Question

Case 5-33 Cost Structure; Break-Even and Target Profit Analysis (LO5-4, LO5-5, LO5-6) Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission of 15% for all items sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year as follows: $26,000,000 15, 340,000 10,660,000 Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales Manufacturing expenses Variable $11,700,000 Fixed overhead 3.640,000 Gross margin Selling and administrative expenses: Commissions to agents 3,900,000 Fixed marketing expenses 182,000 Fixed administrative expenses 2,200,000 Net operating income Fixed interest expenses Income before income taxes Income taxes (30%) Net income 6,282,000 4,370,000 910,000 3,468,000 1.040.400 $ 2,427,600 *Primarily depreciation on storage facilities.

Answer 1

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Ans to Q-3 Let Breakeven Sales value be 100X Income Statement 20% Commission Own Sales Force Sales 100X 100% Commission 20% 7.5 20%, 7.50% of 100X Net Sales 80X 100X Variable cost 45% 45X 45.00% of net sales Contribution 35X 47.5X Fixed Cost 6,932,000.00 10,712,400.00 As per calculation done in Q-1 Income before tax 35X-6,932,000 47.5X-10,712,400 Tax @ 30% 30%*(35X-6,932,000) 30%*(47.5X-10,712,400) Net Income |(35X-6,932,000)-30%*(35X-6,932,000) |(47.5X-10,712,400)-30%*(47.5X-10,712,400) In our case By solving for X, we will get USD Breakeven Sales is 100X (35X-6,932,000)-30%*(35X-6,932,000) is equal to (47.5X-10,712,400)-30%*(47.5X-10,712,400) 302,432.00 30,243,200.00 20% Commission Own Sales Force Proof Break-even Sales Commission at 20% Variable Manufacturing Exp. Contribution Total Fixed cost Net Income Net Income is same 30,243,200.00 6,048,640.00 13,609,440.00 10,585,120.00 6,932,000.00 3,653,120.00 30,243,200.00 2,268,240.00 13,609,440.00 14,365,520.00 10,712,400.00 3,653,120.00

USD 26,000,000.00 5,200,000.00 20,800,000.00 11,700,000.00 9,100,000.00 See E X Answer 4 a Particulars USD Sales 26,000,000.00 Commission to agents 3,900,000.00 Net Sales (net of commission 22,100,000.00 Variable Manufacturing Exp. 11,700,000.00 Contribution 10,400,000.00 Fixed costs Fixed Manufacturing Exp. 3,640,000.00 Fixed marketing expenses 182,000.00 Fixed administrative expenses 2,200,000.00 Total Fixed costs 6,022,000.00 Net Operating Income 4,378,000.00 Degree of operating leverage 2.38 Answer 4b Particulars Sales Commission to agents Net Sales (net of commission) Variable Manufacturing Exp. Contribution Fixed costs Fixed Manufacturing Exp. Fixed marketing expenses Fixed administrative expenses Total Fixed costs Net Operating Income Degree of operating leverage 3,640,000.00 182,000.00 2,200,000.00 6,022,000.00 3,078,000.00 2.96 U Y WEE/U Z=X/Y Answer 40 Particulars USD Sales 26,000,000.00 Commission to agents 1,950,000.00 Net Sales (net of commission 24,050,000.00 Variable Manufacturing Exp. 11,700,000.00 Contribution 12,350,000.00 Fixed costs 10,712,400.00 Net Operating Income 1,637,600.00 Degree of operating leverage 7.54 AA See o AB AC=AA/AB
.

Pittman Company
Particulars	USD	USD
Sales		26,000,000.00
Manufacturing Exp.
Variable	11,700,000.00
Fixed	3,640,000.00	15,340,000.00
Gross Margin		10,660,000.00
Selling & Administrative Exp.
Commission to agents	3,900,000.00
Fixed marketing expenses	182,000.00
Fixed administrative expenses	2,200,000.00	6,282,000.00
Net Operating Income		4,378,000.00
Fixed Interest Exp.		910,000.00
Income before tax		3,468,000.00
Income tax (30%)		1,040,400.00
Net Income		2,427,600.00

Particulars	USD
Sales	26,000,000.00	A
Commission to agents	3,900,000.00	B
Net Sales (net of commission)	22,100,000.00	C
Variable Manufacturing Exp.	11,700,000.00	D
Contribution	10,400,000.00	E
Fixed costs
Fixed Manufacturing Exp.	3,640,000.00	F
Fixed marketing expenses	182,000.00	G
Fixed administrative expenses	2,200,000.00	H
Fixed Interest Exp.	910,000.00	I
Income before tax	3,468,000.00	J
Income tax (30%)	1,040,400.00	K
Net Income	2,427,600.00	L
Variable cost to % of sales	45.00%	M= D/A
Contribution to % of sales	40.00%	N=E/A

Particulars	USD
Fixed Manufacturing Exp.	3,640,000.00
Fixed marketing expenses	182,000.00
Fixed administrative expenses	2,200,000.00
Fixed Interest Exp.	910,000.00
Total Fixed cost	6,932,000.00	O
We know at Break even point Contribution is equal to fixed cost and profit is zero.
So contribution needed for breakeven business is $ 6,932,000.
Contribution to % of net sales	40.00%	N
So net sales will be contribution/Contribution to % of net sales:
Break-even Sales	17,330,000.00	P=O/N
Proof
Break-even Sales	17,330,000.00
Commission at 15%	2,599,500.00
Variable Manufacturing Exp.	7,798,500.00
Contribution	6,932,000.00
Total Fixed cost	6,932,000.00
Net Income	-
Ans to 1 a	17,330,000.00

Particulars	USD
Fixed Manufacturing Exp.	3,640,000.00
Fixed marketing expenses	182,000.00
Fixed administrative expenses	2,200,000.00
Fixed Interest Exp.	910,000.00
Total Fixed cost	6,932,000.00
We know at Break even point Contribution is equal to fixed cost and profit is zero.
So contribution needed for breakeven business is $ 6,932,000.
Now here commission increased by 5% so contribution
will decrease by 5% as commission has direct impact on contribution.
Contribution to % of net sales	35.00%
Break-even Sales	19,805,714.29
Proof
Break-even Sales	19,805,714.29
Commission at 20%	3,961,142.86
Variable Manufacturing Exp.	8,912,571.43
Contribution	6,932,000.00
Total Fixed cost	6,932,000.00
Net Income	-
Ans to 1 b	19,805,714.29

Particulars	USD
Fixed Manufacturing Exp.	3,640,000.00
Fixed marketing expenses	182,000.00
Fixed administrative expenses	2,200,000.00
Fixed Interest Exp.	910,000.00
Cost of own sales force	3,900,000.00
Less: Savings in auditor's fees	119,600.00
Total Fixed cost	10,712,400.00	Q
We know at Break even point Contribution is equal to fixed cost and profit is zero.
Now here commission is 7.50% so contribution
will increase by 7.50% as commission has direct impact on contribution.
So contribution needed for breakeven business is $ 8,140,600.
Contribution to % of net sales	47.50%	N
So net sales will be contribution/Contribution to % of net sales:
Break-even Sales	22,552,421.05	R=Q/N
Proof
Break-even Sales	22,552,421.05
Commission	1,691,431.58
Variable Manufacturing Exp.	10,148,589.47
Contribution	10,712,400.00
Total Fixed cost	10,712,400.00
Net Income	-
Ans to 1 c	22,552,421.05

	Ans to Q-2
	If the commission rate is 20% and we need the same net income level then we will do back calculation to arrive at the figures
	Net Income Required	2,427,600.00
Add	Income tax (30%)	1,040,400.00
	Income before tax	3,468,000.00
Add	Fixed costs
	Fixed Manufacturing Exp.	3,640,000.00
	Fixed marketing expenses	182,000.00
	Fixed administrative expenses	2,200,000.00
	Fixed Interest Exp.	910,000.00
	Contribution required	10,400,000.00	T
	So contribution needed is $ 10,400,000
	Contribution to % of net sales	35.00%	N
	Break-even Sales	29,714,285.71	S=T/N
	Proof
	Break-even Sales	29,714,285.71
	Commission at 20%	5,942,857.14
	Variable Manufacturing Exp.	13,371,428.57
	Contribution	10,400,000.00
	Total Fixed cost	6,932,000.00
	Income before tax	3,468,000.00
	Income tax (30%)	1,040,400.00
	Net Income	2,427,600.00