Question

E19.14 (LO 4) The CVP income statements shown below are available for Armstrong Company and Contador Company Armstrong Co. Contador Co. Sales $500,000 S500,000 Variable costs 240.000 50.000 Contribution margin 260.000 450,000 Fixed costs 160,000 350,000 Net income $100,000 S100,000 Instructions a. Compute the degree of operating leverage for each company and interpret your results. b. Assuming that sales revenue increases by 10%, prepare a variable costing income statement for each company c. Discuss how the cost structure of these two companies affects their operating leverage and profitability,

Answer 1

Answer E 19.14

a)

	Armstrong company	Contador company
Contribution (A)	$                   260,000	$                 450,000
Net Income (B)	$                   100,000	$                 100,000
DOL (A/B)	2.60	4.50

Armstrong company has lower DOL as compared to Contador company.

b)

Income statement
	Armstrong company	Contador company
Sales	$                    550,000	$                 550,000
Less: variable Cost	$                    264,000	$                   55,000
Contribution	$                    286,000	$                 495,000
Less: Fixed Cost	$                    160,000	$                 350,000
Net Income	$                    126,000	$                 145,000

c)

Armstrong company has lower fixed cost and higher variable cost. On the contrary, Contador company has higher fixed cost and lower variable cost. This means that  Contador company is affected more than Armstrong company to change in sales as its DOL is higher.

It can be seen that incresae in sales of 10% gives more profit to Contador company than Armstrong company.

Answer BE 19.11

	Product A	Product B
Contribution	$         10	$         12
Machine hours per unit	2	3
Contribution per Machine hour	$           5	$           4

Product B is better.

In case of any doubt, please comment.