CASE 434 Cost Structure; Break-Even Point; Target Profits [LO4, LO5, LO6]

Crescent Corporation manufactures multi-function photocopiers that are sold to businesses

through a network of independent sales agents located in the United States and Canada. These

sales agents sell a variety of products to businesses in addition to Crescents multi-function

photocopiers. The sales agents are currently paid a 19% commission on sales, and this commission

rate was used when Crescents management prepared the following budgeted income

statement for the upcoming year:

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,000,000

Cost of goods sold:

Variable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,400,000

Fixed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400,000 9,800,000

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,200,000

Selling and administrative expenses:

Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,850,000

Fixed advertising expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000

Fixed administrative expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600,000 4,850,000

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 350,000

Since the completion of the above statement, Crescents management has learned that

the independent sales agents are demanding an increase in the commission rate to 22% 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, Crescents management has decided to

investigate the possibility of hiring its own sales staff to replace the independent sales

agents.

Crescents controller estimates that the company would have to hire six salespeople to

cover the current market area, and the total annual payroll cost of these employees would be

about $350,000, including benefits. The salespeople would also be paid commissions of 12% of

sales. Travel and entertainment expenses are expected to total about $200,000 for the year. The

company would also have to hire a sales manager and support staff, whose salaries and benefits

would total $100,000 per year. To make up for the promotions that the independent sales

agents had been running on behalf of Crescent, management believes that the companys budget

for fixed advertising expenses should be increased by $250,000.

Required:

1. Assuming sales of $15,000,000, construct a budgeted contribution format income statement

for the upcoming year for each of the following alternatives:

a. The independent sales agents commission rate remains unchanged at 19%.

b. The independent sales agents commission rate increases to 22%.

c. The company employs its own sales force.

2. Calculate Crescent Corporations break-even point in sales dollars for the upcoming year

assuming the following:

a. The independent sales agents commission rate remains unchanged at 19%.

b. The independent sales agents commission rate increases to 22%.

c. The company employs its own sales force.

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Chapter 4 CostVolumeProfit Relationships 149

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 operating income the company would

realize if sales are $15,000,000 and the company continues to sell through agents (at a 22%

commission rate)?

4. Determine the volume of sales at which operating income would be equal regardless of

whether Crescent Corporation sells through agents (at a 22% commission rate) or employs

its own sales force.

5. Prepare a profit graph on which you plot the profits for both of the following alternatives:

a. The independent sales agents commission rate increases to 22%.

b. The company employs its own sales force.

On the graph, use total sales revenue as the measure of activity.

6. Write a memo to the president of Crescent Corporation in which you recommend whether

the company should continue to use independent sales agents (at a 22% commission rate)

or employ its own sales force. Fully explain the reasons for your recommendation in the

memo.