Question

Exercise 6-9 Compute and Use the Degree of Operating Leverage [LO6-8]

Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution format income statement follows:

	Amount			Percent of Sales
Sales	$	127,000		100	%
Variable expenses		50,800		40	%
Contribution margin		76,200		60	%
Fixed expenses		23,000
Net operating income	$	53,200

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 16% increase in sales.

3. Construct a new contribution format income statement for the company assuming a 16% increase in sales.

Answer 1

Solution

Degree of operating leverage = 1.43

If sales increase by 16% operating income will increase by 22.88%

Engberg Company
Contribution income statement
	Amount
Sales revenue	$      147,320.00
Variable costs	$         58,928.00
Contribution margin	$         88,392.00
Fixed cost	$         23,000.00
Net Operating income	$         65,392.00

Working

Degree of operating leverage = Contribution margin /Net operating income
Degree of operating leverage = 76200/53200
Degree of operating leverage =	1.43

.

Operating leverage = Change in operating income / Change in sales
Change in operating income = Operating leverage x Change in sales
Change in operating income = 1.43 x 16%
Change in operating income =	22.88%

.