Smyth Inc. has decided to do a scenario analysis for the year 2022. Their pessimistic prediction for sales is $360,000, the most likely amount of sale is $450,000, and the optimistic sales prediction is $520,000. Smyth’s income statement for the latest year follows.

a. Refer to the income statement for December 31, 2021, and using the percent of sales method, develop the pessimistic, most likely, and optimistic pro forma income statement for the coming year ending on December 31, 2022.

b. The percent-of-sales method may result in an overstatement of profits for the pessimistic case and an understatement of profit for the most likely and optimistic cases. Explain why.

c. Restate the pro forma income statement in part a to accommodate the following information about the 2022 costs: 

$75,000 of the cost of goods sold is fixed, rest is variable.

$40,000 of operating expenses is fixed, rest is variable. All the interest expense is fixed.

d. Compare your results in part a to the results in part c. Do your observations confirm your explanation in part b?

Transcribed Image Text:

Smyth Inc. Income Statement for the Year Ended December 31, 2021 Sales revenue Less: Cost of goods sold Gross profits Less: Operating expenses Operating profits Less: Interest expense Net profits before taxes Less: Taxes (rate= 30%) Net profits after taxes $370,000 168,000 $202,000 92,000 $110,000 12,500 $97,500 29,250 $ 68,250