Q35E - Horngren'S Financial And Managerial Accounting

Question

Following is the income statement for Marrow Mufflers for the month of June 2018:

MARROW MUFFLERS

Contribution Margin Income Statement

Month Ended June 30, 2018

Net Sales Revenue (140 units _ \(250)                       \) 35,000

Variable Costs (140 units _ \(50)                                  7,000

Contribution Margin                                                      28,000

Fixed Costs                                                                    11,500

Operating Income                                                         \) 16,500

 

Requirements 

1. Calculate the degree of operating leverage. (Round to four decimal places.) 

2. Use the degree of operating leverage calculated in Requirement 1 to estimate the change in operating income if total sales increase by 40% (assuming no change in sales price per unit). (Round interim calculations to four decimal places and final answer to the nearest dollar.) 

3. Verify your answer in Requirement 2 by preparing a contribution margin income statement with the total sales increase of 40%.   

Step-by-Step Solution

Answer

1. Degree of operating leverage equals 1.6970
2. Percentage change in operating income equals 68%.
3. Operating income equals $27,700, which represents increase of 68% in operating income.

Step 1: Calculation of operating leverage

$$\begin{gathered} \mathbf{Degreeofoperatingleverage}\mathbf{=}\frac{\mathbf{Contributionmargin}}{\mathbf{Operatingincome}} \\ \mathbf{=}\frac{\mathbf{\$}\mathbf{28}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{16}\mathbf{,}\mathbf{500}} \\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{6970} \end{gathered}$$

Step 2: Calculation of estimated change in operating income

$\begin{array}{rcl}\mathbf{Operatingincome}& =& \mathbf{Degreeofoperatingleverage}\times \text{Percentage change in sales}\\ & \mathbf{=}& \mathbf{1}\mathbf{.}\mathbf{6970}\times 40\%\\ & =& 67.88\%\text{ or }68\%\\ & & \end{array}$

Step 3: Contribution margin income statement

 

Revised unit sold (140 x (1+40%)	196 units
Estimated sales (196 x $250)	$49,000
Variable cost ($196 x $50)	$9,800
Contribution margin	$39,200
Fixed costs	$11,500
Operating income	$27,700
Change in operating income percentage  ($27,700-$16,500) / $16,500)	67.88% or 68%