Answer:
The problem with Blake's reasoning is that he believes that all costs are variable, and that is not true. In order to predict future profits, he divided $6,565 by 2,000 stuffed mascots = $3.2825 profit per stuffed mascot sold. But when sales increased to 3,000 units, the profits increased much more.
This happens because some costs are variable and change directly with the number of units sold, while others are fixed and remain the same regardless of the number of units sold.
The question is incomplete, the accounts are missing, so I looked for them:
February March
Sales revenue $25,000 $37,500
Cost of goods sold 10,000 15,000
Gross profit 15,000 22,500
Rent expense 1,500 1,500
Wages expense 3,500 5,000
Shipping expense 1,100 1,650
Utilities expense 750 750
Advertising expense 1,000 1,400
Insurance expense 585 585
Operating income $6,565 $11,615
The income statement using the contribution margin format would be as follows:
Income Statement Year 1 Year 2
Sales revenue $25,000 $37,500
Variable costs:
- Cost of goods sold $10,000 $15,000
- Wages expense* $3,000 $4,500
- Shipping expense $1,100 $1,650
- Advertising expense* $800 $1,200
Contribution margin $10,100 $15,150
Period costs:
- Wages expense* $500 $500
- Advertising expense* $200 $200
- Rent expense $1,500 $1,500
- Insurance expense $585 $585
- Utilities expense $750 $750
Net income $6,565 $11,615
*high low cost method for wages expense and advertisement expense:
variable wages expense = ($5,000 - $3,500) / (3,000 - 2,000) = $1.50 per unit
fixed wages expense = $5,000 - (3,000 x $1.50) = $500
variable advertising expense = ($1,400 - $1,000) / (3,000 - 2,000) = $0.40 per unit
fixed advertising expense = $1,400 - (3,000 x $0.40) = $200
