Pro Forma Statements

• Stating the owners' salaries in terms of officers' salaries.
• Calculating the applicable federal taxes on the predecessor business as though it were a corporation.
• Including corporate state franchise taxes.

• Adding the balance of the partners' capital to contributed capital in the combined company rather than to retained earnings for partnerships acquired through the pooling of interests.

Subchapter S corporations exercise the tax-option of the shareholders to individually assume the tax liability rather than have it assumed by the corporation as a whole. If the shareholders choose to go public or change their qualifications, the corporation loses the tax-option. Therefore, in addition to the pro forma statement showing historical earnings, the new company will make pro forma provision for the taxes that it would have paid had it been a regular corporation in the past. When acquisition of a Subchapter S corporation is accomplished through the pooling of interests, the pro forma financial statement may not include any of the retained earnings of the Subchapter S corporation in the pooled retained earnings.

When presenting the historical operations of a business previously operated as a partnership, the financial information is adjusted to bring the statement in line with the acquiring corporation. Historical data listed in these instances includes net sales; cost of sales; gross profit on sales; selling, general, and administrative expenses; other income; other deductions; and income before taxes on income. Pro forma adjustments would restate partnership operations on a corporate basis, including estimated partnership salaries as officers and estimated federal and state taxes on income, as well as pro forma net income and pro forma net income per share. Accountants make similar adjustments to pro forma statements for businesses previously operated as sole proprietorships and Subchapter S corporations.

Acquisition or Disposal of Part of a Business

For a company that decided to acquire part of a new business or dispose of part of its existing business, a meaningful pro forma statement should adjust the historical figures to demonstrate how the acquired part would have fared had it been a corporation. Pro forma statements should also set forth conventional financial statements of the acquiring company, and pro forma financial statements of the business to be acquired. Notes to the pro forma statements explain the adjustments reflected in the statements.

A pro forma income statement combines the historical income statement of the acquiring company and a pro forma income statement of the business to be acquired for the previous five years, if possible. Pro forma adjustments exclude overhead costs not applicable to the new business entity, such as division and head office expenses.

The purchase of a sole proprietorship, partnership, Sub-Chapter S corporation, or business segment requires pro forma statements for a series of years in order to reflect adjustments for such items as owners' or partners' salaries and income taxes. In this way, each year reflects the results of operations of a business organization comparable with that of the acquiring corporation. However, the pro forma statements giving effect to the business combination should be limited to the current and immediately preceding periods.

SUMMARY

Pro forma statements are an integral part of business planning and control. Managers use them in the decision-making process when constructing an annual budget, developing long-range plans, and choosing among capital expenditures. Pro forma statements are also valuable in external reporting. Public accounting firms find pro forma statements indispensable in assisting users of financial statements in understanding the impact on the financial structure of a business due to changes in the business entity, or in accounting principles or accounting estimates.

Although pro forma statements have a wide variety of applications for ongoing, mature businesses, they are also important for small businesses and start-up firms, which often lack the track record required for preparing conventional financial statements. As a planning tool, pro forma statements help small business owners minimize the risks associated with starting and running a new business. The data contained in pro forma statements can also help convince lenders and investors to provide financing for a start-up firm.

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