Janice Smalls is a manufacturer of equipment. The company does not have a sales force; however, they do have independent sales agents to market its products, they are paid a commission of 15% of selling price for all items sold.

JANICE SMALLS

Income Statement

For the Year Ended December 31 2011

Sales $16,000,000

Manufacturing costs:

Variable $7,200,000

Fixed overhead 2,340,000 9,540,000

Gross margin.. 6,460,000

Selling and administrative costs:

Commissions to agents. 2,400,000

Fixed marketing costs... 120,000*

Fixed administrative costs 1,800,000 4,320,000

Net operating income. 2,140,000

Less fixed interest cost 540,000

Income before income taxes 1,600,000

Less income taxes (30%). 480,000

Net income.. $1,120,000

Henry used the agents 15% commission rate in completing these statements, but he just learned that they refuse to handle our products next year unless we increase the commission rate to 20%. Elizabeth wants to know if you can work up some cost figures.

Henry said Weve already worked them up, Several companies we know about pay a 7.5% commission to their own salespeople, along with a small salary. We would have to handle all promotion costs, too and our fixed costs would increase by $2,400,000 per year, but it would be more than offset by the $3,200,000 (20% x $16,000,000) that we would avoid on agents commissions.

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

Salaries:

Sales manager $ 100,000

Salespersons.. 600,000

Travel and entertainment.. 400,000

Advertising.. 1,300,000

Total $ 2,400,000

And I note that the $2,400,000 is just what were paying the agents under the old 15% commission rate.Its even better than that, explained Henry, Janice Smalls can save $75,000 per year because thats what we have to pay the auditing firm now to check out the agents reports, resulting in our overall administrative costs would be less. Pull all of these numbers together and well show them to the executive committee tomorrow.

a. Using Excel, prepare contribution format income statements for each of the three alternatives.

b. Compute Pittman Companys break-even point in sales dollars for next

year assuming:

That the agents commission rate remains unchanged at 15%.

That the agents commission rate is increased to 20%.

That the company employs its own sales force.

Use income before income taxes in your break-even computation.

c. Assume that Janice Smalls decides to continue selling through agents and pays the 20% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year. Use income before taxes in your break-even computation.

d. Based on the data in 1, 2, and 3 above, make a recommendation as to whether the company should continue to use sales agents at a 20%commission rate or employ its own sales force, what is the reasons for your answer.