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: $ 30,500 $ 13,725 3,660 17,385 $ 13, 115 Lionel Corporation Budgeted Income Statement For the Year Ending June 30, 2019 ($000 omitted) Sales Cost of goods sold Variable Fixed Gross profit Selling and administrative costs Commissions $ 5,490 Fixed advertising cost 915 Pixed administrative cost 2,440 Operating income Fixed interest cost Income before income taxes Income taxes (308) Net income 8,845 $ 4.270 763 $ 3,507 1,052 $ 2,455 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 $800,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $250,000. 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 $700,000 if the eight salespeople are hired.

Answer 1

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Lionel Corporation
Data Given in Question
Particulars	USD'000	USD'000
Sales		30,500.00
Cost of goods sold
Variable	13,725.00
Fixed	3,660.00	17,385.00
Gross Margin		13,115.00
Selling & Administrative cost
Commission to agents	5,490.00
Fixed advertising cost	915.00
Fixed administrative cost	2,440.00	8,845.00
Net Operating Income		4,270.00
Fixed Interest cost		763.00
Income before tax		3,507.00
Income tax (30%)		1,052.00
Net Income		2,455.00

	Current Income Statement
	Particulars	USD'000	Note
	Sales	30,500.00	A
Less	Commission to agents	5,490.00
	Net Sales (net of commission)	25,010.00
Less	Variable portion- Cost of goods sold	13,725.00	C
	Contribution	11,285.00	B
Less	Fixed costs
	Fixed Manufacturing Exp.	3,660.00
	Fixed advertising cost	915.00
	Fixed administrative cost	2,440.00
	Fixed Interest cost	763.00
	Income before tax	3,507.00
Less	Income tax (30%)	1,052.00
	Net Income	2,455.00
	Variable cost to % of sales	45.00%	D= C/A
	Contribution to % of sales	37.00%	E=B/A

Revised advertising cost	USD'000
Fixed advertising cost	915.00
Increase by $ 700,000	700.00
Revised advertising cost	1,615.00	F
Cost of own sales force	USD'000
Payroll cost of 1 employee	80,000.00	G
Number of employees	8.00	H
Total Payroll cost	640,000.00	I=G*H
Travel and entertainment expense	800,000.00
Cost of sales manager and secretary	250,000.00
Cost of own sales force	1,690,000.00	J
Cost of own sales force ($'000)	1,690.00	K=J/1000

Calculation of fixed cost if own sales force
Particulars	USD'000	Note
Fixed portion- Cost of goods sold	3,660.00
Fixed advertising cost	1,615.00
Fixed administrative cost	2,440.00
Fixed Interest cost	763.00
Cost of own sales force	1,690.00	See J
Total Fixed cost	10,168.00	K
We know at Break even point Contribution is equal to fixed cost and operating profit is zero.
Now here commission is 10% so contribution
will increase by 8% as commission has direct impact on contribution.
So contribution needed for breakeven business is (USD'000) 10,168.
Contribution to % of net sales	45.00%	L=E+8%
So net sales will be contribution/Contribution to % of net sales:
Break-even Sales	22,595.56	R=K/L
Contribution Income Statement	USD'000	USD'000
Break-even Sales		22,595.56
Variable Costs
Commission	2,259.56
Variable Manufacturing Exp.	10,168.00	12,427.56
Contribution		10,168.00
Fixed Costs
Fixed portion- Cost of goods sold	3,660.00
Fixed advertising cost	1,615.00
Fixed administrative cost	2,440.00
Fixed Interest cost	763.00
Cost of own sales force	1,690.00	10,168.00
Operating Profit		-

Ans to Q-2
If the commission rate is 23% and we need the same operating profit then we will do back calculation to arrive at the figures
Net Income Required	2,455.00
Income tax (30%)	1,052.00
Income before tax	3,507.00
Fixed costs
Fixed portion- Cost of goods sold	3,660.00
Fixed advertising cost	915.00
Fixed administrative cost	2,440.00
Fixed Interest cost	763.00
Contribution required	11,285.00	S
As commission is 23% so contribution will decrease by 5% as commission has direct impact on contribution.
Contribution to % of net sales	32.00%	T=E-5%
Target Sales	35,265.63	U=S/T
Contribution Income Statement	USD'000	USD'000
Break-even Sales		35,265.63
Variable Costs
Commission	8,111.09
Variable Manufacturing Exp.	15,869.53	23,980.63
Contribution		11,285.00
Fixed Costs
Fixed portion- Cost of goods sold	3,660.00
Fixed advertising cost	915.00
Fixed administrative cost	2,440.00
Fixed Interest cost	763.00	7,778.00
Income before tax		3,507.00
Income tax (30%)		1,052.00
Net Income		2,455.00