Case 5-33 Cost Structure; Break-Even and Target Profit Analysis [LO5-4, LO5-5, LO5-6]

Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission of 18% for all items sold.

Barbara Cheney, Pittmans controller, has just prepared the companys budgeted income statement for next year. The statement follows:

As Barbara handed the statement to Karl Vecci, Pittmans president, she commented, I went ahead and used the agents 18% commission rate in completing these statements, but weve just learned that they refuse to handle our products next year unless we increase the commission rate to 23%.

Thats the last straw, Karl replied angrily. Those agents have been demanding more and more, and this time theyve gone too far. How can they possibly defend a 23% commission rate?

They claim that after paying for advertising, travel, and the other costs of promotion, theres nothing left over for profit, replied Barbara.

I say its just plain robbery, retorted Karl. And I also say its 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?

Weve already worked them up, said Barbara. Several companies we know about pay a 7.6% 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 $3,528,000 per year, but that would be more than offset by the $4,508,000 (23% $19,600,000) that we would avoid on agents commissions.

Super, replied Karl. And I noticed that the $3,528,000 is just what were paying the agents under the old 18% commission rate.

Its even better than that, explained Barbara. We can actually save $135,000 a year because thats what were having to pay the auditing firm now to check out the agents reports. So our overall administrative costs would be less.

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

Required:

1.

Compute Pittman Companys break-even point in dollar sales for next year assuming: (Enter your answer in whole dollars and not in thousands. Round CM ratio to 3 decimal places and final answer to the nearest dollar amount.)

Pittman Company For the Year Ended December 31 Sales Manufacturing expenses: 5 19,600,000 Variable S 7,800,000 Fixed overhead 2,820,000 10,620,000 8,980,000 Gross margin Selling and administrative expenses 3,528,000 240,000 Commissions to agents Fioxed marketing expenses Fixxed administrative expenses 2,400,000 ,168,000 Net operating income Foxed interest expenses S 2,812,000 880,000 Income before income taxes Income taxes (40%) 2,152,000 880,800 Net income 1,291,200 Primarily depreciation on storage facilities Pittman Company For the Year Ended December 31 Sales Manufacturing expenses: 5 19,600,000 Variable S 7,800,000 Fixed overhead 2,820,000 10,620,000 8,980,000 Gross margin Selling and administrative expenses 3,528,000 240,000 Commissions to agents Fioxed marketing expenses Fixxed administrative expenses 2,400,000 ,168,000 Net operating income Foxed interest expenses S 2,812,000 880,000 Income before income taxes Income taxes (40%) 2,152,000 880,800 Net income 1,291,200 Primarily depreciation on storage facilities