Select cases are available in Connect. CASE 5-32 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 15% for all items sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income state- ment for next year as follows: Pittman Company Budgeted Income Statement For the Year Ended December 31 Sales $ 16,000,000 Manufacturing expenses: Variable. .. $7,200,000 Fixed overhead . 2,340,000 9,540,000 Gross margin . .. 6,460,000 Selling and administrative expenses: Commissions to agents . 2,400,000 Fixed marketing expenses. 120,000 Fixed administrative expenses .. .. ...... . . 1,800,000 4,320,000 Chorqol Net operating income. . . 2, 140,000 Fixed interest expenses 540,000 Income before income taxes. . 1,600,000 Income taxes (30%) . . . . . . 480,000 Net income . ..... . . . . $ 1,120,000 *Primarily depreciation on storage facilities. As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, "I went ahead and used the agents' 15% commission rate in completing these statements, but we've just learned that they refuse to handle our products next year unless we increase the commission rate to 20%." "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 20% commission rate?" "They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing left over for profit," replied Barbara. "I say it's just plain robbery," 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 about pay a 7.5% 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 $2,400,000 per year, but that 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 follows: Salaries: Sales manager. . $ 100,000 Salespersons . . 600,000 Travel and entertainment. 400,000 Advertising . ..... 1,300,000 s boitic Total . .... $2,400,000
