CASE $5-32$ Cost Structure; Break$-$Even and Target Profit Analysis LO$5-4,$ LO$5-5,$ LO$5-6$ its products. These agents are paid a sales commission of $15\%$ for all items sold.

Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year as follows:

Pittman Company

Budgeted Income Statement

For the Year Ended December $31$

Sales

Manufacturing expenses:

Variable

Fixed overhead

Gross margin

Selling and administrative expenses:

Commissions to agents

Fixectmarketing expenses

Fixed administrative expenses

Net operating income

Fixed interest expenses

Income before income taxes

Income taxes $(30\%)$

Net income

"Primarily depreciation on storage facilities.

$$16,000,000$

$$7,200,000$

$2,340,{000}_{,}\frac{9,540,000}{6,460,000}$

$2,400,000$

$120,000$

$1,800,000,4,320,{000}_{?}$

$2,140,000$

$540,000$

$1,600,000$

$480,000$

$$1,120,000$ that they refuse to handle our products next year unless we increase the commission rate to $20\%."$

"They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing left over for profit," replied Barbara. commissions."

The breakdown of the $$2,400,000$ cost follows:

Salaries:

Sales manager

$$100,000$

Salespersons

$600,000$

Travel and entertainment

$400,000$

commissions."

The breakdown of the $$2,400,000$ cost follows:

Salaries:

Sales manager

Salespersons

Travel and entertainment

Advertising

Total

page $234$

"Super," replied Karl. "And I noticed that the $$2,400,000$ equals what we're paying the agents under the old $15\%$ commission rate." expenses would be less."

"Pull all of these numbers together and we'll show them to the executive committee tomorrow," said Karl. "With the approval of the committee, we can move on the matter immediately."

Required:

Compute Pittman Company's break$-$even point in dollar sales for next year assuming:

a$.$ The agents' commission rate remains unchanged at $15\%.$

b$.$ The agents' commission rate is increased to $20\%.$

c$.$ The company employs its own sales force. contained in the budgeted income statement for next year.

Determine the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents $($at a $20\%$ commission rate$)$ or employs its own sales force.

Compute the degree of operating leverage that the company would expect to have at the end of next year assuming:

a$.$ The agents' commission rate remains unchanged at $15\%.$

b$.$ The agents' commission rate is increased to $20\%.$

c$.$ The company employs its own sales force.

Use income before income taxes in your operating leverage computation. reasons for your answer.

$($CMA$,$ adapted$)$