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.

Question

Quizplus · Accepted Answer

The use of past cost and expense ratios tends to understate profits when sales are increasing because the assumption that there are no fixed costs does not hold true in reality. As sales increase, fixed costs such as rent and equipment expenses remain the same, leading to higher profits than what the percent-of-sales method predicts.

The Percent-Of-Sales Method to Prepare a Pro Forma Income Statement