Question

The following income statement was drawn from the records of Finch Company, a merchandising firm: FINCH COMPANY Income Statement For the Year Ended December 31, Year 1 Sales revenue (4,000 units x $163) Cost of goods sold (4,000 units * $89) Gross margin Sales commissions (5% of sales) Administrative salaries expense Advertising expense Depreciation expense Shipping and handling expenses (4,000 units * $1) Net income $ 652,000 (356,000) 296,000 (32,600) (89,000) (34,000) (44,000) (4,000) $ 92,400 Required a. Considering cost behavior, reconstruct the above "GAAP-based" income statement using our new "Contribution Margin" (CM) format. b. Calculate the magnitude of operating leverage. c. Use the above measure of operating leverage to determine the amount of net income Finch will earn if sales increase by 10 percent. Complete this question by entering your answers in the tabs below. Req A Req B and C Reconstruct the income statement using the contribution margin format. FINCH COMPANY Income Statement For the Year Ended December 31, Year 1 Sales revenue Less: Variable costs Cost of goods sold Sales commissions Shipping and handling expenses 0 Less: Fixed costs Administrative salaries Advertising expense Depreciation expense Net income $

Answer 1

a.  Finch company

Income statement

For the year ended December31, year 1

Sales revenue	652,000
Less: Variable costs
Cost of goods sold	356,000
Sales commissions	32,600
Shipping and handling expenses	4,000
Total variable expense	392,600
Contribution margin	259,400
Less: Fixed costs
Administrative salaries	89,000
Advertising expense	34,000
Depreciation expense	44,000
Total fixed expense	167,000
Net income	92,400

b.	Operating leverage	2.80 times
c.	Net Income	$118,272

b. Operating leverage= Contribution margin/ Net income

=259,400/92,400

=2.80 times

c. Percentage increase in net income can be calculated with the help of degree of operating leverage:

DOL= %change in operating income/%change in sales

Putting the values in the formula,

2.80= %change in operating income/10

2.80*10=%change in operating income

%change in operating/net income= 28%

Net income after increase= 92,400*28%+92,400

=$118,272