Question

Consider the following simplified financial statements for the Wims Corporation (assuming no income taxes): Income Statement ♡ Balance Sheet Sales $33,600 Assets $24,350 Debt $ 6,850 Costs 27,800 Equity 17,500 Net income $ 5,800 Total $24,350 Total $24,350 The company has predicted a sales increase of 20 percent. It has predicted that every item on the balance sheet will increase by 20 percent as well. Create the pro forma statements and reconcile them. (Input all answers as positive values. Do not round intermediate calculations.) Assets Pro forma income statement Sales Costs Net Income Pro forma balance sheet Debt Equity Total Total

Answer 1

Since every item is increasing by 20%, we have:

Sales = 1.2 x 33600 = $40320

Costs = 1.2 x 27800 = 33360

Net income = 1.2 x 5800 = 6960

Assets = 1.2 x 24350 = 29220 = Total

Debt = 6850 x 1.2 = 8220.

We can't increase all the items on the balance sheet. This is because if we increase the debt and equity both, it will lead to the assets not being equal to the liability. Hence, we need a plug variable which we choose as the Equity number. A plug variable varies to ensure that the balance sheet balances and to ensure that the pro forma balance sheet figures are consistent with the pro forma income statement figures. That is, the growth assumptions cannot concern all items on the statements.

We choose Equity as the plug variable here. Since we have the net income = $6960 in the proforma balance sheet, our equity will increase by this amount already. Hence, calculating the equity we can have (so that assets = liabilities + equity): Equity = 29220 - 8220 = 21000. Out of this, $6960 comes from the net income, hence it reduces the net increase to 21000 - 6960 = 14040.