Question

Pittman 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 18% for all items sold. Barbara Cheney, Pittman’s controller, has just prepared the company’s budgeted income statement for next year. The statement follows: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales $ 16,900,000 Manufacturing expenses: Variable $ 7,350,000 Fixed overhead 2,460,000 9,810,000 Gross margin 7,090,000 Selling and administrative expenses: Commissions to agents 3,042,000 Fixed marketing expenses 150,000* Fixed administrative expenses 1,950,000 5,142,000 Net operating income 1,948,000 Fixed interest expenses 570,000 Income before income taxes 1,378,000 Income taxes (20%) 275,600 Net income $ 1,102,400 *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’ 18% 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 23%.” “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 23% 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 6.3% 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 $3,042,000 per year, but that would be more than offset by the $3,887,000 (23% × $16,900,000) that we would avoid on agents’ commissions.” The breakdown of the $3,042,000 cost follows: Salaries: Sales manager $ 130,000 Salespersons 750,000 Travel and entertainment 520,000 Advertising 1,642,000 Total $ 3,042,000 “Super,” replied Karl. “And I noticed that the $3,042,000 is just what we’re paying the agents under the old 18% commission rate.” “It’s even better than that,” explained Barbara. “We can actually save $90,000 a year because that’s what we’re having to pay the auditing firm now 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: (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places and final answers to the nearest dollar amount.) a. The agents’ commission rate remains unchanged at 18%. b. The agents’ commission rate is increased to 23%. c. The company employs its own sales force.

Answer 1

	(a)	(b)	(c)
Sales	16900000	16900000	16900000
Variable costs:
Manufacturing expenses	7350000	7350000	7350000
Commission to agents (18%, 23%, 6.3%)	3042000	3887000	1064700
Total variable costs	10392000	11237000	8414700
Contribution margin	6508000	5663000	8485300
Fixed costs:
Manufacturing expenses	2460000	2460000	2460000
Marketing expenses	150000	150000	3192000
Administrative expenses	1950000	1950000	1860000
Interest expenses	570000	570000	570000
Total fixed costs	5130000	5130000	8082000
Income before taxes	1378000	533000	403300
Income tax expense	275600	106600	80660
Net income	1102400	426400	322640
Contribution margin ratio	0.385	0.335	0.502
Contribution margin/Sales
Break-even in dollar sales
Fixed costs/Contribution margin ratio	13324675	15313433	16099602

Marketing expenses = 150000 + 3042000 = $3192000

Administrative expenses = 1950000 - 90000 = $1860000