Course: Cost Accounting Course I.

D: 9703

Pittman’s Case study
[Case 6-32]
Barbara Karl Vecci Group Name : The Gainers Presenters:   (3833) •   
 

Instructor: Mr. Arsalan Hashmi

Case

 

The company’s budgeted income statement that Barbara has prepared for the next year is by assuming 15% commission. But they have just learned that agents refused to handle Pittman's’ products unless the commission rate is 20%. Karl Vecci, Pitman’s President says it’s time we dumped those guys and got our own sales force and asked Barbara to work up some cost figures to look at the matter

Presentation by: The Gainers

Or
sale s  fo rc e No sales force

Pittman Company Budgeted Income Statement For year Ended December Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,000,000 Manufacturing costs: Variable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. $7,200,000 Fixed overhead. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 2,340,000 9,540,000 Gross margin. . . . . . . . . . . . . . . . . . . . . . . . . . . 6,460,000 Selling & Administrative costs: Commission to agents(15%). . . . . . . . . . . . . . . . .. . . . . . 2,400,000 Fixed marketing costs. . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000 Fixed administrative cost . . . . . . . . . . . . . . . . . . . . . . . . . 1,800,000 4,320,000 Net Operating profit/ 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

Presentation by: The Gainers

Question # 1

Presentation by: The Gainers

Break even Point (At 15%, 20% & with own sales force)

a).
Sales Variable expenses: Manufacturing over head Commissions (15%) Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Marketing Administrative Interest Total fixed expenses Income before income taxes Less income taxes (30%) Net income

15% Commission $16,000,000 7,200,000 2,400,000 9,600,000 6,400,000 2,340,000 120,000 1,800,000 540,000 4,800,000 1,600,000 480,000 $ 1,120,000 100%

60 40%

Presentation by: The Gainers

Break-even point in dollar sales if the commission remains 15%.
Fixed costs $4,800,000 = =$12,000,000 CM ratio 0.40

b).
Sales Variable expenses: Manufacturing over head Commissions (20%) Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Marketing Administrative Interest Total fixed expenses Income before income taxes Less income taxes (30%) Net income

20% Commission $16,000,000 7,200,000 3,200,000 10,400,000 5,600,000 2,340,000 120,000 1,800,000 540,000 4,800,000 800,000 240,000 $  560,000 100%

65 35%

Presentation by: The Gainers

Break-even point in dollar sales if the commission increases to 20%.

Fixed costs $4,800,000 = =$13,714,286 CM ratio 0.35

c). T h e d a ta i th e sta te m e n ts b e l w a re i n o n th o u sa n d s
Sales Variable expenses: Manufacturing over head Commissions ( 7.5%) Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead . Marketing Administrative Interest Total fixed expenses Income before income taxes Less income taxes (30%) Net income

Own Sales Force $16,000,000 100.0% 7,200,000 1,200,000 8,400,000 7,600,000 2,340,000 2,520,000* 1,725,000** 540,000 7,125,000 475,000 142,500 $  332,500 52.5 47.5%

N o te :
*$120,000 + $2,400,000 = $2,520,000. **$1,800,000 – $75,000 = $1,725,000.

Break-even point in dollar sales if the company employs its own sales force.

Fixed costs $7,125,000 = =$15,000,000 CM ratio 0.475 Presentation by: The Gainers

QUESTION #  2
Vo lume  o f sale s that wo uld be   re quire d to  ge ne rate  the  same   se t inc o me  as c o ntinue d in the   budge te d inc o me  state me nt  (20% )
xes Dollar sales = Fixed expenses + Target income before ta to attain target CM ratio = $4,800,000 + $1,600,000 $6,400,000 = = $18,285,714 0.35 0.35
Presentation by: The Gainers

Question # 3

Presentation by: The Gainers

Volume of sales at which net income would be equal in both cases whether it is 20% commission rate or employs its sales force

X =  T tal Sale s re ve nue o 0.65X +  $4,800,000 =  0.525X +  $7,125,000
Presentation by: The Gainers

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

Question #4
 

Presentation by: The Gainers

Degree of Operating leverage (At 15%, 20% & with own sales force)

a) Degree of operating leverage, when commission rate remains unchanged at 15% = $6,400,000 = 4 $1,600,000 b) Degree of operating leverage, when commission rate is 20% = $5,600,000 = 7 $   800,000 c) Degree of operating leverage, when employs its own sales force = $7,600,000 = 16 $   475,000

Presentation by: The Gainers

Presentation by: The Gainers

Recommendations

Question #5

 

Own sales force could generate higher net income. But of course, company would have to handle all promotion costs, too. So the fixed cost would increase by $2,400,000, which would decrease the net income, and The breakeven point of owning sales force is higher that means more sales are required in order to earn higher profit. The company could generate higher profit by increasing sales, as the operating leverage is higher (16) For the moment, profits will be greater and risks will be lesser by staying with the agents, even at the higher 20% commission rate

Presentation by: The Gainers

Presentation by: The Gainers

Que stio ns ?

Presentation by: The Gainers

Thank you!

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