Question

Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution format income statement follows: Amount Percent of Sales Sales $ 138,000 100 % Variable expenses 55,200 40 % Contribution margin 82,800 60 % Fixed expenses 21,000 Net operating income $ 61,800 Required: 1. What is the company’s degree of operating leverage? 2. Using the degree of operating leverage, estimate the impact on net operating income of a 13% increase in sales. 3. Construct a new contribution format income statement for the company assuming a 13% increase in sales.

Answer 1

Answer:

1. Degree of operating leverage = $\frac{Contribution}{Net\ Operating\ Income}$

Contribution = 82,800

Net Operating Income = $61,800

Thus, operating Leverage = $\frac{82,800}{61,800} = 1.339$ = 1.34

2. If Company's sales increase by 13% then contribution also increases by 13%,

Revised Contribution = $82,800 + 13% = $93,564

Revised net Operating income = $93,564 - $21,000 (Fixed Cost) = $72,564

Degree of operating leverage = $\frac{93,564}{72,564} = 1.289$ = 1.29

3. Contribution format income statement:

Sales = $138,000 + 13% = $155,940

Less: Variable Cost 55,200 + 13% = $62,376

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Contribution = $93,564

Less: Fixed Cost = $21,000

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Net Operating Income = $72,564