-Refer to Kooshy.Suppose pro forma net income is $50 and pro forma total assets are $525.If accounts payable maintain the same percent of sales,no new long term debt is issued,and the only addition to owners' equity is to retained earnings,what will be the pro forma balance in notes payable for a forecasted 20% increase in sales? (That is,use notes payable as the balancing account.)

Question

Quizplus · Accepted Answer

Pro forma notes payable can be calculated as follows:
Pro Forma Assets = Pro Forma Liabilities + Pro Forma Owners' Equity
Pro Forma Owners' Equity = Retained Earnings
Pro Forma Liabilities = Accounts Payable + Notes Payable
Given:
Pro Forma Net Income = $50
Pro Forma Total Assets = $525
Accounts Payable as % of Sales is constant
No new Long Term Debt is issued
Only addition to Owners' Equity is to Retained Earnings
Forecasted increase in sales = 20%
So,
Pro Forma Liabilities + Pro Forma Owners' Equity = $525 + $50 = $575
Retained Earnings = Pro Forma Owners' Equity = $50
Let Notes Payable be x
Accounts Payable = (Accounts Payable as % of Sales) * Sales = Constant * Sales
Therefore,
Pro Forma Liabilities = Accounts Payable + Notes Payable = Constant * Sales + x
Pro Forma Assets = Pro Forma Liabilities + Pro Forma Owners' Equity = Constant * Sales + x + $50
Pro Forma Assets = Total Assets = Constant * Previous year sales + x + $50
($525/$50) = (Constant * Previous year sales + $50 + x)/$50
Solving for Constant * Previous year sales + x = $610
20% increase in sales implies:
New Sales = 1.2 * Previous year sales
(Notes Payable)/New Sales = (x)/1.2 * Previous year sales
(Notes Payable)/New Sales = x/(1.2 * Previous year sales)
(Notes Payable)/New Sales = (Constant * Previous year sales + x - $50)/(1.2 * Previous year sales)
(Notes Payable)/New Sales = (610 - $50)/(1.2 * Previous year sales)
Notes Payable = (560/1.2) - $39
Notes Payable = $74 (approx.)