Question

Contribution Income Statement and Operating Leverage
Florida Berry Basket harvests early-season strawberries for shipment throughout the eastern United States in March. The strawberry farm is maintained by a permanent staff of 10 employees and seasonal workers who pick and pack the strawberries. The strawberries are sold in crates containing 100 individually packaged one-quart containers. Affixed to each one-quart container is the distinctive Florida Berry Basket logo inviting buyers to "Enjoy the berry best strawberries in the world!" The selling price is $110 per crate, variable costs are $90 per crate, and fixed costs are $272,000 per year. In the year 2008, Florida Berry Basket sold 49,000 crates.

(a) Prepare a contribution income statement for the year ended December 31, 2008. HINT: Use a negative sign with both "costs" answers.

FLORIDA BERRY BASKET Income Statement For the Year Ended December 31, 2008
Sales	$Answer
Variable costs	Answer
Contribution margin	Answer
Fixed costs	Answer
Net income	$Answer

(b) Determine the company's 2008 operating leverage. (Round your answer to two decimal places.)
Answer

(c) Calculate the percentage change in profits if sales decrease by 10 percent. (Round your answer to one decimal place.)
Answer % decrease

(d) Management is considering the purchase of several berry-picking machines. This will increase annual fixed costs to $372,000 and reduce variable costs to $87.50 per crate. Calculate the effect of this acquisition on operating leverage and explain any change. (Round your answer to two decimal places.)
Answer

The acquisition of the berry-picking machines will reduce variable costs, thereby increasing the contribution margin. It will also reduce fixed costs, thereby increasing the difference between the contribution margin and net income. The net effect would be a decrease in operating leverage.

The acquisition of the berry-picking machines will decrease variable costs, thereby increasing the contribution margin. It will also increase fixed costs, thereby increasing the difference between the contribution margin and net income. The net effect would be an increase in operating leverage.

The acquisition of the berry-picking machines will increase variable costs, thereby increasing the contribution margin. It will also increase fixed costs, thereby decreasing the difference between the contribution margin and net income. The net effect would be an increase in operating leverage.

The acquisition of the berry-picking machines will increase variable costs, thereby increasing the contribution margin. It will also decrease fixed costs, thereby decreasing the difference between the contribution margin and ne

Answer 1

Formula sheet

A	B	C	D	E	F	G	H	I
2
3		Number of units sold	49000
4
5		Selling Price	110	per unit
6		Variable cost	90	per unit
7		Fixed cost	272000	per year
8
9		a)
10
11		Contribution margin income statement:
12		Sales	=D3*D5
13		Variable costs	=-D3*D6
14		Contribution margin	=D12+D13
15		Fixed Costs	=-D7
16		Net Income	=SUM(D14:D15)
17
18		b)
19
20		Degree of operating leverage (DOL) can be calculated using following formula:
21		DOL	=Contribution margin ratio / Operating margin
22
23		Operating margin	=Operating income / Sales
24
25		Using following data
26		Operating income	=D16
27		Sales	=D12
28
29		Operating margin	=Operating income / Sales
30			=D26/D27
31
32		Now Degree of operating leverage (DOL) can be calculated using following formula:
33		DOL	=Contribution margin ratio / Operating margin
34
35		Using the following data
36		Contribution margin ratio	=D14/D12
37		Operating margin	=D30
38
39		DOL	=Contribution margin ratio / Operating margin
40			=D36/D37
41
42		Hence degree of operating leverage is	=D40
43
44		c)
45
46		Degree of operating leverage (DOL) can be represented using following formula:
47		DOL	=% change in operating income / % change in sales
48
49		% increase in operating income with % increase in sales can be calculated as follows:
50		% increase in operating income	=DOL*% change in sales
51
52		Using the following data
53		DOL	=D42
54		% change in sales	-0.1
55
56		% increase in operating income	=DOL*% change in sales
57			=D53*D54
58
59		Hence % decrease in operating income	=D57
60
61
62		d)
63
64		Number of units sold	49000
65
66		Selling Price	110	per unit
67		Variable cost	87.5	per unit
68		Fixed cost	372000	per year
69
70
71
72		Contribution margin income statement:
73		Sales	=D64*D66
74		Variable costs	=-D64*D67
75		Contribution margin	=D73+D74
76		Fixed Costs	=-D68
77		Net Income	=SUM(D75:D76)
78
79
80
81		Degree of operating leverage (DOL) can be calculated using following formula:
82		DOL	=Contribution margin ratio / Operating margin
83
84		Operating margin	=Operating income / Sales
85
86		Using following data
87		Operating income	=D77
88		Sales	=D73
89
90		Operating margin	=Operating income / Sales
91			=D87/D88
92
93		Now Degree of operating leverage (DOL) can be calculated using following formula:
94		DOL	=Contribution margin ratio / Operating margin
95
96		Using the following data
97		Contribution margin ratio	=D75/D73
98		Operating margin	=D91
99
100		DOL	=Contribution margin ratio / Operating margin
101			=D97/D98
102
103		Hence degree of operating leverage is	=D101
104
105		Thus due to change the operating leverage increases to 1.51 from 1.38.
106