Ptman Company is a small but growing manufacturer of telecommunications equipmen

Question

Ptman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of ts own rather, t relies complete on independen sales a ents to market its pro ucts. These a ents are paid a sales commission of 15% for all Iterns sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year as follows Budgeted Income Statesent Sales Hanufacturing expenses: 18,500,e00 Variable Fixed overhead 8,325,00e 2,598, 1,915,000 7,S85,eee Gross margin Selling and administrative expenses: Commissions to agents Fixed marketing expenses Fixed administrative expenses 2,775,009 129,500* 1,900,090 Net operating income Fixed interest expenses Income before income taxes Income taxes (3ex) Net income 4,8e4,se8 2,780,58e 647,500 2,133,00e 639,900 $ 1.493,100 "Primartly depreciation on storage facilities. As Barbara handed the statement to Karl commission rate in completing these stotements, but we've just learned that they refuse to hande our products next year unless we vecc?, Pittman's president, she commented, "I went ahead and used the agents' 15% increase the commission rate to 20% Thar's the last strew. Kar repled angn y. Those agents have been demanding more and more, and this time they've gone too for How can they possibly defend a 20% commission rate?" They claim that after paying for advertsing, trave. and the other costs of promotion, there's nothing left over for profit; repilied Barbara. robbery" retorted Karl. And i also say it's time we dumped those guys and got our own sales force Can you get your people to work up some cost figures for us to look a1? e Several companies we know about pay a 75% commission to their own sales eo along with a small salary Of course, we would have to nandle all promotion costs, too. We figure our fixed expenses would increose by $2775.000 per year, but that would be more than omset by the S3700000 20% . s8.500000, that we would avoid on agents commissions. said Barbara e already worked them up

Explanation / Answer

Answer:-

1)Pittman Company's Break Even Sales in terms of dollars :

a) under 1st assumption :- commission rates remains unchanged - 15% of sales value.

calculations:-

Variable cost as % to the sales

Variable cost = $ 8,325,000

Sales = $18,500,000

Percetage of sales = 8325000/18500000 = 45%

and Commission to agent = 15%

therefore total Variable cost in percetage terms = 45+15 = 60%

so contribution margin = 40%

TOtal Fixed Cost of Pittman =

Fixed Overhead = $2590000

Fixed Marketing Overhead = $ 129500

Fixed Administrative Overhead = $ 1900000

Fixed Interest Expenses = $ 647500

Total = 2590000+129500+1900000+647500 = $5,267,000

Calculation of Break Even Point in Dollars =

Fixed Costs/ Contribution Margin

= $5,267,000/ 40% = $ 13,167,500 Revenue required for break even .

b) Under assumption of 20 % sales commission .

As we already calculated

Fixed cost = $5,267,000

Contribution Margin = 40% - (20-15%)

that comes to 40-5% = 35%

Break even sales in dollars =

$5,267,000 / 35% = $ 15,485,714.43 sales revenue required for break even

c) the company employs its own force

Answer :-

As we already calculated

Total Fixed Costs = $5,267,000

Adjustments :-

1. Fixed Force salary = $2,775,000 added to the fixed costs

2. Auditors cost - $85,100 to be deducted as this will be saved from postioning own work force in the field.

Total Fixed costs = $5267000 + 2,775,000 - 85,100 = $7,956,900

Contribution margin = 40%

Adjustments :-

1. As new force was positioned on behalf of agents commission to them will no longer required to be paid so , 15% to be added back to contribution margin

40+15% = 55%

Break Even sales in relation to dollars = $7,956,900/ 55%

= $ 14,467,090.91 required break even sales in dollars

2. Decided to give 20% commission rate

dollar sales that would required to generate same level of profit ?

Answer:-

Budgeted Current level of profit before taxes = $2,133,000

Budgeted Current Level of sales = $ 18,500,000

Budgeted Variable cost % = 45 % excluding Commission % of 15

inclusive of commission = 60%

Contribution margin = 100-60% = 40%

therefore contribution in dollars = 18,500,000 *40% = $740,000

same contribution margin required to be maintained by company if wants to have same level of profit.

that means

Required contribution = Sales value * Contribution margin

$740,000 = Sales value * 35% ( as 5% of increase in commission rate will decrease contribution margin )

sales value = $ 740,000 / 35%

=$ 21,142,857.14 of sales value required to kept the same level of profit.

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