I.

TITLE OF THE CASE: Pittman company

II. FACTS OF THE CASE:

Pittman company is a small but growing manufacturer of telecommunications equipment.
The company has no sales force of its own; it avails the service of sales agents to market its
products. These agents are being paid 15% of the selling price as commissions.

Barbara Cheney, Pittman’s controller, created the company’s budgeted income statement for
next year as stated below

The breakdown of the $2,400,000 cost follows:

Barbara handed it to the company’s president and informed him that agents now refuse to
handle their products unless commissions will be increased into 20%

With this demand of the sales agent; the company is now considering the option of
establishing its own sales force with lesser commission rate of 7.5% and a small salary.

III. STATEMENT OF THE PROBLEM/REQUIREMENTS:

 1. Compute the Pittman Company’s break even point in sales dollars 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 employ its own sales force.

2. Assume that Pittman Company decides to continue selling through agents and 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 next
year.

3. Determine the volume of sales at which net income would be equal regardless of
whether pittman company sells through agents or employ its own sales force.

4. Compute the degree of operating leverage that the company would expect to have on
Dec 31 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 computations

5. Based on the data in 1 to 4 above make a recommendation as to whether the company

should continue to use sales agents (at a 20% commission rate) or employ its own sales
force. Give reasons for your answer.

IV. ANALYSIS/SOLUTION
1. Company’s breakeven point at different commission rates are as follows
a. When commission rate remains unchanged at 15%
Based on below budgeted income statement
 Breakeven point (@15%) = Fixed costs / CM Ratio
= $ 4,800,000 / 0.4
= $ 12,000,000
b. When commission rate is increased to 20%
Based on below budgeted income statement

Breakeven point (@20%) = Fixed costs / CM Ratio

= $ 4,800,000 / 0.35
= $ 13,714,286

c. When company employs its own sales force

 Breakeven point (@7.5%) = Fixed costs / CM Ratio
= $ 7,125,000 / 0.475
= $ 15,000,000

2. Determine the volume of sales that would be required to generate the same net
income as contained in the budgeted income statement for next year. (@20%)

Dollar sales to attain target = (Fixed expenses + Target income before taxes) / CM Ratio

= ($4,800,000 + $1,600,000)/ .35

= $18,285,714

3. Determine the volume of sales at which net income would be equal regardless of
whether pittman company sells through agents or employ its own sales force

X= TOTAL SALES REVENUE

0.65X + $4,800,000 = 0.525X + $7,125,000
0.125X = $2,325,000
X = $2,325,000 / 0.125
X= $18,600,000

4. Compute the degree of operating leverage that the company would expect to have on
Dec 31 at the end of next year assuming:
 a. The agents’ commission rate remains unchanged at 15%
Degree of Operating Leverage = CM/Net income
DOL= $6,400,000 / $1,600,000
DOL= 4

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

Degree of Operating Leverage = CM/Net income
DOL= $ 5,600,000 / $800,000
DOL= 7

c. The company employs its own sales force.

Degree of Operating Leverage = CM/Net income
DOL= $7,600,000 / $475,000
DOL= 16

V. CONCLUSION (answer to question 5)

Based on the data in 1 to 4 above make a recommendation as to whether the company
should continue to use sales agents (at a 20% commission rate) or employ its own sales
force. Give reasons for your answer.

Answer: We would continue to use the agents for at least one more year, and possibly
for two more years because

a. First, use of the sales agents would have a less dramatic effect on net income.
b. Second, use of the sales agents for at least one more year would give the company
more time to hire competent people and get the sales group organized.
c. Third, the sales force plan doesn’t become more desirable than the use of sales
agents until the company reaches sales of $18,600,000 a year
d. Fourth, the sales force plan will be highly leveraged since it will greatly increase
fixed costs (and decrease variable costs).

VI. RECOMMENDATION
It is important you analyze every item of the financial statements and to make a
statement out of financial analysis of these statements. Not because it appears that you could
eliminate cost on one item means that it would already be a good decision. Opportunity cost
must be considered and also the cost-benefit.
Moreover, it is essential to compute the degree of operating leverage to know how stable
the company would be. The higher the degree of operating leverage means the more
unpredictable the company is; slight change can greatly affect your company’s performance.

APPENDIX
 The budgeted income statement at 20% commission rate and same net income as of 15%

The comparative statement at 15%, 20% and 7.5% commission rate at breakeven

Commission rate 15% 20% 7.50%

Sales 18,600,000 18,600,000 18,600,000
Manufacturing 9,410,000 8,480,000 8,480,000
Commissions 2,790,000 3,720,000 1,395,000
Total variable expenses 12,200,000 12,200,000 9,875,000
Contribution Margin 6,400,000 6,400,000 8,725,000
Less fixed expenses
Manufacturing overhead 2,340,000 2,340,000 2,340,000
Marketing 120,000 120,000 2,520,000
Administrative 1,800,000 1,800,000 1,725,000
Interest 540,000 540,000 540,000
Total fixed expenses 4,800,000 4,800,000 7,125,000
Income before income taxes 1,600,000 1,600,000 1,600,000
Income taxes 480,000 480,000 480,000
Net income 1,120,000 1,120,000 1,120,000