Question

The following income statement was drawn from the records of Benson Company, a merchandising firm:

BENSON COMPANY
Income Statement
For the Year Ended December 31, Year 1
Sales revenue (4,500 units × $170) $ 765,000
Cost of goods sold (4,500 units × $88) (396,000 )
Gross margin 369,000
Sales commissions (10% of sales) (76,500 )
Administrative salaries expense (88,000 )
Advertising expense (36,000 )
Depreciation expense (46,000 )
Shipping and handling expenses (4,500 units × $1) (4,500 )
Net income $ 118,000

a. Reconstruct the income statement using the contribution margin format.
b. Calculate the magnitude of operating leverage

Answer 1

Benson company

Income statement

In the revised contribution margin format.

Sales is $765,000

Variable costs is $477,000

Contribution Margin is $288,000

Fixed costs is $170,009

Net income is $118,000

Operating leverage is contribution margin divided by net income.

It measures the degree of impact fixed costs has on the net income of a firm.

A low operating leverage indicates the business is able to cover its fixed costs with very minimum sales and this return a profitable position as a result.

A high operating leverage on the other hand shows the fixed elements of costs are hampering the profitability nature of the business. And much volume will be required to absorb all its fixes costs to boost profits.

Operating Leverage = $288,000 / $118,000 = 2.44

Kindly refer to the attached document for clearer presentation of workings.