For firms with high fixed costs, the percent-of-sales approach for preparing a pro forma incomestatement tends to
A) be a difficult model to apply.
B) overestimate profits when sales are increasing.
C) be an accurate predictor of profits.
D) underestimate profits when sales are increasing.

Question

Quizplus · Accepted Answer

The percent-of-sales approach assumes that fixed costs remain constant as sales volume changes, which is not the case for firms with high fixed costs. As sales increase, the firm's total profit should increase at a faster rate than the percentage increase in sales. Therefore, the percent-of-sales approach tends to underestimate profits when sales are increasing for firms with high fixed costs.

For Firms with High Fixed Costs, the Percent-Of-Sales Approach for Preparing