Case 3-32 Cost Structure; Break-Even Point; Target Profits [LO3-4, LO3-5, LO3-6]

Question

Case 3-32 Cost Structure; Break-Even Point; Target Profits [LO3-4, LO3-5, LO3-6] Marston Corporation manufactures disposable thermometers that are sold to hospitals through a network of independent sales agents located in the United States and Canada. These sales agents sell a variety of products to hospitals in addition to Marston's disposable thermometer. The sales agents are currently paid an 16% commission on sales, and this commission rate was used when Marston's management prepared the following budgeted absorption income statement for the upcoming year. Marston Corporation Budgeted Income Statement Sales $ 35,000,000 Cost of goods sold: Variable $ 17,200,000 Fixed 2,790,000 19,990,000 Gross margin 15,010,000 Selling and administrative expenses: Commissions 5,600,000 Fixed advertising expense 740,000 Fixed administrative expense 2,800,000 9,140,000 Net operating income $ 5,870,000 Since the completion of the above statement, Marston’s management has learned that the independent sales agents are demanding an increase in the commission rate to 18% of sales for the upcoming year. This would be the third increase in commissions demanded by the independent sales agents in five years. As a result, Marston’s management has decided to investigate the possibility of hiring its own sales staff to replace the independent sales agents. Marston's controller estimates that the company will have to hire eight salespeople to cover the current market area, and the total annual payroll cost of these employees will be about $610,000, including fringe benefits. The salespeople will also be paid commissions of 10% of sales. Travel and entertainment expenses are expected to total about $360,000 for the year. The company will also have to hire a sales manager and support staff whose salaries and fringe benefits will come to $190,000 per year. To make up for the promotions that the independent sales agents had been running on behalf of Marston, management believes that the company’s budget for fixed advertising expenses should be increased by $470,000. Required: 1. Assuming sales of $35,000,000, construct a budgeted contribution format income statement for the upcoming year for each of the following alternatives (Enter your answers in thousands of dollars (i.e., 15,000,000 should be entered as 15,000.)): a. The independent sales agents' commission rate remains unchanged at 16%. b. The independent sales agents' commission rate increases to 18%. c. The company employs its own sales force. 2. Calculate Marston Corporation's break-even point in sales dollars for the upcoming year assuming the following: (Round the CM ratio to 2 decimal places. Enter your answers in whole dollars and not in thousands.) a. The independent sales agents' commission rate remains unchanged at 16%. b. The independent sales agents' commission rate increases to 18%. c. The company employs its own sales force. 3. Refer to your answer to (1)(b) above. If the company employs its own sales force, what volume of sales would be necessary to generate the net operating income the company would realize if sales are $35,000,000 and the company continues to sell through agents (at a 18% commission rate)? (Round the CM ratio to 2 decimal places. Enter your answers in whole dollars and not in thousands.) 4. Determine the volume of sales at which net operating income would be equal regardless of whether Marston Corporation sells through agents (at a 18% commission rate) or employs its own sales force. (Round the CM ratio to 2 decimal places. Enter your answers in whole dollars and not in thousands.)

Explanation / Answer

Solution 1)

Solution 2)

Solution 3)

Fixed elements = 7960 + 5170 = 13130

Volume of sales for attaining Net Operating Income of 5170 by employing own sales force =

=13130 / 40.85% =$ 32142

Solution 4)

Sales (32.85%) - 6330 = Sales (40.85%) - 7960

Sales = $20375 (where net operating income be equal)

Particulars No change (16% comm.) At 18% comm to agents Own sales force Sales 35000 35000 35000 Less: Variable costs: CGS 17200 17200 17200 COMMISSION 5600 22800 6300 23500 3500 20700 Contribution (34.85%) 12200 (32.85%) 11500 (40.85%) 14300 Less: Fixed Costs: CGS 2790 2790 2790 ADVERTISEMENT 740 740 1210 ADMINISTRATIVE 2800 6330 2800 6330 3960 7960 Net Operating Income 5870 5170 6340

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