CVP Analysis; Commissions; Ethics Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019:Lionel Corporation Budgeted Income Statement For the Year Ending June 30, 2019 ($000 omitted)Sales $28,500Cost of goods sold   Variable$12,825  Fixed    3,500  16,325Gross profit $12,175Selling and administrative costs   Commissions$ 5,130  Fixed advertising cost800  Fixed administrative cost    2,150    8,080Operating income $ 4,095 Fixed interest cost 705Income before income taxes $ 3,390 Income taxes (30%) 1,017Net income $ 2,373Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel’s president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel’s controller, to gather information on the costs associated with this change.Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $600,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $150,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $500,000 if the eight salespeople are hired.RequiredDetermine Lionel’s breakeven point in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement. If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement.Describe the general assumptions underlying breakeven analysis that may limit its usefulness.What is the indifference point in sales for the firm to either accept the agents’ demand or adopt the proposed change? Which plan is better for the firm? Why?What are the ethical issues, if any, that Alan should consider?(CMA Adapted)

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Asked Jul 19, 2019
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CVP Analysis; Commissions; Ethics Lionel Corporation manufactures pharmaceutical products sold through a network of sales agents in the United States and Canada. The agents are currently paid an 18% commission on sales; that percentage was used when Lionel prepared the following budgeted income statement for the fiscal year ending June 30, 2019:

Lionel Corporation Budgeted Income Statement For the Year Ending June 30, 2019 ($000 omitted)

Sales

 

$28,500

Cost of goods sold

 

 

 Variable

$12,825

 

 Fixed

    3,500

  16,325

Gross profit

 

$12,175

Selling and administrative costs

 

 

 Commissions

$ 5,130

 

 Fixed advertising cost

800

 

 Fixed administrative cost

    2,150

    8,080

Operating income

 

$ 4,095

 Fixed interest cost

 

705

Income before income taxes

 

$ 3,390

 Income taxes (30%)

 

1,017

Net income

 

$ 2,373

Since the completion of the income statement, Lionel has learned that its sales agents are requiring a 5% increase in their commission rate (to 23%) for the upcoming year. As a result, Lionel’s president has decided to investigate the possibility of hiring its own sales staff in place of the network of sales agents and has asked Alan Chen, Lionel’s controller, to gather information on the costs associated with this change.

Alan estimates that Lionel must hire eight salespeople to cover the current market area, at an average annual payroll cost for each employee of $80,000, including fringe benefits expense. Travel and entertainment expenses is expected to total $600,000 for the year, and the annual cost of hiring a sales manager and sales secretary will be $150,000. In addition to their salaries, the eight salespeople will each earn commissions at the rate of 10% of sales. The president believes that Lionel also should increase its advertising budget by $500,000 if the eight salespeople are hired.

Required

  1. Determine Lionel’s breakeven point in sales dollars for the fiscal year ending June 30, 2019, if the company hires its own sales force and increases its advertising costs. Prove this by constructing a contribution income statement. 

  2. If Lionel continues to sell through its network of sales agents and pays the higher commission rate, determine the estimated volume in sales dollars that would be required to generate the operating profit as projected in the budgeted income statement.

  3. Describe the general assumptions underlying breakeven analysis that may limit its usefulness.

  4. What is the indifference point in sales for the firm to either accept the agents’ demand or adopt the proposed change? Which plan is better for the firm? Why?

  5. What are the ethical issues, if any, that Alan should consider?

(CMA Adapted)

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Expert Answer

Step 1

Note: Since we are entitled to answer up to 3 sub-parts, we’ll answer the first 3. Please resubmit the question and specify the other subparts (up to 3) you’d like to get answered.

Cost-volume profit analysis is a tool that helps in decision making by establishing a relationship between volume, price, variable cost, fixed cost and profit.

Step 2

To calculate Break-even point:

Contribution margin ratio= contribution margin ÷ sales

                                         = $12,825 ÷ 28,500

                                         = 45%

Total fixed operating expenses= $8,340

Break-even point (in sales $) = Total fixed expenses ÷ Contribution margin ratio

                                               = $8,340 ÷ 45%

                                               = $18,533

1. Contribution income statement
$000.S
S'000s
28,500
Selling price per unit
Less: Variable expenses
Variable COGS
Variable sales commission (10% 28,500)
Total variable expenses
Contribution margin
Less: Fixed expenses
Fixed COGS
Fixed sales salaries (S80,000 x 8)
Fixed advertising cost (800 +500)
Travel and entertainment expenses
Cost of hiring sales manager
Fixed administrative costs
Total fixed expenses
Operating expenses
Less: Fixed interest cost
Income before income taxes
Less: Income tax (30%)
Net income
12,825
2,850
(15,675)
12,825
3,500
640
1,300
600
150
2,150
(8,340)
4,485
(705)
3,780
(1,134)
2,646
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1. Contribution income statement $000.S S'000s 28,500 Selling price per unit Less: Variable expenses Variable COGS Variable sales commission (10% 28,500) Total variable expenses Contribution margin Less: Fixed expenses Fixed COGS Fixed sales salaries (S80,000 x 8) Fixed advertising cost (800 +500) Travel and entertainment expenses Cost of hiring sales manager Fixed administrative costs Total fixed expenses Operating expenses Less: Fixed interest cost Income before income taxes Less: Income tax (30%) Net income 12,825 2,850 (15,675) 12,825 3,500 640 1,300 600 150 2,150 (8,340) 4,485 (705) 3,780 (1,134) 2,646

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Step 3

2) Values are in $’000s.

 Existing budgeted contribution= Existing budgeted sales – existing budgeted COGS – existing budgeted variable commission

                                                     = $28,500 - $12,825 - $5,130

                                                     = $10,545

Existing contribution margin ratio= existing budgeted contribution margin ÷ sales

                                                      = $10,545 ÷ $28,500

             &nb...

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