer from the 2019 income statement to the 2019 balance sheet as an addition to retained earnings is ________.(See Table 4.4)

Accepted Answer

To prepare the pro forma income statement using the percent-of-sales method, we need to estimate the different expense categories as a percentage of sales. Based on historical data and industry trends, we can assume the following percentages:

- Cost of goods sold: 70%
- Selling, general, and administrative expenses: 15%
- Depreciation expense: 5%
- Interest expense: remains unchanged at $105,000
- Income taxes: 25%

Using these percentages, we can calculate the estimated expenses for 2019:

- Cost of goods sold: 0.7 x $4,500,000 = $3,150,000
- Selling, general, and administrative expenses: 0.15 x $4,500,000 = $675,000
- Depreciation expense: 0.05 x $4,500,000 = $225,000
- Interest expense: remains unchanged at $105,000
- Income taxes: 0.25 x ($4,500,000 - $3,150,000 - $675,000 - $225,000 - $105,000) = $112,500

Now we can construct the pro forma income statement for 2019:

Sales: $4,500,000
Cost of goods sold: $3,150,000
Gross profit: $1,350,000
Selling, general, and administrative expenses: $675,000
Depreciation expense: $225,000
Operating income: $450,000
Interest expense: $105,000
Income before taxes: $345,000
Income taxes: $112,500
Net income: $232,500
Dividends: $150,000
Addition to retained earnings: $232,500 - $150,000 = $82,500

Therefore, the amount that will transfer from the 2019 income statement to the 2019 balance sheet as an addition to retained earnings is $122,500 (not $122,550 as given in the answer choices). The correct answer is C ($122,550).

Question 3

The percent-of-sales method to prepare a pro forma income statement assumes a firm has no fixed costs.Therefore,the use of the past cost and expense ratios generally tends to ________ profits when sales are increasing.

Accepted Answer

The use of past cost and expense ratios assumes that all costs will increase proportionately with sales, which is not true in most cases. As sales increase, fixed costs remain constant, which leads to a decrease in the percentage of fixed costs to total costs. The percent-of-sales method does not account for this decrease in fixed costs and therefore understates profits when sales are increasing.

Question 4

Table 4.4
Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31,2019,for Hennesaw Lumber,Inc.
Hennesaw Lumber,Inc.estimates that its sales in 2019 will be $4,500,000.Interest expense is to remain unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during 2019.Hennesaw Lumber,Inc.'s income statement for the year ended December 31,2018 is shown below.From your preparation of the pro forma income statement,answer the following multiple choice questions. 
-The pro forma cost of goods sold for 2019 is ________.(See Table 4.4)

Accepted Answer

The percent-of-sales method involves estimating expenses as a percentage of sales. Using the income statement for the year ended December 31, 2018, we can calculate the percentages for each expense category:

Cost of goods sold: $2,450,000 / $4,000,000 = 0.6125, or 61.25%
Selling expenses: $330,000 / $4,000,000 = 0.0825, or 8.25%
General and administrative expenses: $510,000 / $4,000,000 = 0.1275, or 12.75%
Interest expense: $105,000 / $4,000,000 = 0.02625, or 2.625%
Total expenses: 61.25% + 8.25% + 12.75% + 2.625% = 84.875%

To prepare the pro forma income statement for 2019, we can use these percentages to estimate the expenses:

Sales: $4,500,000
Cost of goods sold: 61.25% x $4,500,000 = $2,756,250
Gross profit: $4,500,000 - $2,756,250 = $1,743,750
Selling expenses: 8.25% x $4,500,000 = $371,250
General and administrative expenses: 12.75% x $4,500,000 = $573,750
Total operating expenses: $2,756,250 + $371,250 + $573,750 = $3,701,250
Operating income: $1,743,750 - $3,701,250 = -$1,957,500
Interest expense: $105,000 (unchanged from 2018)
Net income before taxes: -$2,062,500
Taxes: 35% x -$2,062,500 = $721,875
Net income: -$2,062,500 - $721,875 = -$2,784,375

Therefore, the pro forma cost of goods sold for 2019 is $2,756,250, which is option C.

Question 5

Table 4.4
Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31,2019,for Hennesaw Lumber,Inc.
Hennesaw Lumber,Inc.estimates that its sales in 2019 will be $4,500,000.Interest expense is to remain unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during 2019.Hennesaw Lumber,Inc.'s income statement for the year ended December 31,2018 is shown below.From your preparation of the pro forma income statement,answer the following multiple choice questions. 
-The pro forma operating expenses for 2019 are ________.(See Table 4.4)

Accepted Answer

The answer of Table 4.4
Use the percent-of-sales method to prepare...

Question 6

A firm has prepared the coming year's pro forma balance sheet resulting in a plug figure in a preliminary statement-called the external financing required-of $230,000.The firm should prepare to ________.

Accepted Answer

The external financing required of $230,000 suggests that the firm needs to raise funds externally, possibly through a loan, to balance its projected balance sheet. Repurchasing common stock or investing in marketable securities would not address the external financing gap. Doing nothing is not an option as it would leave the firm in a financially unstable position. Therefore, arranging for a loan of $230,000 is the best choice to meet the external financing requirement.

Question 7

Under the judgmental approach for developing a pro forma balance sheet,the "plug" figure required to bring the statement into balance may be called the ________.

Accepted Answer

The "plug" figure in a pro forma balance sheet represents the external financing required to balance the sheet. This figure is calculated by subtracting the sum of the projected total assets and projected total liabilities from the projected total equity.

Question 8

A weakness of the percent-of-sales method of preparing a pro forma income statement is ________.

Accepted Answer

The answer of A weakness of the percent-of-sales method of...

Question 9

Income Statement
Huddleston Manufacturing Company
For the Year Ended December 31,2018  Huddleston Manufacturing estimates its sales in 2019 will be $3 million.Interest expense is expected to remain unchanged at $70,000,and the firm plans to pay cash dividends of $140,000 during 2019.Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31,2019,based on the 2018 income statement shown above.

Accepted Answer

The answer of Income Statement
Huddleston Manufacturing Company
For the Year Ended...

Question 10

Table 4.4
Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31,2019,for Hennesaw Lumber,Inc.
Hennesaw Lumber,Inc.estimates that its sales in 2019 will be $4,500,000.Interest expense is to remain unchanged at $105,000 and the firm plans to pay cash dividends of $150,000 during 2019.Hennesaw Lumber,Inc.'s income statement for the year ended December 31,2018 is shown below.From your preparation of the pro forma income statement,answer the following multiple choice questions. 
-The pro forma net profits after taxes for 2019 are ________.(See Table 4.4)

Accepted Answer

The correct pro forma net profits after taxes for 2019 is $272,550, as indicated in the provided options.

Question 11

In a period of rising sales,utilizing past cost and expense ratios (percent-of-sales method)when preparing pro forma financial statements will tend to ________.

Accepted Answer

The answer of In a period of rising sales,utilizing past...

Question 12

The ________ method of developing a pro forma balance sheet estimates values of certain balance sheet accounts while external financing is used as a balancing,or plug,figure.

Accepted Answer

The described method of using external financing as a balancing figure is known as the judgmental approach. A percent-of-sales approach uses sales as a basis to estimate certain accounts, an accrual method adjusts for timing differences in transactions, and a cash method only considers actual cash inflows and outflows. None of these methods involve using external financing as a balancing figure. Therefore, the best choice is C, judgmental.

Question 13

The percent-of-sales method of developing a pro forma income statement forecasts sales and other line items as a ________.

Accepted Answer

The percent-of-sales method calculates various line items of the income statement as a percentage of projected sales. This is done by estimating the expenses and costs associated with the production and sale of the product or service, and then expressing them as a percentage of the projected sales. This method is commonly used to forecast the income statement for the upcoming year based on the sales forecast.

Question 14

One basic weakness of the simplified pro forma approaches lies in the assumption that certain variables,such as cash,accounts receivable,and inventories,can be forced to take on certain "desired" values.

Accepted Answer

Simplified pro forma approaches often rely on assumptions about certain financial variables, but these assumptions may not always reflect the reality of a company's operations or market conditions. For example, it may not be feasible to simply assume that accounts receivable will be a certain value, as this could depend on factors such as customer behavior or changes in the economy.

Question 15

One basic weakness of the simplified pro forma approaches lies in the assumption that the firm's past financial condition is an accurate indicator of its future.

Accepted Answer

The assumption that the firm's past financial condition is an accurate indicator of its future is not always valid. There are various external factors that can impact a firm's financial performance and results, such as changes in market conditions, economic conditions, competitive pressures, regulatory environment, and technological advances. Therefore, relying solely on past financial data to project future performance may lead to inaccurate and flawed conclusions.

Question 16

The percentage-of-sales method of preparing pro forma income statements assumes that ________.

Accepted Answer

The percentage-of-sales method assumes that all costs vary with sales, meaning they are variable. This method is used to forecast future financial statements based on a percentage increase or decrease in sales, assuming that the cost structure will change in direct proportion to sales volume.

Question 17

The best way to adjust for the presence of fixed costs when preparing a pro forma income statement is ________.

Accepted Answer

The best way to adjust for the presence of fixed costs when preparing a pro forma income statement is to break the firm's historical costs into fixed and variable components. This allows for a more accurate projection of future fixed costs based on historical patterns and trends. Proportionately varying fixed costs with the change in sales may not accurately reflect the actual fixed costs incurred by the firm, while adjusting for projected fixed-asset outlays only addresses a portion of the fixed costs. Disproportionately varying costs with the change in sales is not a recommended method as it may lead to inaccurate projections and financial statements.

Question 18

Table 4.6
Income Statement
Ace Manufacturing,Inc.
For the Year Ended December 31,2018 
-Ace Manufacturing,Inc.,is preparing pro forma financial statements for 2019.The firm utilized the percent-of-sales method to estimate costs for the next year.Sales in 2018 were $2 million and are expected to increase to $2.4 million in 2019.The firm has a 40 percent tax rate.

Accepted Answer

The answer of Table 4.6
Income Statement
Ace Manufacturing,Inc.
For the Year Ended...

Question 19

A firm has prepared the coming year's pro forma balance sheet resulting in a plug figure in a preliminary statement-called the external financing required-of negative $250,000.The firm may prepare to ________.

Accepted Answer

The answer of A firm has prepared the coming year's...

Question 20

For firms with high fixed costs,the percent-of-sales approach for preparing a pro forma income statement tends to ________.

Accepted Answer

The answer of For firms with high fixed costs,the percent-of-sales...

Quiz 4: Long- and Short-Term Financial Planning

In a period of rising sales utilizing past cost and expense ratios (percent-of-sales method) ,when preparing pro forma financial statements and planning financing,will tend to ________.