Question

Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019: $ 28,700 16,359 $ 12,341 Lionel Corporation Budgeted Income Statement For the Year Ending June 30, 2019 ($000 omitted) Sales Cost of goods sold Variable $ 12,915 Fixed 3,444 Gross profit Selling and administrative costs Commissions $ 5,166 Fixed advertising cost 861 Fixed administrative cost 2,296 Operating income Fixed interest cost Income before income taxes Income taxes (30%) Net income $ $ 8,323 4,018 718 3,300 990 2,310 $ Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel's president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel's controller, to gather information on the costs associated with this change. Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $620,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $160,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $520,000 if the eight salespeople are hired.

Answer 1

1.

Sales	$        28,700
less Variable Costs
Variable Cost of Goods Sold	$        12,915
Commissions	$          2,870
Contribution Margin	$        12,915
less Fixed Costs
Fixed Cost of Goods Sold	$          3,444
Fixed Sales Salaries	$             800
Fixed Travel and Entertainment Expenses	$             620
Fixed Advertising Cost	$          1,381
Fixed Admin Cost	$          2,296
Operating Income	$          4,374
Fixed Interest Cost	$             718
Income Before Income Taxes	$          3,656

Contribution Margin ratio = 12915/28700 x 100 = 45%
Fixed Costs = $8541 i.e. 3444+800+620+1381+2296, except for interest cost, as we are finding break even at operating profit = 0

Break even (Dollars) = Fixed Costs / Contribution Margin ratio
= $8541 / 45% = $18980

Sales	$        18,980
less Variable Costs
Variable Cost of Goods Sold	$          8,541	=18980*45%
Commissions	$          1,898	=18980*10%
Contribution Margin	$          8,541
less Fixed Costs
Fixed Cost of Goods Sold	$          3,444
Fixed Sales Salaries	$             800
Fixed Travel and Entertainment Expenses	$             620
Fixed Advertising Cost	$          1,381
Fixed Admin Cost	$          2,296
Operating Income	$                -

2.

Sales	$        28,700
less Variable Costs
Variable Cost of Goods Sold	$        12,915
Commissions	$          6,601
Contribution Margin	$          9,184

Contribution Margin ratio = $9184/28700 = 32%

Required Sales = (Fixed Costs+Target Income) / Contribution Margin ratio
= ($8541+4018) / 32% = $39246.88 or $39247