Managerial Accounting: Case 5-33 Pittman Company is a small but growing manufacturer.XLSX

Managerial Accounting: Case 5-33 Pittman Company is a small but growing manufacturer

Managerial Accounting
Case 5-33 Cost Structure; Break-Even; Target Profits
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 markets its products. These agents are paid a sales commission of 15% for all items sold. Karl Vecci, Pittman's controller, has just prepared the company's budgeted income statement for next year. The statement follows:
Pittman Company
Budgeted Income Statement
For the Year Ended December 31
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 expenses 120,000
Fixed administrative costs 1,800,000 4,320,000
Net operating income 2,140,000
Less: Fixed interest costs 540,000
Income before income taxes 1,600,000
incomes taxes (30%) 480,000
Net Income $1,120,000
*Primarily depreciation on storage facilities

This statement was made using agents 15% commission rate, but next year will increase to 20%. Several companies they know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, they have to handle promotional cost, too. They figure their 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 they would avoid on agents' commissions.
The break down of the $2,400,000 cost follows:
Salaries
Sales manager 100,000
Salespersons 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total $2,400,000

"Super", replied Karl. "And I noticed that the $2,400,000 is just what we're paying the agents under the old 15% commission rate.
"It's even better than that," explained Barbara. "We can actually save $75,000 a year because that's what we're having to pay the auditing firm now to check out the agents' reports. So our overall administrative costs would be less."
"Put all of these numbers together and we'll 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 company's break-even point in dollar sales for next year assuming:
a. the agents' commission rate remains unchanged at 15%
b. the agents' commission rate is increased to 20%.
c. the company employs its own sales force
2.) Assume that pittman company decided 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.
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:
a. the agents' commission rate remains unchanged at 15%
b. the agents' commission rate is increased at 20%
c. the company employs 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 20% commission rate) or employ its own sales force. Give reasons for your answer
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