Question

Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019:

Lionel Corporation
Budgeted Income Statement
For the Year Ending June 30, 2019
($000 omitted)
Sales				$	29,500
Cost of goods sold
Variable	$	13,275
Fixed		3,540			16,815
Gross profit				$	12,685
Selling and administrative costs
Commissions	$	5,310
Fixed advertising cost		885
Fixed administrative cost		2,360			8,555
Operating income				$	4,130
Fixed interest cost					738
Income before income taxes				$	3,392
Income taxes (30%)					1,018
Net income				$	2,374

Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel’s president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel’s controller, to gather information on the costs associated with this change.

Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $700,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $200,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $600,000 if the eight salespeople are hired.

Required

1. Determine Lionel’s breakeven point (operating profit = 0) in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement.

2. If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement.

Answer 1

A. Calculating Lionel's break even point in sales dollar for the fiscal year ended June 30 2019, If company hires its own sales force and increases its advertising costs.

1. PV Ratio = Contribution / sales x 100

Revised PV Ratio = (Sales – Variable Cost) / Sales x 100

Revised PV Ratio = [Sales – (Direct Variable Cost + Commission) / Sales x 100

Revised PV Ratio = {29500 – [13275 + (29500 x 10%)]} / 29500 x 100

Revised PV Ratio = [29500 – (13275 + 2950)] / 29500 x 100

Revised PV Ratio = (29500 – 16225) / 29500 x 100

Revised PV Ratio = 13275 / 29500 x 100

Revised PV Ratio = 45%

2. Revised Fixed Cost Structure

Particulars	Calculations	Amount $(000)
Fixed cost of goods sold		3,540
Fixed advertising cost	(885 + 600)	1485
Fixed administrative cost		2,360
Fixed Salary Cost	[(80 x 8) + 200]	840
Total Fixed Cost		$8,225

3. Break Even Point (Sales) = Total Fixed Cost / PV Ratio

Break Even Point (Sales) = 8225 / 45%

Break Even Point (Sales) = $18277.78

4. Proof:- Revised Income Statement for June 30, 2019

Lionel Corporation
Revised Budgeted Income Statement
For the Year Ending June 30, 2019
($000 omitted)
Sales		18277.78
Cost of goods sold
Variable (45% sales)	8225.00
Fixed	3540.00	11765.00
Gross profit		6512.78
Selling and administrative costs
Commissions (10% sales)	1827.78
Fixed advertising cost	1485.00
Fixed administrative cost	2360.00
Fixed Salary Cost	840.00	6512.78
Operating income		0.00
Fixed interest cost		738.00
Income before income taxes		-738.00
Income taxes (30%)		221.40
Net income		-516.60

B. Calculating estimated sales revenue to generate same operating Profit, If Lionel continues to sell through its network of sales agents and pays the higher commission rate.

1. PV Ratio = Contribution / sales x 100

Revised PV Ratio = (Sales – Variable Cost) / Sales x 100

Revised PV Ratio = [Sales – (Direct Variable Cost + Commission) / Sales x 100

Revised PV Ratio = {29500 – [13275 + (29500 x 23%)]} / 29500 x 100

Revised PV Ratio = [29500 – (13275 + 6785)] / 29500 x 100

Revised PV Ratio = (29500 – 20060) / 29500 x 100

Revised PV Ratio = 9440 / 29500 x 100

Revised PV Ratio = 32%

2. Fixed Cost Structure

Particulars	Amount $(000)
Fixed cost of goods sold	3,540
Fixed advertising cost	885
Fixed administrative cost	2,360
Fixed Salary Cost	0
Total Fixed Cost	$6,785

3. Calculating Required Contribution to achieve desired sales

Required Contribution = Fixed Cost + Desired Operating Profit

Required Contribution = (3540 + 885 + 2360) +4130

Required Contribution = 6785 + 4130

Required Contribution = $10915

4. Calculating Desired level of sales to earn same profit

Desired level of sales = Required Contribution / PV Ratio

Desired level of sales = 10915 / 32%

Desired level of sales = $34109.38