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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Operating leverage
SunRise Inc. and SunSet Inc. have the following operating data:

a. Compute the operating leverage for Sun Rise Inc. and SunSet Inc.
b.How much would operating income increase for each company if the sales of each increased by 25%?
c. Why is there a difference in the increase in operating income for the two companies?
Explain.

To determine

(a)

Concept introduction:

Operating leverage is a cost-accounting formula which shows the percentage or degree increase in the operating income if company increased in revenue or sale quantity.

In comparison of two businesses, that business whosesale is highest with highest gross profit margin and lower variable cost is beneficial.

  Operating leverage=contribution marginprofit

To compute:

Theoperating leverage of SunRise inc and SunSet inc.

Explanation

  Operating leverage of Sun Rise inc.=contribution marginprofit

  Contribution Margin of Sun Rise inc. =$1250,000

  Profit of Sun Rise inc. = $500,000

  Operating leverage of Sun Rise inc.=$1250,000$500,000=2.5 or 250%

  Operating leverage of SunSet inc

To determine

(b)

Concept introduction:

If company's sale is increased then company's profit will also be increased. We can directly determinethe amount of profit which will be increased by using operating leverage.

To compute:

The operating profit which will be increased of SunRise and SunSet Inc. if the sale is increased by 25%

To determine

(c)

Concept introduction:

The increase in profit of the company with respect to increased sale volume depends upon the operating leverage of the company. If one company's operating leverage is higher from the other company then that company's increment in profit will be higher than the other company.

The reason for difference in the increase in operating income of the two companies.

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