Question

ittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission of 15% for all items sold.

Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year as follows:

Pittman Company Budgeted Income Statement For the Year Ended December 31
Sales				$	25,000,000
Manufacturing expenses:
Variable	$	11,250,000
Fixed overhead		3,500,000			14,750,000
Gross margin					10,250,000
Selling and administrative expenses:
Commissions to agents		3,750,000
Fixed marketing expenses		175,000	*
Fixed administrative expenses		2,160,000			6,085,000
Net operating income					4,165,000
Fixed interest expenses					875,000
Income before income taxes					3,290,000
Income taxes (30%)					987,000
Net income				$	2,303,000

*Primarily depreciation on storage facilities.

As Barbara handed the statement to Karl Vecci, Pittman’s president, she commented, “I went ahead and used the agents’ 15% commission rate in completing these statements, but we’ve just learned that they refuse to handle our products next year unless we increase the commission rate to 20%.”

“That’s the last straw,” Karl replied angrily. “Those agents have been demanding more and more, and this time they’ve gone too far. How can they possibly defend a 20% commission rate?”

“They claim that after paying for advertising, travel, and the other costs of promotion, there’s nothing left over for profit,” replied Barbara.

“I say it’s just plain robbery,” retorted Karl. “And I also say it’s time we dumped those guys and got our own sales force. Can you get your people to work up some cost figures for us to look at?”

“We’ve already worked them up,” said Barbara. “Several companies we know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $3,750,000 per year, but that would be more than offset by the $5,000,000 (20% × $25,000,000) that we would avoid on agents’ commissions.”

The breakdown of the $3,750,000 cost follows:

Salaries:
Sales manager	$	156,250
Salespersons		937,500
Travel and entertainment		625,000
Advertising		2,031,250
Total	$	3,750,000

“Super,” replied Karl. “And I noticed that the $3,750,000 equals what we’re paying the agents under the old 15% commission rate.”

“It’s even better than that,” explained Barbara. “We can actually save $115,000 a year because that’s what we’re paying our auditors to check out the agents’ reports. So our overall administrative expenses would be less.”

“Pull all of these numbers together and we’ll show them to the executive committee tomorrow,” said Karl. “With the approval of the committee, we can move on the matter immediately.”

Required:

1. Compute Pittman Company’s break-even point in dollar sales for next year assuming:

a. The agents’ commission rate remains unchanged at 15%.

b. The agents’ commission rate is increased to 20%.

c. The company employs its own sales force.

2. Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year.

3. Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force.

4. Compute the degree of operating leverage that the company would expect to have at the end of next year assuming:

a. The agents’ commission rate remains unchanged at 15%.

b. The agents’ commission rate is increased to 20%.

c. The company employs its own sales force.

Use income before income taxes in your operating leverage computation.

• equired 1
• Required 2
• Required 3
• Required 4

Compute Pittman Company’s break-even point in dollar sales for next year assuming: (Round CM ratio to 3 decimal places and final answers to the nearest dollar amount.)

	Break-Even Point a. The agents’ commission rate remains unchanged at 15%. b. The agents’ commission rate is increased to 20%. c. The company employs its own sales force.

Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year. (Round CM ratio to 3 decimal places and final answer to the nearest dollar amount.)

	Volume of sales (in dollars)

Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. (Do not round intermediate calculations.)

	Volume of sales (in dollars)

Compute the degree of operating leverage that the company would expect to have at the end of next year assuming: (Use income before income taxes in your operating leverage computation.) (Round your answers to 2 decimal places.)

	Degree of Operating Leverage a. The agents’ commission rate remains unchanged at 15%. b. The agents’ commission rate is increased to 20%. c. The company employs its own sales force.

Answer 1

Breakeven point is levelof sales where neither profit or nor loss. In simple words, Income before tax must be zero for achieve break even sales point. It means interest consider for calculation of breakeven sales

Part 1A
Option : independent sales agents commission remains unchanged at 15%
			Pittman Company
Budgeted Contribution Income Statement
Sales		25,000,000
Less: Variable cost
Variable Cost of goods sold	11,250,000
Commissions (Sales * 15%)	3,750,000
Total variable cost		15,000,000
Contribution margin		10,000,000
Fixed cost
Fixed Manufacture cost	3,500,000
Fixed marketing cost	175,000
Fixed administrative cost	2,160,000
Fixed interest expenses	875,000
Total Fixed cost		6,710,000
Income before tax		3,290,000
Contribution margin		10,000,000
Divided by: Sales		25,000,000
Contribution margin ratio		0.400
Total Fixed cost		6,710,000
Divided by: Contribution margin ratio		0.400
break-even point in sales revenue		$        16,775,000

Part 1B
Option : independent sales agents commission increased to 20%
			Pittman Company
Budgeted Contribution Income Statement
Sales		25,000,000
Less: Variable cost
Variable Cost of goods sold	11,250,000
Commissions (Sales * 20%)	5,000,000
Total variable cost		16,250,000
Contribution margin		8,750,000
Fixed cost
Fixed Manufacture cost	3,500,000
Fixed marketing cost	175,000
Fixed administrative cost	2,160,000
Fixed interest expenses	875,000
Total Fixed cost		6,710,000
Income before tax		2,040,000
Contribution margin		8,750,000
Divided by: Sales		25,000,000
Contribution margin ratio		0.350
Total Fixed cost		6,710,000
Divided by: Contribution margin ratio		0.350
break-even point in sales revenue		$    19,171,429

Part 1C
Option : company employs its own sales force.
			Pittman Company
Budgeted Contribution Income Statement
Sales		25,000,000
Less: Variable cost
Variable Cost of goods sold	11,250,000
Commissions (Sales * 7.5%)	1,875,000
Total variable cost		13,125,000
Contribution margin		11,875,000
Fixed cost
Fixed Manufacture cost	3,500,000
Fixed marketing cost	175,000
Fixed administrative cost	2,160,000
Fixed interest expenses	875,000
Net increase in Fixed cost due to own sales force (3750000-115000saving)	3,635,000
Total Fixed cost		10,345,000
Income before tax		1,530,000
Contribution margin		11,875,000
Divided by: Sales		25,000,000
Contribution margin ratio		0.475
Total Fixed cost		10,345,000
Divided by: Contribution margin ratio		0.475
break-even point in sales revenue		$      21,778,947

Part 2
Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the dollar sales that would be required to generate the same net income as contained in the budgeted income statement for next year ?
Target Profit before tax (For Achieve Net income of 2303000)		3,290,000
Add: Total Fixed cost		6,710,000
Total Contribution Required for achieve Target		10,000,000
Divided by: Contribution margin ratio		0.350
sales revenue would be necessary to generate net income as per Budgeted		$      28,571,429
Part 3
Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. (Do not round intermediate calculations.)
Difference in fixed cost (10345000-6710000)		3,635,000
Difference in Contribution margin ratio (0.400-0.350)		0.050
sales revenue at which operating income would be the equal		72,700,000

Part 4
Actual formula of operating levarage =Contribution margin divided by Earning before interest and tax.but here as per question instruction, we can use income before income taxes in operating leverage computation.
	Part 4 A	Part 4 B	Part 4 C
Option	unchanged at 15%	increased to 20%	own sales force
Contribution margin	10,000,000	8,750,000	11,875,000
Divided by: Income before tax	3,290,000	2,040,000	1,530,000
operating leverage (rounded to 2 decimal places)	3.04	4.29	7.76