2-48) CVP and Financial Statements for a Mega-Brand Company Procter & Gamble Company is a Cincinnati-based company that produces household products under brand names such as Gillette, Bounty, Crest, Folgers, and Tide. The company’s 2006 income statement showed the following (in millions): Net sales $68,222 Costs of products sold 33,125 Selling, general, and administrative expense 21,848 Operating income $13,249 Suppose that the cost of products sold is the only variable cost; selling, general, and administrative expenses are fixed with respect to sales. Assume that Procter & Gamble had a 10% increase in sales in 2007 and that there was no change in costs except for increases associated with the higher volume of sales. Compute the predicted 2007 operating income for Procter & Gamble and its percentage increase. Explain why the percentage increase in income differs from the percentage increase in sales.
Solutions Guide:
Amounts are in millions (rounded with slight rounding errors).
Net sales (1.10 x $68,222) $75,044
Variable costs:
Cost of goods sold (1.10 x $33,125) 36,438
Contribution margin 38,606
Fixed costs:
Selling, administrative, and general expenses 21,848
Operating income $16,758
The percentage increase in operating income would be ($16,758 $13,249) - 1 = .26 or 26%, compared with a 10% increase in sales. The contribution margin would increase by 10% or .10 x ($68,222 - $33,125) = $3,510 million. Because fixed costs would not change (assuming the new volume is within the relevant range), operating income would also increase by $3,510 million, from $13,249 million to $16,759 million. If all costs had been variable, costs would have increased by an additional .10 x $21,848 = $2,185 million, making operating income $16,758 - $2,185 = $14,573 million, a 10% increase over the 2006 operating income of $13,249 million. Because of the existence of fixed costs, the percentage increase in operating income will exceed the percentage increase in sales.