Chapter 1, Problem 2AE

This Excel worksheet form is to be used to recreate Exhibit 1-7. Download the workbook containing this form from Connect, where you will also receive instructions.

2. Suppose that sales are 10% higher as shown below:

Enter this new data into your worksheet. Make sure that you change all of the data that are different-not just the sales. Print or copy the income statements from your worksheet.
What happened to the variable costs and to the fixed costs when sales increased by 10%? Why? Did the contribution margin increase by 10%? Why or why not? Did the net operating income increase by 10%? Why or why not?

To determine

Variable cost, fixed cost, contribution margin, net operating income:

Variable costs are directly related with production process, so it has the changes according to the sales revenue.

Fixed costs are indirectly related with production process, so it hasn’t change according to the sales revenue.

Contribution income is derived after deducting variable costs from sales revenue.

Net operating income is the real income for the company because it has derived after deduction all costs such as variable and fixed costs from sales revenue.

Whether increase of sales by 10% would change the variable costs and fixed costs.

Whether contribution margin increased or not by the new sales revenue (10%).

Whether net operating income increased or not by new sales revenue (10%).

Answer to Problem 2AE

Solution:

Traditional format income statement
Particulars	Amount	Amount
Sales revenue		$13,200
Less
Cost of goods sold		$6,600
Gross margin		$6,600
Less: Selling and administration expenses
Selling expenses	$3160
Administration expenses	$1940	$5100
Net operating income		$1,500

Contribution Format income statement
Particulars	Amount	Amount
Sales revenue		$13,200
Less: Variable expenses
Cost of goods sold	$6600
Variable selling	$660
Variable administration	$440	$7,700
Contribution margin		$5,500
Less: Fixed expenses
Selling expenses	$2,500
Administration Expenses	$1,500	$4,000
Net operating income		$1,500

Formula:$$

  $\begin{array}{l}Newsalesrevenueincrease=Existingsalesrevenue\ast percentageofincrease\hfill \\ \hfill \\ ContributionMargin=Salesrevenue-costofgoodssold–variableselling–variableadministrative\hfill \\ \hfill \\ Netoperatingincome=Contributionmargin–fixedselling-fixedadministrative.\hfill \\ \hfill \end{array}$

Explanation of Solution

Yes, new sales revenue increased the variable cost by 10%.

Old variable cost:

  $\begin{array}{l}Costofgoodssold=\$6000\hfill \\ \hfill \\ Variableselling=\$600\hfill \\ \hfill \\ Variableadministration=\$400\hfill \end{array}$

Increase variable cost:

  $\begin{array}{l}Costofgoodssold=\$6000*10/100=\$600\hfill \\ \hfill \\ Variableselling=\$600*10/100=\$60\hfill \\ \hfill \\ Variableadministration=\$400*10/100=\$40\hfill \\ \hfill \\ Aftersalesincreasedby10\%\hfill \\ \hfill \end{array}$

New variable cost:

  $\begin{array}{l}Costofgoodssold=\$6000*10/100=\$600+\$6000=\$6600\hfill \\ \hfill \\ Variableselling=\$600*10/100=\$60+\$600=\$660\hfill \\ \hfill \\ Variableadministration=\$400*10/100=\$40+\$400=440\hfill \\ \hfill \\ Butfixedcostremainunchangedduetosalesrevenueincreasedby10\%becauseitisnotdirectly\hfill \\ \hfill \\ relatedwithproductionprocess.\hfill \\ \hfill \end{array}$

Yes, contribution margin increased by 10% due to new sales revenue, new variable costs, if variable

cost has change it reflect the contribution margin.

  $\begin{array}{l}Oldcontributionmargin=\$12,000-\$6000-\$600-\$400=\$5000\hfill \\ \hfill \\ OldVariablecost=\$6000+\$600+\$400=\$7000\hfill \\ \hfill \\ Newcontributionmargin=\$\$13,200-\$6600-\$660-\$440=\$5,500\hfill \\ \hfill \\ Newvariablecost=-\$6600+\$660+\$440=\$7700\hfill \\ \hfill \\ Increasedby10\%=\$7000*10/100=\$700\hfill \\ \hfill \\ Newvariablecost-oldvariablecost=\$7700-\$7000=\$700\hfill \\ \hfill \\ So,newcontributionmarginincreasedby10\%\hfill \\ \hfill \end{array}$

No, net operating income not increased by 10%, because fixed cost remain unchanged made the net

income increased up to 50%.

Old net operating income:

  $\begin{array}{l}\$12,000-\$6000-\$600-\$400-\$2500-\$1500=\$1000\hfill \\ \hfill \end{array}$

New net operating income:

  $\begin{array}{l}\$13,200-\$6600-\$660-\$440-\$2500-\$1500=\$1500\hfill \\ \hfill \\ If10\%increaseinthenewnetoperatingincome:\hfill \\ \hfill \\ \$1,000*10/100=\$100+\$1,000=\$1100\hfill \\ \hfill \\ Actuallynetoperatingincomeis\$1500\hfill \\ \hfill \\ \$1000*50/100=\$500+\$1000=\$1,500\hfill \\ \hfill \end{array}$

Conclusion

Above explanation and calculation stated new sales revenue increased variable cost not the fixed cost and contribution margin also increased by 10% but net operating income not increased by 10%.