Question

Decision Making Activities:

Nardeb company is a software producer and sales company. currently, it pays all sales staff on a fixed base salary. recently management has been considering switching sales staff across to an incentive based reward system. Nardeb's chief accountant Polly Xu has prepared some summarized numbers. for senior management to consider.

Michael Day comments that he cannot see the difference, as sales level and profit are unchanged. Xu argues that it is the difference in cost structure that matters. She argues that the entity is better off staying with the current structure, because the increase in profit is greater when sales levels increase than it would be with the incentive rewards..

	with fixed rewards	with incentive rewards
sales	2500000	2500000
variable costs	1500000	2000000
contribution margin	1000000	500000
fixed costs	750000	250000
profit	250000	250000

a. Explain the basis of Polly Xu's argument

b. calculate the contribution margin ratio under each alternative.

c. if sales were to increase by 10%, which alternative would produce the highest increase in profit?

d. prepare a statement of profit or loss for each alternative.

Answer 1

Answer is given below

(1- Contribution margin ratio ) = Variable cost ratio