Question

Puppy Co. reports the contribution margin income statement for 2020.

Puppy CO. Contribution Income Statement For Year Ended December 31, 2020
Sales (9,600 units at $225 each) $2,160,000
Variable costs (9,600 units at $180 each) 1, 728,000
Contribution margin 432,000
Fixed costs 324,000
Net operating income $108,000

Required:
a. Compute the company's degree of operating leverage for 2019.
b. If sales decrease by 5% in 2020, what will be the company's pretax income?
c. Assume sales for 2020 decrease by 5%. Prepare a contribution margin income statement for 2020.

Answer 1

Answer: See explanation

Step-by-step explanation:

a. Compute the company's degree of operating leverage for 2019.

This will be:

= Contribution / Pre tax income

= 432000 / 108000

= 4

b. If sales decrease by 5% in 2020, what will be the company's pretax income?

We should note that the degree of operating leverage is:

= % change in pre tax income / % change in sales

4 = % change in ore tax Income / 5%

% change in ore tax income = 5% × 4 = 20%

Company's pre-tax income will be:

= 108000 - (20% × 108000)

= 108000 - (0.2 × 108000)

= 108000 - 21600

= $86400

c. Assume sales for 2020 decrease by 5%. Prepare a contribution margin income statement for 2020.

Sales = 2160000 × 95% = 2160000 × 0.95 = 2052000

Less: Variable cost = 1728000 × 95% = 1728000 × 0.95 = 1641600

Contribution margin = 410,000

Less: Fixed cost = 324000

Pre tax net income= 86400