Pittman Company is a small but growing manufacturer of telecommunications equipm
ID: 2336317 • Letter: P
Question
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 Pittean Company Budgeted Income Statenent For the ver Ended Decemb-er 31 Sales 23,500,000 variable Pixed overhead 10,575,000 3,298,0ee 3 865 ,80e 9,635,000 dross margin Selling and administrative expenses Commissions to agents Pixed marketing expenses Pixed administrative expenses 3,525,0ee 164,500 2,100,eee 5,789,50e Net operating incone Fixed interest expensers tncome before incone taxes Income taxes (30%) Net income 3,845,50e 3,023,00ee 2,116,100 Primarily depreciation on storage facilities. As Barbara handed the statement to Kari Vecci, Pittrman's president. she commented, "I went ahead and used the agents, 15% commission rate In completing these statements, but we 've just learned that they refuse to handle our products next year unless we increase the commission rate to 20% That's the lst straw, Karl replied angrily. "Those agents have been demanding more and more, and this time they've gone too far How can they possibly defend a 20% commission rate?" They clalim that after paying for advertising. travel, and the other costs of promotion, there's nothing left over for profit," replied Barbara 1 say it's Just plain robbery." retorted Karl. "And I also say It's time we dumped those guys and got our own sales force. Can you get your people to work up some cost figures for us to look at? "We've already worked them up," said Barbara. "Several companies we know about pay a 7.5% commission to ther own salespeople. along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would Increase by $3.525,000 per year, but that would be more than offset by the $4.700.000 (20% x $23.500,000) that we would avoid on agents' commissions The breakdown of the $3,525,000 cost follows Salaries Sales manager alespersons 146,875 81,250 Sales manager Salespersons Travel and entertainnent Advertising Total 146,875 881,25e 587,500 1,909,375 "Super," replied Karl-And I noticed that the $3.525,000 equals what we're paying the agents under the old 15% commission rate "It's even better than that. explained Barbara. "We can actually save S108,100 a year because that's what we're paying our auditors to check out the agents' reports. So our overall administrative expenses would be less. "Pull all of these numbers together and we'll show them to the executive committee tomorrow.-said Karl·"With the approval of the committee, we can move on the matter Immediately 1 Compute Pittman Company's break-even point in dolliar sales for next year assuming a. The agents' commission rate remains unchanged at 15% b. The agents' commission rate is increased to 20%Explanation / Answer
Working-1 Please hit LIKE button if this helped. For any further explanation, please put your query in comment, will get back to you. Commission 15% Commission 20% Own Sales Force Working Sales. . . . . . . . . . . . . . . . . . . 23500000 23500000 23500000 Less: Variable Cost Variable Manufacturing exp 10575000 10575000 10575000 Agents Commission 3525000 4700000 1762500 7.5% Commission Total Variable Cost 14100000 15275000 12337500 Contribution Margin 9400000 8225000 11162500 Less: Fixed Cost Fixed overhead. . . . . . . . . . . . . . . 3290000 3290000 Fixed marketing expenses. . . . . . . . . . . . 164500 3689500 Additional fixed cost of 3525000 Fixed administrative expenses. . . . . . . 2100000 1991900 Saving audit fee of 108100 Total Fixed Cost 5554500 5554500 8971400 Net Operating Income 3845500 2670500 2191100 Fixed Interest Expenses 822500 822500 822500 Income before income taxes 3023000 1848000 1368600 Income Tax 30% 906900 554400 410580 Net Income 2116100 1293600 958020 a. BEP with 15% Comission BEP=Fixed Cost/Contribution Margin Fixed Cost=3290000+164500+2100000+822500 6377000 Contribution Margin 9400000/23500000 40% BEP=6377000/40% 15942500 b. BEP with 20% Comission Fixed Cost=3290000+164500+2100000+822500 6377000 Contribution Margin 8225000/23500000 35% BEP=6377000/35% 18220000 c. BEP with own sales force Fixed Cost Working -1 8971400+822500 9793900 Contribution Margin 11162500/23500000 47.5% BEP=9793900/47.5% 20618737 2. TO maintain budgeted Net Income To maintain budgeted Net Income 2116100 i.e. 3023000 before tax income (Fixed Cost+Target Profit)/Contribution Margin Fixed Cost at 20% Commission 6377000 From b Above Contribution Margin at 20% commission 35% From b Above Target Income before tax 3023000 Target Sales=(6377000+3023000)/35% 26857143 3. Equal Net income Let Sale be x 20% Commission Own Sales force Let Sale be x x Variable Cost Ratio (100-Margin Ratio) 65% 52.50% Fixed Cost (From b and c) 6377000 9793900 0.65x+6377000=0.525x+9793900 x=3416900/0.125 x=27335200 where net income will be equal 4. Degree of operating Leavarage Contribution Margin/Income before tax Commission 15% Commission 20% Own Sales Force Contribution Margin From working-1 9400000 8225000 11162500 Income before tax (From working -1) 3023000 1848000 1368600 Degree of operating leavarage 3.11 4.45 8.16 5. Decision Since Net income is more in giving 20% commssion, should NOT employ own force