Utilizing past cost and expense ratios (percent-of-sales method) when preparing pro forma financial statements will tend to ________.

Question

Quizplus · Accepted Answer

The past cost and expense ratios (percent-of-sales method) assume that expenses will change proportionally with sales. However, this may not always be true, especially when considering changes in fixed costs. Using these past ratios may understate profits when sales are increasing and overstate profits when sales are decreasing. This is because fixed costs remain the same even when sales volume changes. Option A is incorrect because it suggests that profits will be understated when sales are decreasing, which is not always true. Option B is incorrect because costs may increase or decrease depending on the change in sales. Option D is incorrect because using past ratios will not always overstate profits, as explained earlier.

Utilizing Past Cost and Expense Ratios (Percent-Of-Sales Method) When Preparing