Pittman Company is a small but growing manufacturer of telecommunications equipm
ID: 2489074 • 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 18% for all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
As Barbara handed the statement to Karl Vecci, Pittman’s president, she commented, “I went ahead and used the agents’ 18% 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 23%.”
“That’s the last 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 23% commission rate?”
“They claim that after paying for advertising, travel, and the other costs of promotion, there’s nothing left over for profit,” replied Barbara.
“I 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 6.3% commission to their 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 $3,042,000 per year, but that would be more than offset by the $3,887,000 (23% × $16,900,000) that we would avoid on agents’ commissions.”
“Super,” replied Karl. “And I noticed that the $3,042,000 is just what we’re paying the agents under the old 18% commission rate.”
“It’s even better than that,” explained Barbara. “We can actually save $90,000 a year because that’s what we’re having to pay the auditing firm now to check out the agents’ reports. So our overall administrative costs 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.”
Compute Pittman Company’s break-even point in dollar sales for next year assuming: (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places and final answer to the nearest dollar amount.)
The agents’ commission rate remains unchanged at 18%.
The agents’ commission rate is increased to 23%.
The company employs its own sales force.
Assume that Pittman Company decides to continue selling through agents and pays the 23% 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. (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places.)
Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 23% commission rate) or employs its own sales force. (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places.)
Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:
The agents’ commission rate remains unchanged at 18%. (Round your answer to 2 decimal places.)
The agents’ commission rate is increased to 23%. (Round your answer to 2 decimal places.)
The company employs its own sales force. (Round your answer to 2 decimal places.)
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 18% for all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
Explanation / Answer
1. (a) Pittman company Break even point in dollar sales when the agents commission rate remain unchanged at 18%.
Break - Even point in dollar ales = Fimed expenses/Contribution Ratio = 8,172,000/56.509% = $14,461,413
Working Note:
Calculation of Contribution and Contribution Margin
Sales $16,900,000
Variable Expenses:
Manufacturing expenses 73,50,000
Contribution 95,50,000
Less: Fixed expenses:
Manufacturing 2,460.000
Selling & Admn; Exp
Commission to agents 3,042,000
Fixed marketing 150,000
Fixed administrative 1,950,000
Interest expenses 570,000 5,712,000 81,72,000
Income 1,378,000
Contribution Margin Raio = Contribution/sales = 95,50,000/16,900,000 = 56.509%
1. (b) Break-Even point when agents commission rate is increased by 23% ie. $3,887,000
Break-Even point in dollar sales = Fixed expenses/Contribution ratio =9,017,000/56.509% = $15,956,750.
Working Notes:
Calculation of new Contribution and Contribution Ratio :
Sales $16,900,000
Less Variable manufactuirng cost 7,350,000
Contribution Margin 9,550,000
Less: Fixed expenses
(2,460,000+3,887,000+150,000+1,950,000+570,000) 9,017,000
Income 533,000
Contribution Margin Ratio = Contribution/Sales = 9,550,000/16,900,000 = 56.509%
1. (c) Break-Even point in dollar sales when company employ's its own slaes force (Commission to agents $3,042,000,but Administrative expenses will be reduced by $90,000 in the form of Audit fees)
Break Even point in dollar sales = Fixed expenses/Conribution Margin
=8,122,000/56.509% = $14,372,932
Note: Contributiion i.e $9,550,000 is same as above as no change in variable cost .
Fixed Expenses(Manufacturing Fixed overhead 2,460,000 + Agents commission $3,042,000+Marketing exp. 150,000+Fixed Admn, exp 1,900,000+Interest exp. 570,000) = $8,122,000
2. Sales required to maintain budgeted net income when commission is 23% i.e 3,887,000
Sales = Fixed expenses + Desired income/Contribution Ratio
= 9,017,000 + 533,000/56.509%
= 9,550,000/56.509% = $16,899,963
4.(a) Degree of operating leverae if agents commission remain unchanged i.e @18%
Degree Operating Liverage = Contribution/EBIT = $9,550,000/1,948,000 = 4.90
EBIT = Contribution - All fixed expenses excluding interest expenes (as it is not operating exp.)
= $9.550.000 - (2,460,000 + 150,000 + 3,042,000 + 1,950,000) = 1,948,000
4.(b) Degree of operating legerage if commission is 23%
Degree of operating leverage = Contribution/EBIT = 9,550,000/1,103,000 = 8.66
EBIT = Conribution - (24,60,000+150,000+3,887,000+1.950,000) =9,550,000 - 8,447,000 = 1,103,000
4.(c) Degree of operating leverage if company sales force is employed
Degree of operating leverage = contribution/EBIT = 9,550,000/1,998,000 = 4.78
EBIT = Contribution - (24,60,000 + 150,000 + 3,042,000 +1,900,000) = 9,550,000 - 7,552,000 = 1,998,000