Question

The following income statement was drawn from the records of Walton Company, a merchandising firm: WALTON COMPANY Income Statement For the Year Ended December 31, Year 1 Sales revenue (6,500 units * $170) Cost of goods sold (6,500 units X $88) Gross margin Sales commissions (10% of sales) Administrative salaries expense Advertising expense Depreciation expense Shipping and handling expenses (6,500 units * $5) Net income $1,105,000 (572,000) 533,000 (110,500) (88,000) (35,000) (46,000) (32,500) $ 221,000 Required a. Reconstruct the income statement using the contribution margin format. b. Calculate the magnitude of operating leverage. c. Use the measure of operating leverage to determine the amount of net income Walton will earn if sales increase by 10 percent.

Answer 1

a.

WALTON COMPANY
Income Statement
For the Year Ended December 31, Year 1
Sales revenue	1,105,000
Less: Variable costs
Cost of goods sold	-572,000
Sales commission	-110,500
Shipping and handling expenses	-32,500
Contribution Margin	390,000
Less: Fixed costs
Administrative salaries expense	-88,000
Advertising expense	-35,000
Depreciation expense	-46,000
Net income	$221,000

b.

Operating leverage = Contribution margin/ Net income

= 390,000/221,000

= 1.76

c.

Percentage increase in net income = Percentage increase in sale x Operating leverage

= 10 x 1.76

= 17.60%

Net income = $221,000

Net income after increase in sales by 10% = 221,000+ 221,000 x 17.60%

= 221,000+ 38,896

= $259,896

b.	Operating leverage	1.76
c.	Net income	$259,896

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