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	$	80,000	100%
Variable expenses		32,000	40%
Contribution margin		48,000	60%
Fixed expenses		38,000
Net operating income	$	10,000

   

Required:
1.	Compute the company’s degree of operating leverage. (Round your answer to 1 decimal place.)

     

2.	Using the degree of operating leverage, estimate the impact on net operating income of a 5% increase in sales. (Do not round intermediate calculations.)

     

   

3.	Construct a new contribution format income statement for the company assuming a 5% increase in sales.

     

Answer 1

1.)

Compute degree of operating leverage for company E as follows:

Contribution margin = $48000
Net Operating Income = $10000
Degree of Operating Leverage = Contribution margin / Net Operating Income
=48000/10000
=4.8

2.)
Degree of Operating Leverage = 4.8
Percentage increase in Sales = 5%
Percentage increasing net operating income = (Degree of operating leverage x Percentage increase in sales)
=(4.8 x 5%)
=24%

3.)

	Amount ($)
Sales (80000*105%)	84000
Less: Variable expenses (32000*105%)	33600
Contribution margin	50400
Less: Fixed costs	38000
Net Operarting Income	12400

By comparing the contribution format income statement given in the question and the one prepared above it can be observd that when sales increases by 5% net operating income increases by $2400 that is 24% (2400/10000 x 100)