CASE 4–34 Cost Structure; Break-Even Point; Target Profits [LO4, LO5, LO6]

Crescent Corporation manufactures multi-function photocopiers that are sold to businesses through a network of independent sales agents located in the United States and Canada. These sales agents sell a variety of products to businesses in addition to Crescent’s multi-function photocopiers. The sales agents are currently paid a 19% commission on sales, and this com- mission rate was used when Crescent’s management prepared the following budgeted income statement for the upcoming year:

 

Sales  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Â	$15,000,000
Cost of goods sold:	Â	Â
Variable  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$8,400,000	Â
Fixed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	  1,400,000	   9,800,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Â	5,200,000
Selling and administrative expenses:	Â	Â
Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	2,850,000	Â
Fixed advertising expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	400,000	Â
Fixed administrative expense   . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	  1,600,000	   4,850,000
Operating income  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	Â	$  350,000

 

Since the completion of the above statement, Crescent’s management has learned that the independent sales agents are demanding an increase in the commission rate to 22% of sales for the upcoming year. This would be the third increase in commissions demanded by the independent sales agents in five years. As a result, Crescent’s management has decided to investigate the possibility of hiring its own sales staff to replace the independent sales agents.

Crescent’s controller estimates that the company would have to hire six salespeople to cover the current market area, and the total annual payroll cost of these employees would be about $350,000, including benefits. The salespeople would also be paid commissions of 12% of sales. Travel and entertainment expenses are expected to total about $200,000 for the year. The company would also have to hire a sales manager and support staff, whose salaries and bene- fits would total $100,000 per year. To make up for the promotions that the independent sales agents had been running on behalf of Crescent, management believes that the company’s bud- get for fixed advertising expenses should be increased by $250,000.

Required:

1.                Assuming sales of $15,000,000, construct a budgeted contribution format income state- ment for the upcoming year for each of the following alternatives:

a.       The independent sales agents’ commission rate remains unchanged at 19%.

b.       The independent sales agents’ commission rate increases to 22%.

c.       The company employs its own sales force.

2.                Calculate Crescent Corporation’s break-even point in sales dollars for the upcoming year assuming the following:

a.       The independent sales agents’ commission rate remains unchanged at 19%.

b.       The independent sales agents’ commission rate increases to 22%.

c.       The company employs its own sales force.

 

 

 

 

 

 

3.                Refer to your answer to 1(b) above. If the company employs its own sales force, what vol- ume of sales would be necessary to generate the operating income the company would realize if sales are $15,000,000 and the company continues to sell through agents (at a 22% commission rate)?

4.                Determine the volume of sales at which operating income would be equal regardless of whether Crescent Corporation sells through agents (at a 22% commission rate) or employs its own sales force.

5.                Prepare a profit graph on which you plot the profits for both of the following alternatives:

a.       The independent sales agents’ commission rate increases to 22%.

b.       The company employs its own sales force.

On the graph, use total sales revenue as the measure of activity.

6.                Write a memo to the president of Crescent Corporation in which you recommend whether the company should continue to use independent sales agents (at a 22% commission rate) or employ its own sales force. Fully explain the reasons for your recommendation in the memo.

(CMA, adapted)