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 15,000 Net operating income $ 69,600 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 27% increase in sales. 3. Construct a new contribution format income statement for the company assuming a 27% increase in sales.

Answer 1

1. 1.22

2. 32.94 %

3. Contribution format income statement

Sales Sales ($ 141,000×1.27) $179,070 27%

Variable expenses ($56,400×1.27) ($71,628) 27%

Contribution margin ($84,600×1.27) $107,442 27%

Fixed expenses ($15,000) 0%

Net operating income ($ 69,600× 32.94 %) $92,526 32.94 %

Step-by-step explanation:

Degree of Operating Leverage (DOL) = Contribution ÷ Earnings Before Interest and Tax

= $84,600 ÷ $ 69,600

= 1.22

Effect of an increase in sales of 27% on net operating income

Effect = % increase in sales × DOL

= 27% × 1.22

= 32.94 %

See new contribution income statement with % increases in line items.