Question
In: Accounting
Telecom Company is a small manufacturer of telecommunications equipment and sales have been growing in volume....
Telecom Company is a small manufacturer of telecommunications equipment and sales have been growing in volume. 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 13% for all items sold.
Karen McCarron, Telecom's controller, has just prepared the company’s budgeted income statement for next year. The statement follows:
Telecom Company
Budgeted Income Statement
For the Year Ended December 31
Sales $
18,100,000
Manufacturing expenses:
Variable $ 7,550,000
Fixed overhead 2,620,000
10,170,000
Gross margin
7,930,000
Selling and administrative expenses:
Commissions to agents
2,353,000
Fixed marketing expenses
190,000*
Fixed administrative expenses
2,150,000 4,693,000
Net operating income
3,237,000
Fixed interest expenses
610,000
Income before income taxes
2,627,000
Income taxes (40%)
1,050,800
Net income $
1,576,200
*Primarily depreciation on storage facilities.
As Karen handed the statement to Cassie Bradley, Telecom’s president, she commented, “I went ahead and used the agents’ 13% 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 18%.”
“That’s the last straw,” Cassie replied angrily. “Those agents have been demanding more and more, and this time they’ve gone too far. How can they possibly defend a 18% commission rate?”
“They claim that after paying for advertising, travel, and the other costs of promotion, there’s nothing left over for profit,” replied Karen.
“I say it’s just plain robbery,” retorted Cassie. “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 Karen. “Several companies we know about pay a 8.2% 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 $2,353,000 per year, but that would be more than offset by the $3,258,000 (18% × $18,100,000) that we would avoid on agents’ commissions.”
The breakdown of the $2,353,000 cost follows:
Salaries:
Sales manager $ 170,000
Salespersons 950,000
Travel and entertainment
680,000
Advertising 553,000
Total $ 2,353,000
“Super,” replied Cassie. “And I noticed that the $2,353,000 is just what we’re paying the agents under the old 13% commission rate.”
“It’s even better than that,” explained Karen. “We can actually save $110,000 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 expenses would be less.”
“Pull all of these numbers together and we’ll show them to the executive committee tomorrow,” said Cassie. “With the approval of the committee, we can move on the matter immediately.”
Required:
1. Compute Telecom 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 answers to the nearest dollar amount.)
a. The agents’ commission rate remains unchanged at 13%.
b. The agents’ commission rate is increased to 18%.
c. The company employs its own sales force.
2. Assume that Telecom Company decides to continue selling through agents and pays the 18% 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.)
3. Determine the volume of sales at which net income would be equal regardless of whether Telecom Company sells through agents (at a 18% 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.)
4. Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming:
a. The agents’ commission rate remains unchanged at 13%. (Round your answer to 2 decimal places.)
b. The agents’ commission rate is increased to 18%. (Round your answer to 2 decimal places.)
c. The company employs its own sales force. (Round your answer to 2 decimal places.)
Solutions
Expert Solution
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| Telecom Company | ||
| Particulars | Amount $ | Amount $ |
| Sales | 18,100,000.00 | |
| Manufacturing Exp. | ||
| Variable | 7,550,000.00 | |
| Fixed | 2,620,000.00 | 10,170,000.00 |
| Gross Margin | 7,930,000.00 | |
| Selling & Administrative Exp. | ||
| Commission to agents | 2,353,000.00 | |
| Fixed marketing expenses | 190,000.00 | |
| Fixed administrative expenses | 2,150,000.00 | 4,693,000.00 |
| Net Operating Income | 3,237,000.00 | |
| Fixed Interest Exp. | 610,000.00 | |
| Income before tax | 2,627,000.00 | |
| Income tax (40%) | 1,050,800.00 | |
| Net Income | 1,576,200.00 |
| Particulars | Amount $ | ||
| Sales | 18,100,000.00 | A | |
| Less | Commission to agents | 2,353,000.00 | B |
| Net Sales (net of commission) | 15,747,000.00 | C | |
| Less | Variable Manufacturing Exp. | 7,550,000.00 | D |
| Contribution | 8,197,000.00 | E | |
| Less | Fixed costs | ||
| Fixed Manufacturing Exp. | 2,620,000.00 | F | |
| Fixed marketing expenses | 190,000.00 | G | |
| Fixed administrative expenses | 2,150,000.00 | H | |
| Fixed Interest Exp. | 610,000.00 | I | |
| Income before tax | 2,627,000.00 | J | |
| Less | Income tax (40%) | 1,050,800.00 | K |
| Net Income | 1,576,200.00 | L | |
| Variable cost to % of sales | 41.71% | M= D/A | |
| Contribution to % of sales | 45.29% | N=E/A |
| Particulars | Amount $ | |
| Fixed Manufacturing Exp. | 2,620,000.00 | |
| Fixed marketing expenses | 190,000.00 | |
| Fixed administrative expenses | 2,150,000.00 | |
| Fixed Interest Exp. | 610,000.00 | |
| Total Fixed cost | 5,570,000.00 | O |
| We know at Break even point Contribution is equal to fixed cost and profit is zero. |
| So contribution needed for breakeven business is $ 5,570,000. |
| Contribution to % of net sales | 45.29% | N |
| So net sales will be contribution/Contribution to % of net sales: | ||
| Break-even Sales | 12,299,255.83 | P=O/N |
| Proof | |
| Break-even Sales | 12,299,255.83 |
| Commission at 13% | 1,598,903.26 |
| Variable Manufacturing Exp. | 5,130,352.57 |
| Contribution | 5,570,000.00 |
| Total Fixed cost | 5,570,000.00 |
| Net Income | - |
| Ans to 1 a | 12,299,255.83 |
| We know at Break even point Contribution is equal to fixed cost and profit is zero. |
| So contribution needed for breakeven business is $ 5,570,000. |
| Now here commission increased by 5% so contribution |
| will decrease by 5% as commission has direct impact on contribution. |
| Contribution to % of net sales | 40.29% | N |
| Break-even Sales | 13,825,699.40 | P=O/N |
| Proof | |
| Break-even Sales | 13,825,699.40 |
| Commission at 18% | 2,488,625.89 |
| Variable Manufacturing Exp. | 5,767,073.51 |
| Contribution | 5,570,000.00 |
| Total Fixed cost | 5,570,000.00 |
| Net Income | - |
| Ans to 1 b | 13,825,699.40 |
| Particulars | Amount $ | |
| Fixed Manufacturing Exp. | 2,620,000.00 | |
| Fixed marketing expenses | 190,000.00 | |
| Fixed administrative expenses | 2,150,000.00 | |
| Fixed Interest Exp. | 610,000.00 | |
| Cost of own sales force | 2,353,000.00 | |
| Less: Savings in auditor's fees | 111,000.00 | |
| Total Fixed cost | 7,812,000.00 | Q |
| We know at Break even point Contribution is equal to fixed cost and profit is zero. |
| Now here commission is 8.20% so contribution |
| will increase by 4.80% as commission has direct impact on contribution. |
| So contribution needed for breakeven business is $ 7,812,000 |
| Contribution to % of net sales | 50.09% | N |
| So net sales will be contribution/Contribution to % of net sales: | ||
| Break-even Sales | 15,596,770.28 | R=Q/N |
| Proof | |
| Break-even Sales | 15,596,770.28 |
| Commission | 1,278,935.16 |
| Variable Manufacturing Exp. | 6,505,835.12 |
| Contribution | 7,812,000.00 |
| Total Fixed cost | 7,812,000.00 |
| Net Income | - |
| Ans to 1 c | 15,596,770.28 |
| Ans to Q-2 | |||
| If the commission rate is 18% and we need the same net income level then we will do back calculation to arrive at the figures | |||
| Net Income Required | 1,576,200.00 | ||
| Add | Income tax (40%) | 1,050,800.00 | |
| Income before tax | 2,627,000.00 | ||
| Add | Fixed costs | ||
| Fixed Manufacturing Exp. | 2,620,000.00 | ||
Fixed marketi
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