Pittman Company is a small but growing manufacturer of telecommunications equipm
ID: 2602527 • 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 16% for all items sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year. The statement follows Pittman Company Budgeted Income Statement For the Year Ended December 31 19.000.000 s 7,700.000 0440000 Gross margin 560 000 5.560.000 s 3,000.000 2 360 Primarily depreciation on storage facilities. As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went ahead and used the agents 16% commission rate in completing these statements, but we've just leaned that they refuse to handle our products next year unless we increase the commission rate to 21% 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 21% 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 8.5% 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 $3,040,000 per year, but that would be more than offset by the $3,990,000 (21% x $19,000,000) that we would avoid on agents' commissions. The breakdown of the $3,040,000 cost follows: s 200,000 Super, replied Karl. "And I noticed that the $3,040,000 is just ateExplanation / Answer
BREAKEVEN SALES a Agents commission remains unchanged at 16% A Sales $19,000,000 Variable Expenses B Variable manufactuing expenses $7,700,000 C=0.16*A Commission to agents $3,040,000.00 D=B+C Total Variable expenses $10,740,000 E=A-D Contribution margin $8,260,000 F=E/A Contribution margin Ratio 0.434736842 Fixed Costs Fixed Manufacturing overhead $2,740,000 Fixed marketing expenses $220,000 Fixed administrative expenses $2,300,000 TOTAL FIXED COSTS $5,260,000 Breakeven sales=Fixed Cost/ Contribution margin ratio Breakeven point in dollar sales $12,099,274 (5260000/0.434736842) b Agents commission rate increased to 21% A Sales $19,000,000 Variable Expenses B Variable manufactuing expenses $7,700,000 C=0.21*A Commission to agents $3,990,000 D=B+C Total Variable expenses $11,690,000 E=A-D Contribution margin $7,310,000 F=E/A Contribution margin Ratio 0.384736842 Breakeven point in dollar sales $13,671,683 (5260000/0.384736842)) c Company employs its own sales force A Sales $19,000,000 B Variable manufactuing expenses $7,700,000 C=A-B Contribution margin $11,300,000 F=E/A Contribution margin Ratio 0.594736842 Fixed Costs Fixed Manufacturing overhead $2,740,000 Fixed marketing expenses $220,000 Fixed administrative expenses $2,300,000 Increase in fixed cost of sales $3,040,000 Decrease in auditing cost ($125,000) Total Fixed cost $8,175,000 Breakeven point in dollar sales $13,745,575 (8175000/0.594736842) VOLUME OF SALES WHERE NET INCOME WILL BE EQUAL Selling through agents(21% commission) Assume the Sales Volume for Equal Income=S Break even sales $13,671,683 Contribution margin Ratio 0.384736842 Net Income=0.384736842*(S-13671683) Selling through company's own sales force Breakeven point in dollar sales $13,745,575 Contribution margin Ratio 0.594736842 Net Income=(S-13745575)*0.594736842 0.384736842*(S-13671683)= (S-13745575)*0.594736842 0.384736842*S-13671683*0.384736842= 0.594736842*S-13745575*0.594736842 0.21 0.21S=8175000-5260000 $8,175,000 S=2915000/0.21= $13,880,952 $5,260,000 $2,915,000 Volume of Sales (in dollar) $13,880,952