The marketing department of Metroline Manufacturing estimates that its sales in

Question

The marketing department of Metroline Manufacturing estimates that its sales in 2016 will be $1.5 million. Interest expense is expected to remain unchanged at $35,000, and the firm plans to pay S70.000 in cash dividends during 2016. Metroline Manufacturing's income statement for the year ended December 31, 2015, and a breakdown of the firm's cost of goods sold and operating expenses into their fixed and variable components are given below. Use the percent-of-sales method to prepare a pronominal income statement for the year ended December 31, 2016. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2016. Compare and contrast the statements developed in parts a and b. Which statement probably provides the better estimate of 2016 income? Explain why.

Explanation / Answer

Mteroline Manufacturing a. 2015 Income statement Proforma Income statement 2016 Details Amt $ % Amt $ % Sales Revenue             1,400,000 100.00%              1,500,000 100.00% Less COGS                 910,000 65.00%                  975,000 65.00% Gross Profit                 490,000 35.00%                  525,000 35.00% Less ; Opearting expenses                 120,000 8.57%                  128,571 8.57% Operating Profits                 370,000 26.43%                  396,429 26.43% Less Interest Expense                   35,000 2.50%                    35,000 2.33% Net Profit before Taxes                 335,000 23.93%                  361,429 24.10% Less ; Taxes @40%                 134,000 9.57%                  144,571 9.64% Net Profit After Taxes                 201,000 14.36%                  216,857 14.46% Less ; Cash Dividends                   66,000 4.71%                    70,000 4.67% To retained Earnings                 135,000 9.64%                  146,857 9.79% b. Income statement as per Variable & Fixed parts 2015 Income statement Proforma Income statement 2016 Details % of sales Amt $ % of sales Amt $ Sales revenue             1,400,000            1,500,000 Variable COGS cost 50.00%                700,000 50.0%                750,000 Variable Opearting Expense 6.00%                   84,000 6.0%                  90,000 Total Variable expense 56.00%                784,000 56.0%                840,000 Contribution 44.00%                616,000 44.0%                660,000 Fixed Cost Manufacturing Fixed cost                210,000                210,000 Operating Fixed expense                   36,000                  36,000 Total fixed cost                246,000                246,000 Net Opearting Income                370,000                414,000 Interest Expense                   35,000                  35,000 Net Profit before Taxes                335,000                379,000 Taxes @40%                134,000                151,600 Net Profit After Taxes                201,000                227,400 Cash Dividends                   66,000                  70,000 To retained Earnings                135,000                157,400 c. The Income statement as per % sales shows $216,857 as net profit whereas the variable and fixed data based Income statement shows $227,400 as net profit for 2016 sales of $1.5 million. The % sales method assumes that the fixed expenses will also rise in direct proportion to sales and that is the reason of its lower net profit. However, fixed and variable cost data based Income statement is more accurate as it increases the variable costs in proportion to sales increase , but keep the fixed costs unchanged which is more reasonable approach.

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