Question

Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019

Lionel Corporation
Budgeted Income Statement
For the Year Ending June 30, 2019
($000 omitted)
Sales				$	29,000
Cost of goods sold
Variable	$	13,050
Fixed		3,480			16,530
Gross profit				$	12,470
Selling and administrative costs
Commissions	$	5,220
Fixed advertising cost		870
Fixed administrative cost		2,320			8,410
Operating income				$	4,060
Fixed interest cost					725
Income before income taxes				$	3,335
Income taxes (30%)					1,001
Net income				$	2,335

Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel’s president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel’s controller, to gather information on the costs associated with this change.

Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $650,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $175,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $550,000 if the eight salespeople are hired.

Required

1. Determine Lionel’s breakeven point (operating profit = 0) in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement.

2. If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement.

REQUIREMENT 1

Determine Lionel’s breakeven point (operating profit = 0) in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement. (Do not round intermediate calculations. Enter your answers in thousands of dollars.)

	Breakeven point (in sales dollars) Contribution Income Statement Variable costs: $0 $0 Fixed costs: $0 $0

• Required 2

If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement. (Do not round intermediate calculations. Enter your answers in thousands of dollars.)

	Estimated volume (in sales dollars)

Answer 1

( $000 omitted)

sales for year ending 30th June 2019 = $29000

variable cost = $13050

variable cost as a % of sales = 13050/29000*100 = 45%

If company hires the 8 sales persons then the cost involved will be =

salary $80000*8 = $640

entertainment expenses = $650

sales manager salary = $175

commission 10% of sales(let sales be x) = 0.10x

fixed cost of hiring sales persons = 640+650+175 = $1465

variable cost of commission = 0.10x

calculation for breakeven point for sale

x = 0.45x + 3480+1465+0.1x + 1420+ 2320

x - 0.45x- 0.1x= 8685

x = 8685/0.45 =$ 19300

sales	x	$19,300
cost of sales
variable cost	0.45x	$8,685
fixed cost	$3,480	$3,480
gross profit		$7,135
selling and administration costs
fixed advertising costs	550 +870	$1,420
fixed salary to sales team	$1,465	$1,465
commision to sales team(variable)	0.10x	$1,930
fixed administration costs	$2,320	$2,320
selling and administration costs		$7,135
Net operating profit		$0

1. break even point in sales $ = $19300

If the company continues with the sales agent and pays the increased commission,

let sales be = x, sales commission = 23% 0f x, variable cost of goods sold = 45% of x

x - 0.45x - 3480 - 870 - 0.23x - 2320 = 4060

x = 10730/.32 = $33531.25

sales	x	$33,531.25
cost of sales
variable cost	0.45x	$15,089.06
fixed cost	$3,480	$3,480.00
gross profit		$14,962.19
selling and administration costs
fixed advertising costs	$870	$870.00
commission	0.23x	$7,712.19
fixed administration costs	$2,320	$2,320.00
selling and administration costs
Net operating profit		$4,060