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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.

Presentation by: The Gainers


 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

Or

sale s  No sales force
fo rc e
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

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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
Question # 1

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 Break even Point
 (At 15%, 20% & with own sales
force)
a). 15% Commission
Sales $16,000,000 100%
Variable expenses:
Manufacturing over head 7,200,000
Commissions (15%) 2,400,000
Total variable expenses 9,600,000 60

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Contribution margin 6,400,000 40%
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 1,600,000
Less income taxes (30%) 480,000
Net income $ 1,120,000

Break-even point in dollar sales if the commission remains 15%.


Fixed costs $4,800,000
= =$12,000,000
CM ratio 0.40
b). 20% Commission
Sales $16,000,000 100%
Variable expenses:
Manufacturing over head 7,200,000
Commissions (20%) 3,200,000
Total variable expenses 10,400,000 65

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Contribution margin 5,600,000 35%
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

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 in th e sta te m e n ts b e lo w a re in
th o u sa n d s
Own Sales Force
Sales $16,000,000 100.0%
Variable expenses:
Manufacturing over head 7,200,000
Commissions ( 7.5%) 1,200,000
Total variable expenses 8,400,000 52.5
Contribution margin 7,600,000 47.5%
Fixed expenses:
Manufacturing overhead . 2,340,000 N o te :
Marketing 2,520,000* *$120,000 + $2,400,000 = $2,520,000.
Administrative 1,725,000** **$1,800,000 – $75,000 = $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

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  

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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% )
Dollar sales =toFixed expenses + Target income before
xes ta
attain target CM ratio
$4,800,000 + $1,600,000 $6,400,000
= = = $18,285,714
0.35 0.35
Question # 3

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 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 =  To tal Sale s re ve nue

0.65X +  $4,800,000 =  0.525X +  $7,125,000

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        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

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 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

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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
Recommendations
Question #5

Own sales force could generate higher net income. But

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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

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Que stio ns
?
Presentation by: The Gainers
Thank
you!

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