This answer is incorrect since it also including a 10% increase in fixed costs as well.
In the original Year 2 budget, net income will be reduced to $300,000 from $450,000 in Year 1, a $150,000 decrease. The question says that fixed costs will not change for Year 2, and in the original Year 2 budget, that sales revenue will not change. Therefore, if net income is to decrease by $150,000, the decrease must come from an increase of $150,000 in variable costs. Actual variable costs in Year 1 totaled $3,150,000. If they increase by $150,000, they will increase to a total of $3,300,000. So the original Year 2 budget is as follows: Sales (150,000 units @ $30) $4,500,000 Variable costs 3,300,000 Contribution margin $1,200,000 Fixed costs: Manufacturing overhead 600,000 Selling & marketing exp. 300,000 Net income 300,000 Now, we adjust the revenue to the revised level of 110% of $4,500,000. However, when we do that, we must also increase the variable costs, because this revenue increase will come from increased unit sales, not from price increases. So we must also increase variable costs to 110% of $3,300,000. Now, we have an income statement that looks like this: Sales ($4,500,000 × 1.10) $4,950,000 Variable costs ($3,300,000 × 1.10) 3,630,000 Contribution margin $1,320,000 Fixed costs: Manufacturing overhead 600,000 Selling & marketing expense 300,000 Net income 420,000
This unit contribution margin in year 2 will be $8, not $9.
This is the profit in year 1. It is predicted that the sales level would be increased by 10% in year 2.
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Orange Co. based its next year's budget on the assumption that fixed costs, unit sales, and the sales price would remain as they were in year 1, but with net income being reduced to $300,000. By July of year 2, the controller was able to predict that unit sales would increase over year 1 levels by 10%. Based on the year 2 budget and the new information, the predicted year 2 net income would be: