Managerial Accounting
Managerial Accounting
16th Edition
ISBN: 9781259995484
Author: Ray Garrison
Publisher: MCGRAW-HILL HIGHER EDUCATION
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Chapter 5, Problem 33C
To determine

Break-Even Point:

A break-even point is the point where a company is neither making profit nor incurring any loss.

Target Profit Analysis:

It is an analysis of how much unit sales or dollar sales value a company must attain to realize the target profit estimated by the company.

Degree of operating leverage:

A degree of operating leverage shows the impact of operating leverage on the operating income of a company.

1. Pittman Company’s break-even point in dollar sales

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.The required sales in dollars to generate same net income if the company pays the 20% commission rate.

3. The required sales in dollars to generate same net income regardless of whether company sells through agents or employs its own sales force.

4. The degree of operating leverage

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.

5. Recommendation to make a decision.

Expert Solution & Answer
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Answer to Problem 33C

Solution:

1. Pittman Company’s break-even point in dollar sales

a. The agents’ commission rate remains unchanged at 15% is $12,000,000.

b. The agents’ commission rate is increased to 20% is $13,714,285.7.

c. The company employs its own sales force is $15,000,000.

2. The required sales in dollars to generate same net income if the company pays the 20% commission rate is $18,285,714.

3. At $18,600,000 of sales, the company will generate same amount of net income regardless of whether it sells through agents or employs its own sales force.

4. The degree of operating leverage

a. The degree of operating leverage at 15% is 4.

b. The degree of operating leverage at 20% is 7.

c. If the company employs its own sales force, the degree of operating leverage will be 16.

5. It is recommended that the company should continue using the sales agents at 20% commission rate as it provides a better net income, break-even point and degree operating leverage.

Explanation of Solution

1. Compute Pittman Company’s break-even point in dollar sales for next year assuming;

    Breakeven point in dollar sales = Fixed expensesContribution margin ratio

    a. The agents’ commission rate remains unchanged at 15%

                Breakeven point in dollar sales =  $4,800,000 0.40                                                              = $12,000,000   

    b. The agents’ commission rate is increased to 20%

                Breakeven point in dollar sales =  $4,800,000 0.35                                                              = $13,714,286   

    c. The company employs its own sales force.

                Breakeven point in dollar sales =  $7,125,000 0.475                                                              = $15,000,000   

2. Computation of required sales in dollars to acquire a target profit of $1,600,000 if the company pays 20% commission rate.

  Required sales in dollars =  Fixed expenses + Target profit Contribution margin ratio                                       =  $4,800,000 + $1,600,000 0.35                                       = $18,285,714

3. Computation of dollar sales where net income will be equal whether company sells through 20% commission rate or employs own sales force.

Assume the sales volume is X.

   So,X*65% + $4,800,000 = X*52.5 + $7,125,000     0.65X  0.525X = $7,125,000 + $4,800,000     0.125X = $2,325,000      X = $2,325,000/0.125     X = $18,600,000

4. Computation of degree of operating leverage

  Degree of operating leverage = Contribution marginNet income before tax

a. The agents’ commission rate remains unchanged at 15%.

  Degree of operating leverage =  $6,400,000 $1,600,000                                               = 4 

b. The agents’ commission rate is increased to 20%

  Degree of operating leverage =  $5,600,000 $800,000                                                 = 7

c. The company employs its own sales force.

  Degree of operating leverage =  $7,600,000 $475,000                                                = 16

Pittman Company

Contribution Format Income Statement

For the Year Ended December 31

15%

Agents

Commission

20%

Agents

Commission

Owns Sales

Force

Sales

$16,000,000

100%

$16,000,000

100%

$16,000,000

100%

Variable expenses:

Manufacturing expenses

$7,200,000

$7,200,000

$7,200,000

Commissions to agents

$2,400,000

$3,200,000

$1,200,000

Total variable expenses

$9,600,000

60%

$10,400,000

65%

$8,400,000

52.5%

Contribution margins

$6,400,000

40%

$5,600,000

35%

$7,600,000

47.5%

Fixed expenses:

Manufacturing overheads

$2,340,000

$2,340,000

$2,340,000

Marketing expenses

$120,000

$120,000

$2,520,000

Administrative expenses

$1,800,000

$1,800,000

$1,725,000

Interest expenses

$540,000

$540,000

$540,000

Total fixed expenses

$4,800,000

$4,800,000

$7,125,000

Income before tax

$1,600,000

$800,000

$475,000

Income tax (30%)

$480,000

$240,000

$142,500

Net income

$1,120,000

$560,000

$332,500

Conclusion

It is concluded that Pittman Company should stick with sales agents at 20% commission rate because the decrease in the sales decrease in commission to 7.5% and the administrative expenses by $75,000 is actually less than the increase of fixed expenses of $2,400,000 which results in decreased net income before tax. A break-even point is technique used the companies to predict the outcome of a decision based on the analysis. It shows the exact point where a company will neither make profit nor suffer loss. The lower the break-even point, a company is more likely to make more profits and the higher the break-even point, a company is at high risk of incurring loss.

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Chapter 5 Solutions

Managerial Accounting

Ch. 5.A - Case 5A-11 Mixed Cost Analysis and the Relevant...Ch. 5.A - CASE 5A-12 Analysis of Mixed Costs in a Pricing...Ch. 5 - Prob. 1QCh. 5 - Often the most direct route to a business decision...Ch. 5 - Prob. 3QCh. 5 - What is the meaning of operating leverage?Ch. 5 - What is the meaning of break-even point?Ch. 5 - 5-6 In response to a request from your immediate...Ch. 5 - Prob. 7QCh. 5 - Prob. 8QCh. 5 - Prob. 9QCh. 5 - Prob. 1AECh. 5 - Prob. 2AECh. 5 - Prob. 3AECh. 5 - Prob. 4AECh. 5 - Prob. 5AECh. 5 - Prob. 1F15Ch. 5 - Prob. 2F15Ch. 5 - Prob. 3F15Ch. 5 - Prob. 4F15Ch. 5 - Prob. 5F15Ch. 5 - Prob. 6F15Ch. 5 - Prob. 7F15Ch. 5 - Prob. 8F15Ch. 5 - Prob. 9F15Ch. 5 - Prob. 10F15Ch. 5 - Prob. 11F15Ch. 5 - Prob. 12F15Ch. 5 - Prob. 13F15Ch. 5 - Prob. 14F15Ch. 5 - Prob. 15F15Ch. 5 - Prob. 1ECh. 5 - Prob. 2ECh. 5 - Prob. 3ECh. 5 - Prob. 4ECh. 5 - Prob. 5ECh. 5 - Prob. 6ECh. 5 - Prob. 7ECh. 5 - Prob. 8ECh. 5 - Prob. 9ECh. 5 - EXERCISE 5-10 Multiproduct Break-Even Analysis...Ch. 5 - Prob. 11ECh. 5 - EXERCISE 5-12 Multiproduct Break-Even Analysis...Ch. 5 - EXERCISE 5-13 Changes in Selling Price, Sales...Ch. 5 - Prob. 14ECh. 5 - Prob. 15ECh. 5 - Prob. 16ECh. 5 - Prob. 17ECh. 5 - Prob. 18ECh. 5 - Prob. 19PCh. 5 - PROBLEM 5-20 CVP Applications: Break-Even...Ch. 5 - PROBLEM 5-21 Sales Mix; Multiproduct Break-Even...Ch. 5 - Prob. 22PCh. 5 - Prob. 23PCh. 5 - Prob. 24PCh. 5 - PROBLEM 5-25 Changes in Fixed and Variable Costs;...Ch. 5 - PROBLEM 5-26 CVP Applications; Break-Even...Ch. 5 - Prob. 27PCh. 5 - Prob. 28PCh. 5 - Prob. 29PCh. 5 - Prob. 30PCh. 5 - PROBLEM 5-31 Interpretive Questions on the CVP...Ch. 5 - CASE 5-32 Break-Even Analysis for Individual...Ch. 5 - Prob. 33C
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