Question

ngberg Company installs lawn sod in home yards. The company’s most recent monthly contribution format income statement follows:

Amount/ Percent of Sales
Sales $ 80,000/ 100%
Variable expenses 32,000/ 40%
Contribution margin 48,000 /60%
Fixed expenses 38,000/
Net operating income $ 10,000 /
Required:
What is the company’s degree of operating leverage?
Using the degree of operating leverage, estimate the impact on net operating income of a 5% increase in unit sales.
Construct a new contribution format income statement for the company assuming a 5% increase in unit sales.

Answer 1

To calculate the degree of operating leverage (DOL) for Ngberg Company, we can use the formula:

\[ \text{Degree of Operating Leverage} = \frac{\text{Contribution Margin}}{\text{Net Operating Income}} \]

### Calculating DOL:

1. Contribution Margin = $48,000
2. Net Operating Income = $10,000

Now, substituting the values into the formula:

\[ \text{DOL} = \frac{48,000}{10,000} = 4.8 \]

### Estimating the Impact of a 5% Increase in Unit Sales:

The impact on net operating income can be estimated using the following formula:

\[ \text{Percentage Change in Net Operating Income} = \text{Degree of Operating Leverage} \times \text{Percentage Change in Sales} \]

In this case:

- Percentage Change in Sales = 5% (or 0.05)

Now substituting the values into the formula:

\[ \text{Percentage Change in Net Operating Income} = 4.8 \times 0.05 = 0.24 \text{ or } 24\% \]

Now, we can calculate the new net operating income after the 5% increase in sales.

### New Net Operating Income:

With a 24% increase, the new net operating income will be:

\[ \text{New Net Operating Income} = \text{Old Net Operating Income} + \left( \text{Old Net Operating Income} \times 24\% \right) \]

\[ \text{New Net Operating Income} = 10,000 + (10,000 \times 0.24) = 10,000 + 2,400 = 12,400 \]

### Constructing a New Contribution Format Income Statement:

First, we need to calculate the new sales amount following the 5% increase in sales.

1. New Sales = Old Sales + (Old Sales × 5%)
2. New Sales = $80,000 + ($80,000 × 0.05) = $80,000 + $4,000 = $84,000

Next, we need to calculate the variable expenses after the increase. Since variable expenses are 40% of sales:

1. New Variable Expenses = 40% of New Sales = 0.40 × $84,000 = $33,600

Now we can calculate the new contribution margin:

1. New Contribution Margin = New Sales - New Variable Expenses
2. New Contribution Margin = $84,000 - $33,600 = $50,400

Lastly, the fixed expenses remain the same at $38,000.

Now we can complete the new contribution format income statement:

### New Contribution Format Income Statement

| **Description** | **Amount** | **Percent of Sales** |
|-------------------------------|-------------------|-----------------------|
| Sales | $84,000 | 100% |
| Variable expenses | $33,600 | 40% |
| **Contribution Margin** | $50,400 | 60% |
| Fixed expenses | $38,000 | |
| **Net Operating Income** | $12,400 | |

### Summary:

- **Degree of Operating Leverage**: 4.8
- **Estimated Impact on Net Operating Income** from a 5% increase in unit sales: 24%, resulting in a new net operating income of $12,400.
- **New Contribution Format Income Statement** provided above.