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	$	135,000		100	%
Variable expenses		54,000		40	%
Contribution margin		81,000		60	%
Fixed expenses		18,000
Net operating income	$	63,000

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 14% increase in sales.

3. Construct a new contribution format income statement for the company assuming a 14% increase in sales.

Answer 1

1. Degree of operating leverage = Contribution margin/Net operating income = $81000/$63000 = 1.2857 = 1.29

Note: Rounded off to 2 decimal places in the absence of specific instructions regarding the same. Kindly round off as required.

2. Impact on net operating income of a 14% increase in sales = 14% x 1.29 = 18.06%

Note: Kindly round off as required.

3.

Contribution Format Income Statement
	Amount	Percent of Sales
Sales	153900	100%
Variable expenses	61560	40%
Contribution margin	92340	60%
Fixed expenses	18000
Net operating income	74340

Check: Increase in net operating income = ($74340 - $63000)/$63000 = $11340/$63000 = 18%