Question

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Oslo Company prepared the following contribution format income statement based on a sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units):

Sales	$	30,000
Variable expenses		16,500
Contribution margin		13,500
Fixed expenses		7,830
Net operating income	$	5,670

1. If the selling price increases by $2 per unit and the sales volume decreases by 100 units, what would be the net operating income?

2. If the variable cost per unit increases by $1, spending on advertising increases by $1,200, and unit sales increase by 140 units, what would be the net operating income?

3. What is the break-even point in unit sales?

4. What is the break-even point in dollar sales?

5. How many units must be sold to achieve a target profit of $8,100?

6. What is the margin of safety in dollars? What is the margin of safety percentage?

7. What is the degree of operating leverage? (Round your answer to 2 decimal places.)

8. Using the degree of operating leverage, what is the estimated percent increase in net operating income of a 5% increase in sales? (Round your intermediate calculations and final answer to 2 decimal places.)

9.  Assume that the amounts of the company’s total variable expenses and total fixed expenses were reversed. In other words, assume that the total variable expenses are $7,830 and the total fixed expenses are $16,500. Under this scenario and assuming that total sales remain the same, what is the degree of operating leverage? (Round your answer to 2 decimal places.)

10. Assume that the amounts of the company’s total variable expenses and total fixed expenses were reversed. In other words, assume that the total variable expenses are $7,830 and the total fixed expenses are $16,500. Given this scenario and assuming that total sales remain the same. Using the degree of calculated operating leverage, what is the estimated percent increase in net operating income of a 5% increase in sales? (Round your intermediate calculations and final answer to 2 decimal places.)

11.

Answer 1

Solution

Oslo Company

1. Determination of net operating income if selling price increases by $2 per unit and sales volume decreases by 100 units –

Basic calculations –

Determination of contribution margin per unit:

Contribution margin (CM) per unit = sales price per unit – variable cost per unit

Sales price per unit = $30,000/1,000 = $30 +$2 increase = $32

Variable cost per unit = $16,500/1,000 = $16.50

CM per unit = 32 – 16.5 = $15.50

Total contribution = $15.50 (1,000 – 100 units) = $15.50 x 900 units

Contribution margin = $13,950

Less: fixed expenses$7,830

Net operating income$6,120

Hence, the net operating income when selling price increases by $2 per unit and sales volume decreases by 100 units is $6,120.

1. Determination of net operating income when –

Variable cost increase by $1 = $16.50 + $1 = $17.50

Advertising expense = $1,200; total fixed cost = 7,830 + 1,200 = $9,030

Increase in unit sales by 140 = 1,000 + 140 = 1,140 units

Sales price (original) = $30

Contribution margin = 30 – 17.5 = $12.50

Total contribution margin = $12.50 x 1,140 units = $14,250

Less: fixed expenses$9,030

Net operating income = 14,250 – 9,030 = $5,220

Hence, net operating income with revised information = $5,220

1. Break-even point in unit sales:

Break-even point in unit sales = fixed cost/CM per unit

Fixed cost = $7,830

CM per unit (original) = $30 - $16.50 = $13.50

Break-even point in unit sales = 7,830/13.50 = 580 units

1. Break-even point in dollar sales:

Break-even point in dollar sales = fixed cost/CM ratio

Fixed cost = $7,830

Contribution margin ratio:

CM ratio = (CM per unit/sales price per unit) x 100

= (13.50/30) x 100 = 45%

Break-even point in dollar sales = $7,830/45% = $17,400

1. Determination of the number of units to be sold to achieve target profit of $8,100:

Desired sales = (fixed cost + target profit)/ CM per unit

= ($7,830 + $8,100)/$13.50 = 1,180 units

Hence, the number of units to be sold to achieve a target profit of $8,100 is 1,180 units.

1. What is margin of safety in dollars and in percentage:

Margin of safety = actual sales – break-even sales

Actual sales = $30,000

Break-even sales = $17,400

Margin of safety = 30,000 – 17,400 = $12,600

Margin of safety in percentage = ($12,600/$30,000) x 100

Margin of safety in percentage = 42%

1. Degree of operating leverage = CM/net operating income

CM = $13,500

Net operating income = $5,670

Degree of operating leverage = 13,500/5,670 = 2.38

1. Determination of increase in net operating income when sales increase by 5%

% increase in sales = degree of operating leverage x % increase in sales

= 2.38 x 5% = 11.90%

1. Variable expenses and fixed expenses reversed,

So, variable expenses = $7,830

Fixed expenses = $16,500

Now, CM = $30,000 - $7,830 = $22,170

Net operating income = 22,170 – 16,500 = $5,670

Degree of operating leverage = $22,170/$5,670 = 3.91

Note: high fixed expenses result in high degree of operating leverage.

1. Variable expenses and fixed expenses reversed,

So, variable expenses = $7,830

Fixed expenses = $16,500

% increase in sales = 5%

Percentage increase in net operating income = degree of operating leverage x % increase in sales

= 3.91 x 5% = 19.55%