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Case About Break Even Point

Case About Break Even Point

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Published by: adeeba hassan on Jul 27, 2010
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MADI HA SHAKI L 4423

FARHEEN KARI M ALI 4104
KHADDAM AHMED 4075
ADEEBA HUSSAM 3926
HASSAN RAHI M 3932
COST AND MANAGERIAL
ACCOUNTING
CASE 6-32 COST STRUCTURE;
BREAKEVEN; TARGET PROFITS
INTRODUCTION
Pi t t ma n c o mpa ny
Budgeted income statement
For the year ended December 31
Sales
$16,000,000
Manufacturing costs
Variable Costs 7,200,000
Fixed overhead 2,340,000 9,540,000
Gross margin 6,460,000
Selling and administrative costs:
Commissions to agents 2,400,000
Fixed marketing costs 120,000*
Fixed administrative costs 1,800,000 4,320,000
Net operating income 2,140,000
Less fixed interest cost 540,000
Income before income taxes 1,600,000
Less income taxes (30%) 480,000
Net income $1,120,000
Salaries
Sales manager $100,000
Salespersons 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total $ 2,4OO,OOO
THE BREAKDOWN OF THE COMMISSIONS TO AGENTS
($2,400,000)
Restructuring Data Into Contribution Format For
The 3 Alternatives
15% Commission
Sales ................................................................................................................................$16,000,000 @100%
Less variable expenses
Manufacturing..................................................................................................................7,200,000
Commissions (15%)......................................................................................................2,400,000
Total variable expenses......................................................................................... 9,600,000 @ 60%
Contribution marginǥǥǥǥ..................................................................................6,400,000 @40%
Less fixed expenses
Manufacturing overhead.............................................................................................2,340,000
Marketing..............................................................................................................................120,000
Administrative.................................................................................................................1,800,000
Interestǥ................................................................................................................................540,000
Total fixed expenses.....................................................................................4,800,000
Income before income taxesǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥǥ...1,600,000
Less income taxes (30%)...............................................................................................480,000
Net income ǥ..................................................................................................1,120,000
20% Commission
Sales .....................................................................................................16,000,000 @ 100%
Less variable expenses:
Manufacturing......................................................................................................7,200,000
Commissions (20%) ǥǥǥ..............................................................................3,200,000
Total variable expenses............................................................................10,400,000 @ 65%
Contribution margin.....................................................................................5,600,000 @ 35%
Less fixed expenses:
Manufacturing overhead..................................................................................2,340,000
Marketing................................................................................................................120,000
Administrative......................................................................................................1,800,000
Interest......................................................................................................................540,000
Total fixed expenses.......................................................................................4,800,000
Income before income taxes............................................................................ 800,000
Less income taxes (30%)...................................................................................240,000
Net income ............................................................................................................$560,000
Restructuring Data Into Contribution Format For
The 3 Alternatives
Own Sales Force
Sales ................................................................................................$16,00,0000 @ 100%
Less variable expenses:
Manufacturing..................................................................................7,200,000
Commissions 7.5% ǥǥǥǥ..........................................................1,200000
Total variable expenses................................................................8,400,000 @ 52.5%
Contribution margin......................................................................7,600,000 @ 47.5%
Less fixed expenses:
Manufacturing overhead..............................................................2,340,000
Marketing.............................................................................................2,520,000
Administrative...................................................................................1,725,000
Interest......................................................................................................540,000
Total fixed expenses.........................................................................7,125,000
Income before income taxes............................................................475,000
Less income taxes (30%)..................................................................142.500
Net income ............................................................................................ 332.500
Restructuring Data Into Contribution Format For
The 3 Alternatives
‡Fixed marketing cost increase by 2,400,000 so fixed marketing cost become $120,000 + $2,400,000 =
$2,520,000
‡ Fixed administrative cost decrease by 75,000 so fixes administrative cost become $1,800,000 ± $75,000 =
$1,725,000
1
ST
REQUIREMENT
Compute Pittman Company's
reak e en point in sales ollars
for t e next year assuming:
Agent¶s
commission
rate remains
unc ange
at 15%
Agent¶s
commission
rate
increase to
20%
Company
employs its
own sales
force
Break-even oint @ 15% commission
Fi ed costs/CM Ratio
= $4,800,000/ 0.4
=$12,000,000
Compute Pittman Company¶s
reak e en point in sales ollars
for t e next year assuming:
Agent¶s
commission
rate remains
unc ange
at 15%
Agent¶s
commission
rate
increase to
20%
Company
employs its
own sales
force
1
ST
REQUIREMENT
Break-even oint @ 20% commission
Fi ed costs/CM
Ratio
= $4,800,000/
0.35
=$13,714,286
Compute Pittman Company¶s
reak e en point in sales ollars
for t e next year assuming:
Agent¶s
commission
rate remains
unc ange
at 15%
Agent¶s
commission
rate
increase to
20%
Company
employs its
own sales
force
1
ST
REQUIREMENT
Fi ed costs/CM
Ratio
= $7,125,000/
0.475
=$15,000,000
Own Sales Force
Fi ed costs/CM
Ratio
= $7,125,000/
0.475
=$15,000,000
2nd
REQUIREMENT
Assume that ittman Company
decides:
‡ To continue selling through agents
‡ Pays the 20% commission rate
Determine the volume of
sales that would be required to
generate the same net income
as contained in the budgeted
income statement for the ne t
year.
= $18,285,714
=$6,400,000/0.35
=($4,800,000 + $1,600,000) / 0.35
Dollar Sales to Attain Target = (Fi ed E penses + Target Income
before Ta es )/ CM Ratio
In order to generate a $1,120,000 net income, the company must
generate $1,600,000 in income before ta es. Therefore
3rd
REQUIREMENT
Determine the volume of 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
above this sales level, the sales force plan would yield the largest net income.
Below this sales level, the commission plan would yield the largest net income
Thus, at a sales level of $18,600,000 either plan would yield the same income before
ta es and net income.
X = $18,600,000
X = $2,325,000 ÷ 0.125
0.125X = $2,325,000
0.65X $ ,800,000 = 0.525X $ ,125,000
X = Total Sales Revenue
we find the volume of sales where costs before income ta es under the two plans are
equal.
4th
REQUIREMENT
Compute the degree of operating leverage that
the company would e pect to have on
December 31 at the end of ne t year assuming:
Agents¶
commission rate
remains unchanged
at 15%.
Agents¶ commission
rate is increased to
20%.
Company employs
its own sales force.
15% Commission:
$6,400,000/$1,600,000
=4
Formula
‡ Operating L everage= Contribution Margin/ Net Income
4th
REQUIREMENT
Compute the degree of operating leverage that
the company would e pect to have on
December 31 at the end of ne t year assuming:
Agents¶
commission rate
remains unchanged
at 15%.
Agents¶ commission
rate is increased to
20%.
Company employs
its own sales force.
Formula
‡ Operating L everage= Contribution Margin/ Net Income
20% Commission: $5,600,000/$ 800,000 =7
4th
REQUIREMENT
Compute the degree of operating leverage that
the company would e pect to have on
December 31 at the end of ne t year assuming:
Agents¶
commission rate
remains unchanged
at 15%.
Agents¶ commission
rate is increased to
20%.
Company employs
its own sales force.
Formula
‡ Operating L everage= Contribution Margin/ Net Income
Own sales force: $7,600,000/$ 475,000 =16
5th
REQUIREMENT
Based on the data in (1) through
(4) above
make a recommendation as to
whether the company should
continue to use sales agents (at
20% commission rate)
or employs its own sales force.
Give reasons for your answer.
We would use the sales We would use the sales
agents for at least 1 agents for at least 1
more year or possibly more year or possibly
for 2 years for 2 years-- Reasons are Reasons are
1) would have a less 1) would have a less
effect on net income. effect on net income.
2) would give the 2) would give the
company more time company more time
to hire competent to hire competent
people and get the people and get the
sales group sales group
organized. organized.
3) The sales force 3) The sales force
plan doesn¶t become plan doesn¶t become
more desirable than more desirable than
the use of sales the use of sales
agents until the agents until the
company reaches company reaches
sales of $18,600,000 sales of $18,600,000
a year. a year.
4 ) The sales force 4 ) The sales force
plan will be highly plan will be highly
leveraged since it will leveraged since it will
greatly increase fixed greatly increase fixed
costs (and decrease costs (and decrease
variable costs). variable costs).
Thank you

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