Question

Chapter 5 The breakdown of the $2,400,000 cost follows: Salaries: Sales manager ........ Salespersons Travel and entertainment ..... Advertising $ 100,000 600,000 400,000 1,300,000 $2,400,000 Total .. Super, replied Karl. "And I noticed that the $2.400,000 is just what we're paying the under the old 15% commission rate." he $2,400,000 is just what we're paying the agents "It's even better than that," explained Barbara. "We can actually save $75,000 a that's what we're having to pay the auditine firm now to check out the agents' reports. So our Sarbara. "We can actually save $75,000 a year because all administrative expenses would be less." "Pull all of these numbers together and we'll show them to the executive committee tomor- row," said Karl. "With the approval of the committee, we can move on the ma the committee, we can move on the matter immediately." Required: 1. Compute Pittman Company's break-even point in dollar sales for next year assuming: a. The agents' commission rate remains unchanged at 15%. b. The agents' commission rate is increased to 20%. c. The company employs its own sales force. 2. Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year. 3. Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. Compute the degree of operating leverage that the company would expect to have on Decem ber 31 at the end of next year assuming: a. The agents' commission rate remains unchanged at 15% b. The agents' commission rate is increased to 20%. c. The company employs its own sales force. Use income before income taxes in your operating leverage computation 5 Based on the data in (1) through (4) above, make a recommendation as to whether th pany should continue to use sales agents (at a 20% commission rate) or employ its own force. Give reasons for your answer. (CMA, adapted)

Answer 1

The data in the statements below are in thousands.

	15% Commission		20% Commission		Own Sales Force
Sales	$	16000		100	%		$	16000		100	%		$	16000		100.0	%
Variable expenses:
Manufacturing		7200						7200						7200
Commissions (15%, 20%, 7.5%)		2400						3200						1200
Total variable expenses		9600		60.0	%			10400		65.0	%			8400		52.5	%
Contribution margin		6400		40.0	%			5600		35.0	%			7600		47.5	%
Fixed expenses:
Manufacturing overhead		2340						2340						2340
Marketing		120						120						2520
Administrative		1800						1800						1725
Interest		540						540						540
Total fixed expenses		4800						4800						7125
Income before income taxes		1600						800						475
Income taxes (30%)		480						240						142.50
Net income	$	1120					$	560					$	332.50

120000+2400000 = 2520000 1800000-75000 = 1725000

Part 1 A

Dollar sales to break even= fixed expenses/CM ratio = 4800000/0.400 = $12000000

Part 1 B

Dollar sales to break even= fixed expenses/CM ratio = 4800000/0.350 = $13714286

Part 1 C

Dollar sales to break even= fixed expenses/CM ratio = 7125000/0.475 = $15000000

Part 2

In order to generate a $1120000 net income, the company must generate $1600000 in income before taxes

Dollar sales to attain target= target income before taxes + fixed expenses / contribution margin ratio = (1600000+4800000)/ 0.350 = $18285714

Part 3

X = total sales revenue

0.650x+4800000 = 0.525x+7125000

0.125x =2325000

X = $18600000

Part 4

	15% Commission	20% Commission	Own Sales Force
Contribution margin (Part 1) (a)	6400000	5600000	7600000
Income before taxes (Part 1) (b)	1600000	800000	475000
Degree of operating leverage: (a) ÷ (b)	4.00	7.00	16.00

Part 5

The company make use of Own Sales Force as it give higher contribution margin and higher DOL.