Question

This Excel worksheet form is to be used to recreate Exhibit 1–7. The workbook, and instructions on how to complete the file, can be found in Connect.

Required:

1. Check your worksheet by changing the variable selling cost in the Data area to $900, keeping all of the other data the same as in Exhibit 1–7. If your worksheet is operating properly, the net operating income under the traditional format income statement and under the contribution format income statement should now be $700 and the contribution margin should now be $4,700. If you do not get these answers, find the errors in your worksheet and correct them.

How much is the gross margin? Did it change? Why or why not?

2. Suppose that sales are 10% higher as shown below:

 

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,200

Variable costs:

Cost of goods sold . . . . . . . . . . . . . $6,600

Variable selling . . . . . . . . . . . . . . . . $660

Variable administrative . . . . . . . . . $440

Fixed costs:

Fixed selling . . . . . . . . . . . . . . . . . . $2,500

Fixed administrative . . . . . . . . . . . . $1,500

 

Enter this new data into your worksheet. Make sure that you change all of the data that are different—not just the sales. Print or copy the income statements from your worksheet.

What happened to the variable costs and to the fixed costs when sales increased by 10%? Why? Did the contribution margin increase by 10%? Why or why not? Did the net operating income increase by 10%? Why or why not?

Answer 1

1. When the variable selling cost is changed to $900, the worksheet changes as show below:

The gross margin is $6,000; the same as it was before. It did not change because the variable selling expense is deducted after the gross margin, not before it on the traditional format income statement.

2. The new worksheet appears below:

The variable costs increased by 10% when the sales increased by 10%, however the fixed costs did not increase at all. By definition, total variable cost increases in proportion to activity whereas total fixed cost is constant. (In the real world, cost behavior may be messier.) The contribution margin also increased by 10%, from $5,000 to $5,500, because both of its components—sales and variable costs—increased by 10%. The net operating income increased by more than 10%, from $1,000 to $1,500, because even though sales and variable expenses increased by 10%, the fixed costs did not increase by 10%.