Question

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Monterey Co. makes and sells a single product. The current selling price is $17 per unit. Variable expenses are $10.2 per unit, and fixed expenses total $31,000 per month.

(Unless otherwise stated, consider each requirement separately.)

Management is considering a change in the sales force compensation plan. Currently each of the firm's two salespeople is paid a salary of $2,500 per month.

g-1. Calculate the monthly operating income (or loss) that would result from changing the compensation plan to a salary of $400 per month, plus a commission of $0.85 per unit, assuming a sales volume of 5,000 units per month. (Do not round intermediate calculations.)

g-2. Calculate the monthly operating income (or loss) that would result from changing the compensation plan to a salary of $400 per month, plus a commission of $0.85 per unit, assuming a sales volume of 6,200 units per month. (Do not round intermediate calculations. Losses should be indicated by a minus sign.)

h-1. Assuming that the sales volume of 6,200 units per month achieved in part g could also be achieved by increasing advertising by $1,000 per month instead of changing the sales force compensation plan. What would be the operating income or loss? (Do not round intermediate calculations. Losses should be indicated by a minus sign.)

h-2. Which strategy would you recommend?

• Plan to change the sales force compensation.

• Plan to increase advertising expenses.

Answer 1

Solution

Monterey Co

g-1. calculation of the monthly operating income (loss) that would result from changing the compensation plan to a salary of $400 per month plus a commission of $0.85 per unit, assuming a sales volume of 5,000 units per month:

Monterey Company
Income Statement
Sales at $17 each	$85,000
Variable costs:
variable expenses	$51,000
Sales commission	$4,250
Total variable costs	$55,250
Contribution Margin	$29,750
Less: fixed expenses:	$31,400
Net Loss		($1,650)

The company incurs a net loss of $1,650 when the compensation plan comprises salary of $400 per month plus sales commission of $0.85 per unit at 5,000 units per month.

g-2. calculation of the monthly operating income (loss) that would result from changing the compensation plan to a salary of $400 per month plus a commission of $0.85 per unit, assuming a sales volume of 6,200 units per month:

Monterey Company
Income Statement
Sales at $17 each	$105,400
Variable costs:
variable expenses	$63,240
Sales commission	$5,270
Total variable costs	$68,510
Contribution Margin	$36,890
Less: fixed expenses:	$31,400
Net Loss		$5,490

The company reports net income of $5,490 when the compensation plan comprises salary of $400 per month plus sales commission of $0.85 per unit at 6,200 units per month.

Note: for the above two computations, the fixed expenses includes $400 per month for sales salary.

h-1. Determination of the operating income or loss resulting from changing compensation plan to increasing advertising expenses assuming sales of 6,200 units:

Monterey Company
Income Statement
Sales at $17 each	$105,400
Variable costs:	$63,240
Contribution margin	$42,160
Less: fixed expenses	$32,000
Net Income		$10,160

Note: the fixed expenses comprise of $1,000 for advertising expense.

h-2. recommendation –

Plan to increase advertising expenses.

Explanation: the net income for plan to increase advertising expenses by $1,000 earns higher net income $10,160 compared to the net income of $5,490 earned under plan to change the sales force compensation. Hence, plan to increase advertising expenses is recommended.