October 13, 2021

This management analysis brief is for Peyton Approved’s management team and is the second part of the first brief. This current brief discusses Peyton Approved’s 2018 future expansion goals. It introduces and explains the impact of using Pro Forma financial statements for predicting future expansion goals. It also discusses the implications of inventory costing, contingent liabilities, revenue recognition, potential issues in interpreting financial information, and regulations and ethical standards used in the workbook and the briefs. The brief has multiple headings for easier locating and accessing information.

Pro Forma Financial Statements

Pro forma financial statements are used to predict the future of a business. It is helpful when a business is “seeking financing [from investors], planning for the future, anticipating changes [such as buying something significant or expanding the business]” (Guillory, 2020). However, since pro forma financial statements are only predictions, investors must consider that the business trajectory can change. In Peyton Approved’s case, the business wants to know if it can expand in 2018. There were several things factored in creating the business’s pro forma financial statements related to expansion. A few of these factors are the cost of leasing commercial space, purchase of new equipment, hiring, and training. These aspects have influenced the numbers in the pro forma income statement and balance sheet. The pro forma income statement predicts a net income of $74,036.30 in 2018. It is still a positive number, but lower than the net income of $175,476.18 in 2017. The lowered net income is not necessarily a bad thing, especially if a business has just expanded. It is to be looked at as an investment, and eventually, the business will earn a similar and even higher net income. Additionally, the business can opt for cash financing instead of using its’ own cash and assets for the expansion.

Implications of Inventory Costing, Contingent Liabilities, and Revenue Recognition

In the case of inventory costing, Peyton Approved uses periodic LIFO (last-in, first-out) for both baking and merchandise. “Under LIFO, the cost of the most recent products purchased (or produced) are the first to be expensed as cost of goods sold (COGS), which means the lower cost of older products will be reported as inventory” (Smith, 2020). Using this method “may cause a company to report lower net income… [and] computing taxable income may result in lower payments for income taxes” (Wahlen et al., 2017). IFRS is currently unaccepted by the IFRS but accepted in the US GAAP. If the company decides to change its’ costing method, its’ inventory and COGS will change depending on the method used.

Contingent liabilities are liabilities “that may occur depending on the outcome of an uncertain future event. [It] is recorded if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements unless both conditions are not met” (Banton, 2021). As of the moment, Peyton’s Approved does not have any outstanding contingent liabilities nor pending lawsuits.

Revenue recognition under accrual accounting “requires that revenues are recognized when realized and earned–not when cash is received” (Tuovila, 2021). Some of the business’s revenues may be uncollected but listed in the accounts receivable. With the predicted accounts receivable turnover of 4, the business collects the receivables four times throughout the year. It may be something the management has to take a deeper look at or become more aggressive with.

Potential Issues in Interpretation of Financial Information

Immediately, several factors such as a difference in experience dealing with financial information come to mind, especially that some of these statements are prepared in Pro-forma. Some stakeholders may not be as well-versed in the terminology used in the industry. For example, a stakeholder from another country may misinterpret the financial information, especially with different accounting standards and processes. Even stakeholders within the same country may interpret financial information differently. For example, one stakeholder may be used to recording assets at the historical cost compared to another stakeholder who may prefer to record assets at a fair value market price. As mentioned earlier, pro forma financial statements are only predictions and are subject to changes. Even with the official 2017 financial statements, it only covers a specific period in the business but remains a valuable tool in assessing the business’s health.

Regulations and Ethical Reporting

The first part of this brief has been discussed. However, the second part requires a different explanation. The pro forma financial statements are not accepted by GAAP standards and regulations. Pro forma financial statements only discuss the “what-ifs” of a business. There may still be room for error regarding the computation of values in the scenarios given by Peyton Approved. However, the writer of this brief has checked the given scenarios multiple times to the best of their ability to ensure a close prediction of Peyton’s Approved with the expansion in mind. The references used are listed on the final page so that readers may trace the information.

Conclusion

Based on the numbers computed from the pro forma statements, it is viable for Peyton’s Approved to expand. There is no need for worry if the net income drops; expenses must be incurred for the expansion. In addition, the business may consider another option, which are loans and other financing options, if it wants to avoid the significant drop in net income.

References

Smith, T. (2020, September 29). Last In, First Out (LIFO). Investopedia. Retrieved from https://www.investopedia.com/terms/l/lifo.asp

Tuovila, A. (2021, May 31). Revenue Recognition. Investopedia. Retrieved from https://www.investopedia.com/terms/r/revenuerecognition.asp

Wahlen, J. M., Jones, J. P., & Pagach, D. P. (2017). Intermediate Accounting: Reporting and Analysis (2nd ed.). Boston, MA: Cengage Learning

Guillory, S. (2020, June 30). Pro Forma Financial Statements: Why they are important to your business | Nav. Nav. https://www.nav.com/blog/pro-forma-financial-statements-633649/

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