Question
Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies 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, just prepared the company’s budgeted income statement 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
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 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 after paying for advertising, travel, and the other costs of promotion, there’s nothing left over for profit,” replied Barbara.
“That’s ridiculous,” 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 of 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% × $16,000,000) 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
Total $ 2,400,000
“Super,” replied Karl. “And I noticed the $2,400,000 equals 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 paying our auditors to check out the agents’ reports. So our overall administrative expenses would be less.”
“Pull 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.”
Compute Pittman Company’s break-even point in dollar sales for next year assuming
The company employs its own sales force.
Barbara Cheney, Pittman’s controller, just prepared the company’s budgeted income statement 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
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 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 after paying for advertising, travel, and the other costs of promotion, there’s nothing left over for profit,” replied Barbara.
“That’s ridiculous,” 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 of 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% × $16,000,000) 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
Total $ 2,400,000
“Super,” replied Karl. “And I noticed the $2,400,000 equals 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 paying our auditors to check out the agents’ reports. So our overall administrative expenses would be less.”
“Pull 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.”
Compute Pittman Company’s break-even point in dollar sales for next year assuming
The company employs its own sales force.
Answers
GPT-4o mini
To calculate Pittman Company's break-even point in dollar sales for next year assuming it employs its own sales force, we need to determine the fixed and variable costs.
### Step 1: Gather Costs
#### Fixed Costs:
1. Sales Manager Salary: $100,000
2. Salespersons Salaries: $600,000
3. Travel and Entertainment: $400,000
4. Advertising: $1,300,000
5. Fixed Marketing Expenses: $120,000 (remains unchanged)
6. Fixed Administrative Expenses: $1,800,000
7. Auditors’ Fees: -$75,000 (this will be a saving, thus will reduce fixed costs)
**Total Fixed Costs Calculation:**
\[
\text{Total Fixed Costs} = \text{Sales Manager} + \text{Salespersons} + \text{Travel and Entertainment} + \text{Advertising} + \text{Fixed Marketing Expenses} + \text{Fixed Administrative Expenses} - \text{Savings on Auditors' Fees}
\]
\[
\text{Total Fixed Costs} = 100,000 + 600,000 + 400,000 + 1,300,000 + 120,000 + 1,800,000 - 75,000
\]
\[
\text{Total Fixed Costs} = 3,265,000
\]
#### Variable Costs:
The variable costs will include manufacturing expenses and the sales commission for the own sales force.
1. **Variable Manufacturing Expenses**: $7,200,000 (as stated in the budget)
2. **Sales Commission at 7.5%** on Sales:
\[
\text{Commission} = 0.075 \times 16,000,000 = 1,200,000
\]
**Total Variable Costs Calculation:**
\[
\text{Total Variable Costs} = \text{Variable Manufacturing Expenses} + \text{Sales Commission}
\]
\[
\text{Total Variable Costs} = 7,200,000 + 1,200,000 = 8,400,000
\]
### Step 2: Contribution Margin
The contribution margin (CM) is calculated by subtracting variable costs from sales.
\[
\text{Contribution Margin} = \text{Sales} - \text{Total Variable Costs}
\]
\[
\text{Contribution Margin} = 16,000,000 - 8,400,000 = 7,600,000
\]
The contribution margin ratio (CM ratio) can also be useful in determining the break-even point:
\[
\text{CM Ratio} = \frac{\text{Contribution Margin}}{\text{Sales}} = \frac{7,600,000}{16,000,000} = 0.475
\]
### Step 3: Break-even Point Calculation
The break-even point in dollar sales can be calculated using the formula:
\[
\text{Break-even Point (S)} = \frac{\text{Total Fixed Costs}}{\text{CM Ratio}}
\]
\[
\text{Break-even Point (S)} = \frac{3,265,000}{0.475} \approx 6,865,263.16
\]
### Conclusion
Thus, the break-even point in dollar sales for Pittman Company, if it employs its own sales force, is approximately **$6,865,263.16**.
### Step 1: Gather Costs
#### Fixed Costs:
1. Sales Manager Salary: $100,000
2. Salespersons Salaries: $600,000
3. Travel and Entertainment: $400,000
4. Advertising: $1,300,000
5. Fixed Marketing Expenses: $120,000 (remains unchanged)
6. Fixed Administrative Expenses: $1,800,000
7. Auditors’ Fees: -$75,000 (this will be a saving, thus will reduce fixed costs)
**Total Fixed Costs Calculation:**
\[
\text{Total Fixed Costs} = \text{Sales Manager} + \text{Salespersons} + \text{Travel and Entertainment} + \text{Advertising} + \text{Fixed Marketing Expenses} + \text{Fixed Administrative Expenses} - \text{Savings on Auditors' Fees}
\]
\[
\text{Total Fixed Costs} = 100,000 + 600,000 + 400,000 + 1,300,000 + 120,000 + 1,800,000 - 75,000
\]
\[
\text{Total Fixed Costs} = 3,265,000
\]
#### Variable Costs:
The variable costs will include manufacturing expenses and the sales commission for the own sales force.
1. **Variable Manufacturing Expenses**: $7,200,000 (as stated in the budget)
2. **Sales Commission at 7.5%** on Sales:
\[
\text{Commission} = 0.075 \times 16,000,000 = 1,200,000
\]
**Total Variable Costs Calculation:**
\[
\text{Total Variable Costs} = \text{Variable Manufacturing Expenses} + \text{Sales Commission}
\]
\[
\text{Total Variable Costs} = 7,200,000 + 1,200,000 = 8,400,000
\]
### Step 2: Contribution Margin
The contribution margin (CM) is calculated by subtracting variable costs from sales.
\[
\text{Contribution Margin} = \text{Sales} - \text{Total Variable Costs}
\]
\[
\text{Contribution Margin} = 16,000,000 - 8,400,000 = 7,600,000
\]
The contribution margin ratio (CM ratio) can also be useful in determining the break-even point:
\[
\text{CM Ratio} = \frac{\text{Contribution Margin}}{\text{Sales}} = \frac{7,600,000}{16,000,000} = 0.475
\]
### Step 3: Break-even Point Calculation
The break-even point in dollar sales can be calculated using the formula:
\[
\text{Break-even Point (S)} = \frac{\text{Total Fixed Costs}}{\text{CM Ratio}}
\]
\[
\text{Break-even Point (S)} = \frac{3,265,000}{0.475} \approx 6,865,263.16
\]
### Conclusion
Thus, the break-even point in dollar sales for Pittman Company, if it employs its own sales force, is approximately **$6,865,263.16**.