Pro forma income statementlong dashScenario analysis Allen Products, Inc., wants to do a scenario analysis for the coming year. The pessimistic prediction for sales is$906,000; the most likely amount of sales is $1,120,000; and the optimistic prediction is 1,290,000. Allen's income statement for the most recent year is shown here a. Use the percent-of-sales method, the income statement for December 31, 2015, and the sales revenue estimates to develop pessimistic, most likely, and optimistic pro forma income statements for the coming year. b. Explain how this method could result in overstatement of profits for the pessimistic case and understatement of profits for the most likely and optimistic cases. c. Restate the pro forma income statements prepared in part a. to incorporate the following assumptions about the 2015 costs: $233,630 of the cost of goods sold is fixed; the rest is variable. $188,123 of the operating expenses is fixed; the rest is variable. All the interest expense is fixed. (Please see: Compare your findings in part c. to your findings in part a. Do your observations confirm your explanation in part

a. Use the percent-of-sales method, the income statement for December 31, 2015, and the sales revenue estimates to develop pessimistic, most likely, and optimistic pro forma income statements for the coming year.

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (pessimistic scenario): (Round the percentage of sales to one decimal place and the pro forma income statement accounts to the nearest dollar.)

Allen Products, Inc. Income Statement for

the Year Ended December 31, 2015

Sales revenue $936,700

Less: cost of good sold 407,465

Gross profits $529,235

Less: operating expenses 237,922

Operating profits $291,313

Less: interest expense 29,038

Net profit before taxes $262,275

Less: taxes (rate 25%) 65,569

Net profits after taxes $196,706

Allen Products, Inc. Income Statement for

the Year Ended December 31, 2015

Sales revenue $936,700

Less: cost of good sold

Fixed 233,630

Variable 173,835

Gross profits $529,235

Less: operating expenses

Fixed 188,123

Variable 49,799

Operating profits $291,313

Less: interest expense 29,038

Net profit before taxes $262,275

Less: taxes (rate 25%) 65,569

Net profits after taxes $196,706

Pessimistic
Sales	$	906000
Less: Cost of goods sold	$			%
Gross profits	$
Less: Operating expense	$			%
Operating profits	$
Less: Interest expense	$			%
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (most likely scenario): (Round the percentage of sales to one decimal place and the pro forma income statement accounts to the nearest dollar.)

Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2016
	Most Likely
Sales	$
Less: Cost of goods sold	$			%
Gross profits	$
Less: Operating expense	$			%
Operating profits	$
Less: Interest expense	$			%
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (optimistic scenario): (Round the percentage of sales to one decimal place and the pro forma income statement accounts to the nearest dollar.)

Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2016
	Optimistic
Sales	$
Less: Cost of goods sold	$			%
Gross profits	$
Less: Operating expense	$			%
Operating profits	$
Less: Interest expense	$			%
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

b. Explain how this method could result in overstatement of profits for the pessimistic case and understatement of profits for the most likely and optimistic cases.(Select from the drop-down menus.)

The simple percent-of-sales method assumes that all costs are variable. In reality some of the expenses will be fixed. In the

pessimistic

most likely

optimistic

case this assumption causes all costs to decrease with the lower level of sales when in reality the fixed portion of the costs will not decrease. The opposite occurs for the

pessimistic

most likely

optimistic

forecast since the percent-of-sales assumes all costs increase when in reality only the variable portion will increase. This pattern results in an

understatement

overstatement

of costs in the

pessimistic

most likely

optimistic

case and an

understatement

overstatement

of profits. The opposite occurs in the

pessimistic

most likely

optimistic

scenario.c. Restate the pro forma income statements prepared in part a. to incorporate the following assumptions about the 2015 costs:

$233 comma 630233,630

of the cost of goods sold is fixed; the rest is variable.

$188 comma 123188,123

of the operating expenses is fixed; the rest is variable. All the interest expense is fixed.

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (pessimistic scenario): (Round the percentage of sales to four decimal places and the pro forma income statement accounts to the nearest dollar.)

Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2016
	Pessimistic
Sales	$
Less: Cost of goods sold
Fixed	$
Variable	$			%
Gross profits	$
Less: Operating expense
Fixed	$
Variable	$			%
Operating profits	$
Less: Interest expense	$
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (most likely scenario): (Round the percentage of sales to four decimal places and the pro forma income statement accounts to the nearest dollar.)

Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2016
	Most Likely
Sales	$
Less: Cost of goods sold
Fixed	$
Variable	$			%
Gross profits	$
Less: Operating expense
Fixed	$
Variable	$			%
Operating profits	$
Less: Interest expense	$
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

Complete the pro forma income statement for the year ending December 31, 2016 that is shown below (optimistic scenario): (Round the percentage of sales to four decimal places and the pro forma income statement accounts to the nearest dollar.)

Pro Forma Income Statement
Allen Products, Inc.
for the Year Ended December 31, 2016
	Optimistic
Sales	$
Less: Cost of goods sold
Fixed	$
Variable	$			%
Gross profits	$
Less: Operating expense
Fixed	$
Variable	$			%
Operating profits	$
Less: Interest expense	$
Net profits before taxes	$
Taxes (25%)	$
Net profits after taxes	$

d. Compare your findings in part c. to your findings in part a. Do your observations confirm your explanation in part

b?

(Select from the drop-down menus.)The profits for the

pessimistic

most likely

optimistic

case are larger in part a. than in part c. For the

pessimistic

most likely

optimistic

case, the profits are lower in part a. than in part c. This outcome

confirms

disproves

the results as stated in part b.