Exercise 6-9 Compute and Use the Degree of Operating Leverage [LO6-8] Engberg Co

Question

Exercise 6-9 Compute and Use the Degree of Operating Leverage [LO6-8] Engberg Company installs lawn sod in home yards. The company's most recent monthly contribution format income statement follows: Percent of Sales 100% 40t Amount Sales Variable expenses Contribution margin Pixed expenses Net operating income 133,000 53,200 79, 800 23,000 S 56,800 60% Required: 1. What is the company's degree of operating leverage? 2. using the degree of operating leverage, estimate the impact on net oper ting income of a 25% increase in sales. 3. Construct a new contribution format income statement for the company assuming a 25% increase in sales.

Explanation / Answer

1 Computaion of degree of operating leverage: Operating leverage = Contribution margin / Net operating Income = $79,800 / $56,800 = 1.40 2 Compuation of effect on Net operating income when sales increase by 25%: Sales increased by = 25% Impact on Net operating Income = Operating leverage X Percentage of sales increased = 1.40 X 25% = 35% Therefore, Net operating income increased by 35% 3 Engberg Company Contribution format Income Statement Sales ($1,33,000 X 125%) $                     1,66,250 Variable expenses ($1,66,250 X 40%) $                        66,500 Contribution margin $                        99,750 Fixed expense $                        23,000 Net operating Income $                        76,750

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