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				$	30,100
Cost of goods sold
Variable	$	13,545
Fixed		3,612			17,157
Gross profit				$	12,943
Selling and administrative costs
Commissions	$	5,418
Fixed advertising cost		903
Fixed administrative cost		2,408			8,729
Operating income				$	4,214
Fixed interest cost					753
Income before income taxes				$	3,461
Income taxes (30%)					1,038
Net income				$	2,423

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 $760,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $230,000. 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 $660,000 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

Answer 1

Increase in fixed cost, if the company hires its own sales force and increases its advertising costs	Whole Amount	(Amount In$ '000)
Payroll cost of salespeople (8*80000)	640,000	640
Travel and entertainment expense	760,000	760
Annual cost of hiring a sales manager and sales secretary	230,000	230
Total fixed cost of own staff force	1,630,000	1,630
Add: increase In advertising cost	660,000	660
Increase in fixed cost, if the company hires its own sales force and increases its advertising costs	2,290,000	2,290
Lionel Corporation
Under Own staff
Budgeted Contribution Income Statement at Budgeted sales level
For the Year Ending June 30, 2019
($000 omitted)
Sales		30,100
Less: Variable cost
Variable Cost of goods sold	13,545
Commissions (sales * 10%)	3,010
Total variable cost		16,555
Contribution margin		13,545
Fixed cost
Fixed Manufacture cost	3,612
Fixed advertising cost (903+660)	1,563
Fixed cost of own staff force	1,630
Fixed administrative cost	2,408
Fixed operating cost		9,213
Operating income		4,332
Contribution margin		13545
Divided by : Sales		30100
Contribution margin ratio		0.45
Fixed operating cost		9213
Divided by: Contribution margin ratio		0.45
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		20473
Proof of above answer
Variable Cost of goods sold in % of sales (13545/30100)		45%
Lionel Corporation
Under Own staff
Budgeted Contribution Income Statement at breakeven point level
For the Year Ending June 30, 2019
($000 omitted)
Sales		20,473
Less: Variable cost
Variable Cost of goods sold (20473*45%)	9,213
Commissions (20473 * 10%)	2,047
Total variable cost		11,260
Contribution margin		9,213
Fixed cost
Fixed Manufacture cost	3,612
Fixed advertising cost (903+660)	1,563
Fixed cost of own staff force	1,630
Fixed administrative cost	2,408
Fixed operating cost		9,213
Operating income		0

Answer 2

Lionel Corporation
Budgeted Contribution Income Statement
For the Year Ending June 30, 2019
($000 omitted)
Sales		30,100
Less: Variable cost
Variable Cost of goods sold	13,545
Commissions (23% of sales)	6,923
Total variable cost		20,468
Contribution margin		9,632
Fixed cost
Fixed Manufacture cost	3,612
Fixed advertising cost	903
Fixed administrative cost	2,408
Fixed operating cost		6,923
Operating income		2,709
Total variable cost		9,632
Divided by : Sales		30,100
Contribution margin ratio		0.32
Projected Income Statement as per Budgeted Income statement (data available from question)		4,214
Add: Fixed operating cost		6,923
Total contribution required to achieve target		11,137
Divided by: Contribution margin ratio		0.32
Sales dollars that would be required to generate the operating profit as projected in the budgeted income statement		34803
Proof of above answer
Lionel Corporation
Budgeted Contribution Income Statement
For the Year Ending June 30, 2019
($000 omitted)
Sales		34,803
Less: Variable cost
Variable Cost of goods sold (34803*45%)	15,661
Commissions (23% of sales)	8,005
Total variable cost		23,666
Contribution margin		11,137
Fixed cost
Fixed Manufacture cost	3,612
Fixed advertising cost	903
Fixed administrative cost	2,408
Fixed operating cost		6,923
Operating income		4,214