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CASE 5 - 3 2 Cost Structure; Break - Even and Target Profit Analysis LO 5 - 4 , LO 5 - 6 , LO
CASE Cost Structure; BreakEven and Target Profit Analysis LO LO LO Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies on independent sales agents to market its products. These agents are paid a sales commission of for all items sold. Barbara Cheney, Pittman's controller, just prepared the company's budgeted income state ment for next year as follows: Pittman Company Budgeted Income Statement For the Year Ended December Primarity depreciation on storage facilities. As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went ahead and used the agents' commission rate in completing these statements, but we've just learned they refuse to handle our products next year unless we increase the commission rate to "That's the last straw," Karl replied angrily. "Those agents have been demanding more and more, and this time they've gone too far. How can they possibly defend a commission rate?" "They claim after paying for advertising, travel, and the other costs of promotion, there's noth ing left over for profit," replied Barbara. "That's ridiculous," 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 at "We've already worked them up said Barbara. "Several companies we know of pay a commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $ per year, but that would be more than offset by the $$ we would avoid on agents' commissions." The breakdown of the $ cost follows: Salaries: Sales manager. $ Salespersons Travel and entertainment. Advertising Total. "Super," replied Karl. "And I noticed the $ equals what we're paying the agents under the old commission rate." "It's even better than that," explained Barbara. We can actually save $ a year because that's what we're paying our auditors to check out the agents' reports. So our overall administrative expenses would be less." "Pull all of these numbers together and we'll show them to the executive committee tomor row," said Karl. "With the approval of the committee, we can move on the matter immediately." Required: Compute Pittman Company's breakeven point in dollar sales for next year assuming: a The agents' commission rate remains unchanged at b The agents' commission rate is increased to c The company employs its own sales force. Assume Pittman Company decides to continue selling through agents and pays the com mission rate. Calculate the dollar sales required to generate the same net income as contained in the budgeted income statement for next year. Calculate the dollar sales at which net income would be equal regardless of whether Pittman Company sells through agents at a commission rate or employs its own sales force. Compute the degree of operating leverage the company would expect to have at the end of next year assuming: a The agents' commission rate remains unchanged at b The agents' commission rate is increased to c The company employs its own sales force. Use income before income taxes in your operating leverage computation. Based on the data in through above, make a recommendation whether the company should continue to use sales agents at a commission rate or employ its own sales force. Give reasons for your answer.
CASE Cost Structure; BreakEven and Target Profit Analysis LO LO LO
Pittman Company is a small but growing manufacturer of telecommunications equipment.
The company has no sales force of its own; rather, it relies on independent sales agents to market
its products. These agents are paid a sales commission of for all items sold.
Barbara Cheney, Pittman's controller, just prepared the company's budgeted income state
ment for next year as follows:
Pittman Company
Budgeted Income Statement
For the Year Ended December
Primarity depreciation on storage facilities.
As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went
ahead and used the agents' commission rate in completing these statements, but we've just
learned they refuse to handle our products next year unless we increase the commission rate to
"That's the last straw," Karl replied angrily. "Those agents have been demanding more and
more, and this time they've gone too far. How can they possibly defend a commission rate?"
"They claim after paying for advertising, travel, and the other costs of promotion, there's noth
ing left over for profit," replied Barbara.
"That's ridiculous," 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 at
"We've already worked them up said Barbara. "Several companies we know of pay a
commission to their own salespeople, along with a small salary. Of course, we would have to
handle all promotion costs, too. We figure our fixed expenses would increase by $ per
year, but that would be more than offset by the $$ we would avoid
on agents' commissions."
The breakdown of the $ cost follows:
Salaries:
Sales manager. $
Salespersons
Travel and entertainment.
Advertising
Total. "Super," replied Karl. "And I noticed the $ equals what we're paying the agents
under the old commission rate."
"It's even better than that," explained Barbara. We can actually save $ a year because
that's what we're paying our auditors to check out the agents' reports. So our overall administrative
expenses would be less."
"Pull all of these numbers together and we'll show them to the executive committee tomor
row," said Karl. "With the approval of the committee, we can move on the matter immediately."
Required:
Compute Pittman Company's breakeven point in dollar sales for next year assuming:
a The agents' commission rate remains unchanged at
b The agents' commission rate is increased to
c The company employs its own sales force.
Assume Pittman Company decides to continue selling through agents and pays the com
mission rate. Calculate the dollar sales required to generate the same net income as contained
in the budgeted income statement for next year.
Calculate the dollar sales at which net income would be equal regardless of whether Pittman
Company sells through agents at a commission rate or employs its own sales force.
Compute the degree of operating leverage the company would expect to have at the end of
next year assuming:
a The agents' commission rate remains unchanged at
b The agents' commission rate is increased to
c The company employs its own sales force.
Use income before income taxes in your operating leverage computation.
Based on the data in through above, make a recommendation whether the company
should continue to use sales agents at a commission rate or employ its own sales force.
Give reasons for your answer.
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