Question

FMGT 2294

Assignment – Cost-Volume-Profit

Question 1

Crescent Corporation manufactures multi-function photocopiers that are sold through a network of independent sales agents. These sales agents sell a variety of products to businesses in addition to crescent’s photocopiers. The sales agents are paid a 19% commission on sales, and this commission rate was used when Crescent’s management prepared the following budgeted income statement for the coming year:

Sales			$20,000,000
Cost of goods sold
Variable		$11,200,000
Fixed		1,400,000	12,600,000
Gross margin			7,400,000
Selling and administrative expenses:
Commissions		3,800,000
Fixed advertising expense		400,000
Fixed administrative expense		1,600,000	5,800,000
Operating income			$1,600,000

Since the completion of the above statement, Crescent’s management has learned that the independent sales agents are demanding an increase in the sales commission rate to 22% of sales for the upcoming year. This would be the third increase in commissions in five years. As a result, Crescent management has decided to investigate the possibility of the hiring its own sales staff to replace the independent sales agents.

Crescent’s controller estimates the company will have to hire six salespeople to cover the current market area, and the total annual payroll cost of these employees will be about $350,000, including benefits. The salespeople will also be paid commissions of 12% of sales. Travel and entertainment expenses are expected to be $200,000 for the year. The company will also have to hire a sales manager whose salary and benefits will total approximately $100,000 per year. To make up for promotions that the independent agents have been running on behalf of Crescent, management believes the company’s budget for fixed advertising expenses will increase by $400,000.

Required:

Assuming sales of $20,000,000, construct a budgeted contribution-format income statement for the upcoming year for each of the following activities:

The independent sales agents commission remains unchanged at 19%

The independent sales agents commission increases to 22%

The company employs its own sales force

Calculate Crescent Corporation’s break-even point in sales revenue for the upcoming year assuming the following:

The independent sales agents commission remains unchanged at 19%

The independent sales agents commission increases to 22%

The company employs its own sales force

Refer to your answer to 1(b) above. If the company employs its own sales force, what level of of sales revenue would be necessary to generate the operating income the company would realize if sales are $20,000,000 and the company continues to sell through agents (at a 22% commission rate)?

Determine the sales revenue at which operating income would be the equal regardless of whether Crescent Corporation sells through sales agents ( at 22% commission rate) or employs its own sales force.

Would you recommend the company retain the sales agents at 22% commission or would you recommend that the company employ its own sales force? Provide a detailed explanation to support your recommendation.

Answer 1

Option : independent sales agents commission remains unchanged at 19%
Crescent Corporation
Budgeted Contribution Income Statement
Sales		20,000,000
Less: Variable cost
Variable Cost of goods sold	11,200,000
Commissions (Sales * 19%)	3,800,000
Total variable cost		15,000,000
Contribution margin		5,000,000
Fixed cost
Fixed Manufacture cost	1,400,000
Fixed advertising cost	400,000
Fixed administrative cost	1,600,000
Fixed operating cost		3,400,000
Operating income		1,600,000
Contribution margin		5,000,000
Divided by: Sales		20,000,000
Contribution margin ratio		0.25
Fixed operating cost		3,400,000
Divided by: Contribution margin ratio		0.25
break-even point in sales revenue		13,600,000

Option : independent sales agents commission remains unchanged at 22%
Crescent Corporation
Budgeted Contribution Income Statement
Sales		20,000,000
Less: Variable cost
Variable Cost of goods sold	11,200,000
Commissions (Sales * 22%)	4,400,000
Total variable cost		15,600,000
Contribution margin		4,400,000
Fixed cost
Fixed Manufacture cost	1,400,000
Fixed advertising cost	400,000
Fixed administrative cost	1,600,000
Fixed operating cost		3,400,000
Operating income		1,000,000
Contribution margin		4,400,000
Divided by: Sales		20,000,000
Contribution margin ratio		0.22
Fixed operating cost		3,400,000
Divided by: Contribution margin ratio		0.22
break-even point in sales revenue		15,454,545

Option : company employs its own sales force.
Crescent Corporation
Budgeted Contribution Income Statement
Sales		20,000,000
Less: Variable cost
Variable Cost of goods sold	11,200,000
Commissions (Sales * 12%)	2,400,000
Total variable cost		13,600,000
Contribution margin		6,400,000
Fixed cost
Fixed Manufacture cost	1,400,000
Fixed advertising cost (400000+400000 increase)	800,000
Fixed administrative cost	1,600,000
Total fixed cost of own staff force	650,000
Fixed operating cost		4,450,000
Operating income		1,950,000
Contribution margin		6,400,000
Divided by: Sales		20,000,000
Contribution margin ratio		0.32
Fixed operating cost		4,450,000
Divided by: Contribution margin ratio		0.32
break-even point in sales revenue		13,906,250
Target Operating profit		1,000,000
Add: Fixed operating cost		4,450,000
Total Contribution Required for achieve Target		5,450,000
Divided by: Contribution margin ratio		0.32
sales revenue would be necessary to generate the operating income the company would realize if sales are $20,000,000 and the company continues to sell through agents (at a 22% commission rate)		17,031,250
Determine the sales revenue at which operating income would be the equal regardless of whether Crescent Corporation sells through sales agents ( at 22% commission rate) or employs its own sales force
Difference in Operating fixed cost (4450000-3400000)		1,050,000
Difference in Contribution margin ratio (0.32-0.22)		0.10
sales revenue at which operating income would be the equal		10,500,000
Analysis Of above answer
Sales level	Decision
Below 10500000	company retain the sales agents at 22% commission
Above 10500000	company employ its own sales force
Company should employ its own sales force. Because Current sales level is more than 10,500,000. In simple word, better option is option which has higher Operating income. (Check Part A Solution )