Chapter 21, Problem 25E

To determine

Concept Introduction:

Degree of operating leverage:

The Degree of operating leverage shows the relation between change in net operating income and change in sales. The formulas for degree of operating leverage are as follows:

  $Degreeofoperatingleverage=\frac{ContributionMargin}{Operatingincome}$

  $Changeinoperatingincome=Changesinsales\times Degreeofoperatingleverage$

Requirement-1:

The Degree of operating leverage

Answer to Problem 25E

The Degree of operating leverage shall be 4 times

Explanation of Solution

The Degree of operating leverage is calculated as follows:

Degree of operating leverage = Contribution Margin / Operating Income

= 432000/108000

= 4

To determine

Concept Introduction:

Degree of operating leverage:

The Degree of operating leverage shows the relation between change in net operating income and change in sales. The formulas for degree of operating leverage are as follows:

  $Degreeofoperatingleverage=\frac{ContributionMargin}{Operatingincome}$

  $Changeinoperatingincome=Changesinsales\times Degreeofoperatingleverage$

Requirement-2:

The Change in Net income after decrease in sales by 5%

Answer to Problem 25E

The Change in Net income after decrease in sales by 5% shall be decrease by 20%

Explanation of Solution

The Change in Net income after decrease in sales by 5% is calculated as follows:

Change in net income = Change in sales * Degree of operating leverage

= -5%*4

= -20%

To determine

Concept Introduction:

Degree of operating leverage:

The Degree of operating leverage shows the relation between change in net operating income and change in sales. The formulas for degree of operating leverage are as follows:

  $Degreeofoperatingleverage=\frac{ContributionMargin}{Operatingincome}$

  $Changeinoperatingincome=Changesinsales\times Degreeofoperatingleverage$

Requirement-3:

To Prepare:

The Contribution margin income statement if sales decreases by 5%

Answer to Problem 25E

The Contribution margin income statement if a sales decrease by 5% is as follows:

Hudson Company
Contribution Margin Income Statement
For the year ended Dec. 31, 2020
Sales	$ 2,052,000
Less: Variable Expenses	$ (1,641,600)
Contribution Margin	$ 410,400
Less: Fixed Costs	$ (324,000)
Income Before tax	$ 86,400

Explanation of Solution

The Contribution margin income statement if a sales decrease by 5% is prepared as follows:

Hudson Company
Contribution Margin Income Statement
For the year ended Dec. 31, 2020
Sales (2160000*95%)	$ 2,052,000
Less: Variable Expenses (1728000*95%)	$ (1,641,600)
Contribution Margin	$ 410,400
Less: Fixed Costs	$ (324,000)
Income Before tax	$ 86,400