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:

Pittman Company Budgeted Income Statement For the Year Ended December 31
Sales				$	16,500,000
Manufacturing expenses:
Variable	$	7,425,000
Fixed overhead		2,310,000			9,735,000
Gross margin					6,765,000
Selling and administrative expenses:
Commissions to agents		2,475,000
Fixed marketing expenses		115,500	*
Fixed administrative expenses		1,820,000			4,410,500
Net operating income					2,354,500
Fixed interest expenses					577,500
Income before income taxes					1,777,000
Income taxes (30%)					533,100
Net income				$	1,243,900

*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’ 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 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 20% 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 7.5% 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 $2,475,000 per year, but that would be more than offset by the $3,300,000 (20% × $16,500,000) that we would avoid on agents’ commissions.”

The breakdown of the $2,475,000 cost follows:

Salaries:
Sales manager	$	103,125
Salespersons		618,750
Travel and entertainment		412,500
Advertising		1,340,625
Total	$	2,475,000

“Super,” replied Karl. “And I noticed that the $2,475,000 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 $75,900 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.”

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 dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year.

3. Determine the dollar 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.

4. Compute the degree of operating leverage that the company would expect to have 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.

Answer 1

Dear student, we cannot able to post solution more than four sub parts of question as per our policy.

Please note that we can also consider fixed interest cost for Calculation of Break even Points sales in dollars Because of Break-even Point means sales Where Net Income Is equal to Zero.

Answer 1

Option : independent sales agents commission remains unchanged at 15%
Pittman Company
Budgeted Contribution Income Statement
Sales		16,500,000
Less: Variable cost
Variable Cost of goods sold	7,425,000
Commissions (Sales * 15%)	2,475,000
Total variable cost		9,900,000
Contribution margin		6,600,000
Fixed cost
Fixed Manufacture cost	2,310,000
Fixed advertising cost	1,820,000
Fixed administrative cost	115,500
Fixed interest expenses	577,500
Total Fixed cost		4,823,000
Profit before tax		1,777,000
Contribution margin		6,600,000
Divided by: Sales		16,500,000
Contribution margin ratio		0.40
Total Fixed cost		4823000
Divided by: Contribution margin ratio		0.4
break-even point in sales revenue		12,057,500

Answer 2

Option : independent sales agents commission increased to 20%
Pittman Company
Budgeted Contribution Income Statement
Sales		16,500,000
Less: Variable cost
Variable Cost of goods sold	7,425,000
Commissions (Sales * 20%)	3,300,000
Total variable cost		10,725,000
Contribution margin		5,775,000
Fixed cost
Fixed Manufacture cost	2,310,000
Fixed advertising cost	1,820,000
Fixed administrative cost	115,500
Fixed interest expenses	577,500
Total Fixed cost		4,823,000
Profit before tax		952,000
Contribution margin		5,775,000
Divided by: Sales		16,500,000
Contribution margin ratio		0.35
Total Fixed cost		4823000
Divided by: Contribution margin ratio		0.35
break-even point in sales revenue		13,780,000

Answer 3

Option : company employs its own sales force.
Pittman Company
Budgeted Contribution Income Statement
Sales		16,500,000
Less: Variable cost
Variable Cost of goods sold	7,425,000
Commissions (Sales * 7.5%)	1,237,500
Total variable cost		8,662,500
Contribution margin		7,837,500
Fixed cost
Fixed Manufacture cost	2,310,000
Fixed advertising cost	1,820,000
Fixed administrative cost	115,500
Fixed interest expenses	577,500
Additional Fixed cost after saving (2475000-75900)	2,399,100
Total Fixed cost		7,222,100
Profit before tax		615,400
Contribution margin		7,837,500
Divided by: Sales		16,500,000
Contribution margin ratio		0.475
Total Fixed cost		7,222,100
Divided by: Contribution margin ratio		0.475
break-even point in sales revenue		15,204,421

Answer 4

Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year
Target Profit before tax (For Achieve Net income of 1,243,900)	1,777,000
Add: Total Fixed cost	4,823,000
Total Contribution Required for achieve Target	6,600,000
Divided by: Contribution margin ratio	0.35
sales revenue would be necessary to generate net income as per Budgeted	18,857,143