Management Accounting

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Summary of Case1
Question:2
Answer:3

Summary of Case
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 commission of 15% of selling price for all item sold.

The company’s budgeted income statement for next year follows: Pittman Company
Budgeted Income Statement
For the Year Ended December 31
Sales | | $16000000|
Manufacturing Costs:| | |
Variable| $7200000| |
Fixed Overhead| 2340000| 9540000|
Gross Margin| | 6460000|
Selling and Administrative Costs:| | |
Commissions to agents| 2400000 | |
Fixed marketing costs| 120000| |
Fixed administrative costs| 1800000| 4320000|
Net operating income| | 2140000|
Fixed interest cost| | 540000|
Income before income taxes| | 1600000|
Income Taxes 30%| | 480000|
Net income| | 1120000|

Scenario:
The sales agents want sales commissions increased to 20%, this will caused the commission to agents would increase to $3,200,000 (20%X $16,000,000). The management of Pittman Company suggested to employ company’s sales force and incurred $2,400,000 fixed costs for the sales force. Besides Pittman Company would also save $75,000 a year because no need to pay the audit firm for check out the agent reports, so the overall administrative costs would be less.

Question:
1. Compute Pittman Company’s break-even point in sales dollars for next year assuming: a. The agent’s commission rate remains unchanged at 15%. b. The agent’s commission rate is increased to 20%.

c. The company employ its own sales force.
2. Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determined the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year. 3. Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at 20% commission rate) or employs its own sales force. 4. Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming. d. The agent’s commission rate remains unchanged at 15%. e. The agent’s commission rate is increased to 20%.

f. The company employ its own sales force.
Use income before income taxes in your operating leverage computation. 5. Based on the data in (1) through (4) 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. Give reasons for your answer.

Answer:
1. Compute Pittman Company’s break-even point in sales dollars for next year assuming: (a) The agents’ commission rate remains unchanged at 15%. Break Even Point (sales dollars) =| Fixed Cost|

| CMR*|
=| $2340,000 + $120,000 + $1800,000| | 40%|
=| $4,260,000 | | 40%|
=| $10,650,000| | |
*Contribution Margin Ratio =| Contribution Margin| | Selling Price|
=| $16,000,000-$7,200,000-$2,400,000| | $16,000,000 |
=| $6,400,000 | | $16,000,000 |
=| 0.4| =| 40%|

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(b) The agents’ commission rate is increased to 20%.
Break Even Point (sales dollars) =| Fixed Cost|
| CMR*|...
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