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	$	141,000		100	%
Variable expenses		56,400		40	%
Contribution margin		84,600		60	%
Fixed expenses		24,000
Net operating income	$	60,600

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 26% increase in sales.

3. Construct a new contribution format income statement for the company assuming a 26% increase in sales.

Answer 1

1	Degree of Operating Leverage =	Contribution Margin/Net Operating Income
		84600/60600
	Degree of Operating Leverage =	1.3960396
2	Increase in Sales =	26%
	New Sales	($141000+$141000*26%)
	New Sales	177660
	Variable Costs	($177660*40%)
		71064
	Degree of Operating Leverage =	Sales- Variable Cost/Sales-Variable Cost-Fixed Cost
		$177660-$71064/$177660-$71064-$24000
		106596/82596
		1.29057097
	Degree of Operating Leverage =	Contribution Margin/Operating Income
	1.2906	106596/Operating Income
	Operating Income=	$106596/1.2906
	Operating Income=	$82,596
	Operating Income will be increased by $	$21,996	($82596-$60600)
3	Contribution Format Income Statement with 26% Increase
	Particulars	Amount
	Sales	$177,660	($141000+$141000*26%)
	Variable Expenses	$71,064	($177660*40%)
	Contribution Margin	$106,596	(177660-71064)
	Fixed Expenses	$24,000
	Net Operating Income	$82,596	($106596-$24000)