Question

The HighStep Shoe Company operates a chain of shoe stores that sell 10 different styles of inexpensive men's shoes with identical unit costs and selling prices. A unit is defined as a pair of shoes. Each store has a store manager who is paid a fixed salary. Individual salespeople receive a fixed salary and a sales commission. HighStep is considering opening another store that is expected to have the revenue and cost relationships shown here: Unit Variable Data (per pair of shoes)

Annual Fixed Costs Selling price $60.00

Rent $30,000

Cost of shoes $37.00

Salaries 100,000

Sales commission 3.00

Advertising 40,000

Variable cost per unit $40.00

Other fixed costs 10,000

Total fixed costs $180,000

HighStep Shoe Company is considering an alternative compensation plan; one in which the sales commissions are discontinued and fixed salaries are raised by a total of $15,500, Assume the role of the owner of HighStep Shoe Company.

1. As owner, which sales compensation plan would you choose if forecasted annual sales of the new store were at least 10,000? What do you think of the motivational aspect of your chosen compensation plan?

2. Suppose the target operating income is $69,000. How many units must be sold to reach the target operating income under (a) the original salary-plus-commissions plan and (b) the higher- fixed-salaries-only plan? Which method would you prefer? Explain briefly.

3. You open the new store on January 1, 2017, with the originalsalary-plus-commission compensation plan in place. Because you expect the cost of the shoes to rise due to inflation, you place a firm bulk order for 11,000 shoes and lock in the $37 price per unit. But toward the end of the year, only 9,500 shoes aresold, and you authorize a markdown of the remaining inventory to $50 per unit.Finally, all units are sold. Salespeople, as usual, get paid a commission of 55% of revenues. What is the annual operating income for the store? Create an Operating Income Statement (Emphasizing Contribution Margin)

Answer 1

Answer 1.
Contribution Format Income Statement
	Compensation Plan
	With Sales Commission	Fixed Salaries
Sales in Units	10,000.00	10,000.00
Sales	600,000.00	600,000.00
Less: Variable Costs
Cost of shoe - $37 per Shoe	370,000.00	370,000.00
Sales Commission - $3 per Shoe	30,000.00	-
Total Variable Costs	400,000.00	370,000.00
Contribution	200,000.00	230,000.00
Less: Fixed Costs
Rent	30,000.00	30,000.00
Salaries	100,000.00	115,500.00
Advertising	40,000.00	40,000.00
Other Fixed Costs	10,000.00	10,000.00
Total Fixed Costs	180,000.00	195,500.00
Net Operating Profit	20,000.00	34,500.00
As Owner, Fixed Salaries Plan should be considered and adopted, since Net Opearating Profit is more than Commisson based compensation.
As a motivational aspect, the employees will be less motivated in Fixed Salaries based compensation, since their overall salary income (Fixed Salary + Compensation) is reduced by $14,500 in Fixed Salaries based Compensation.
Answer 2-a.
Original Salary plus Commission Plan
Contribution per Unit = $60 - ($37 + $3) = $20
BEP (In Units + Target Profit) = (Fixed Costs + Target Profit) / Contribution per Unit
BEP (In Units + Target Profit) = ($180,000 + $69,000) / $20
BEP (In Units + Target Profit) = 12,450 units
Answer 2-b.
Higher Fixed Salaries
Contribution per Unit = $60 - ($37 + $0) = $23
BEP (In Units + Target Profit) = (Fixed Costs + Target Profit) / Contribution per Unit
BEP (In Units + Target Profit) = ($195,500 + $69,000) / $23
BEP (In Units + Target Profit) = 11,500 units
Answer 3.
Contribution Format Income Statement
(With Original salary + Commission Plan)
Sales in Units	11,000.00
Sales - 9,500 Units x $60 + 1,500 Units X $37	625,500.00
Less: Variable Costs
Cost of shoe - $37 X 11,000	407,000.00
Sales Commission - 5% of $625,000	31,275.00
Total Variable Costs	438,275.00
Contribution	187,225.00
Less: Fixed Costs
Rent	30,000.00
Salaries	100,000.00
Advertising	40,000.00
Other Fixed Costs	10,000.00
Total Fixed Costs	180,000.00
Net Operating Profit	7,225.00