Question

Orion Company sells several products. Information of average revenue and costs is as follows: Selling price per unit $23 Variable costs per unit: Direct material $4 Direct manufacturing labor $1.70 Manufacturing overhead $0.40 Selling costs $2 Annual fixed costs $100,000 The company sells 12,000 units at the end of the year. If direct labor and direct material costs increase by $1 each, contribution margin ________.

Question 4 options:

	decreases by $12,000
	increases by $12,000
	decreases by $24,000
	increases by $24,000

Answer 1

Answer :-

The Correct answer is Option C - Decrease by $24,000

Explanation :-

We first find out the Contribution margin before increase in Direct Labor and Direct Material :-

Given, Selling price per unit = $23

Variable cost per unit :

Direct material $4

Direct labor $1.70

Manufacturing overhead $0.40

Selling costs $2

Total variable cost per unit = Direct Material + Direct Labor + Manufacturing Overhead + Selling cost

Total variable cost per unit = $4 + $1.70 + $0.40 + $2

Total variable cost per unit = 8.10

Contribution Margin per unit = Selling price per unit - Total variable cost per unit

Contribution Margin per unit = $23 - $8.10

Contribution Margin per unit = $14.90

Contribution Margin = Contribution Margin per unit × No. of units sold

No.of unit sold = 12,000 units

Contribution Margin = $14.90 × 12,000

Contribution Margin = $178,800

If direct labor and direct material costs increase by $1 each :-

Then Variable cost per unit is increased by $1 for Direct Labor and $1 for Direct Material

New Variable cost per unit = Total Variable cost per unit before any increase + $1 for Direct Labor + $1 for Direct Material

New Variable cost per unit = $ 8.10 + $1 + $1

New Variable cost per unit = $ 10.10

Contribution Margin per unit = Selling price per unit - New Variable cost per unit

Contribution Margin per unit = $23 - $10.10

Contribution Margin per unit = $ 12.90

Contribution Margin = Contribution Margin per unit × No of unit sold

Contribution Margin = $ 12.90 × 12,000

Contribution Margin = $154,800

The Contribution margin before increase in Direct Labor and Direct Material was $ 178,800

Change in Contribution Margin = $178,800 - $ 154,800

Change in Contribution Margin = $ 24,000

Therefore,if direct labor and direct material costs increase by $1 each, contribution margin is Decrease by $24,000