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Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution format income statement follows:
| Amount | Percent of Sales | ||||
| Sales | $ | 134,000 | 100 | % | |
| Variable expenses | 53,600 | 40 | % | ||
| Contribution margin | 80,400 | 60 | % | ||
| Fixed expenses | 15,000 | ||||
| Net operating income | $ | 65,400 | |||
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 14% increase in sales.
3. Construct a new contribution format income statement for the company assuming a 14% increase in sales.
1.Company’s degree of operating leverage
The degree of operating leverage (DOL) is a measure used to evaluate how a company's operating income changes after a percentage change in its sales. A company's operating leverage involves assessing fixed costs and variable costs against sales. Fixed costs do not change depending on production levels; therefore, variable costs must be included in the calculation.
Degree of operating leverage = Contribution margin/Net operating income
= 80,400/65,400
= 1.23
2.Impact on net operating income of a 14% increase in sales.
Increase in net operating income = 1.23*14
= increase by 17.22%
3.New contribution format income statement for the company assuming a 14% increase in sales.
| Sales(134,000+14%) | 152,760 | 100% |
| Variable expenses | 61,104 | 40% |
| Contribution margin | 91,656 | 60% |
| Fixed expenses | 15,000 | |
| Net operating income | 76,656 |
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