Course: Cost Accounting

Course I.D: 9703

Pittman’s Case study

[Case 6-32]
Cost structure; Break even; target profits

Submitted to: Mr. Arsalan Hashmi

Date of Submission: 26 - July - 2010
 ACKNOWLEDGEMENT

First of all, we would like to thanks Almighty Allah who has guided
us the way for a bright future. We would like to acknowledge the
help provided by our parents to make this project a success.

We wish our deepest gratitude to Mr. Arsalan Hashmi, our

teacher, for his valuable guidance and support during the project
study. Without her valuable comments and suggestions, the
Project report writing could have been more difficult to complete.

A special thanks to our greatest source of inspiration and

encouragement from Parents, friends and well wishers. We would
like to thank each and everyone who supported and co-operated
with us in the completion of this project.

We would also like to appreciate the co-operation we got from our

class mates at PAF-KIET, which boosted our moral support to
strive for better results.

Finally, we would like to thank PAF-KIET for providing us a truly

competitive & inspiring environment for studies.

Regards, (3833)
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Submitted by: The Gainers

Submitted to: Mr. Arsalan Hashmi 2
 TABLE OF CONTENTS
TABLE OF CONTENTS.................................................................................................................3
GROUP MEMBERS:......................................................................................................................4
INCOME STATEMENT IN CONTRIBUTION FORMAT...........................................................5
QUESTION NO. 1...........................................................................................................................7
QUESTION NO. 2...........................................................................................................................8
QUESTION NO. 3...........................................................................................................................8
QUESTION NO. 4...........................................................................................................................9
QUESTION NO. 5.........................................................................................................................10
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Submitted by: The Gainers

Submitted to: Mr. Arsalan Hashmi 3
 GROUP MEMBERS:

 (3833)

Group Name: The Gainers

Submitted to Mr. Arsalan Hashmi

Course: Cost and Managerial Accounting

Submitted on 26 July, 2010

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Submitted by: The Gainers

Submitted to: Mr. Arsalan Hashmi 4
 INCOME STATEMENT IN CONTRIBUTION FORMAT
1. In order to calculate the breakeven point in sales in dollar, first we need to find the
fixed expense and CM ratio (contribution margin & sales) so before proceeding to the
solution, it is supportive to restructure the data into contribution format for each of the
three alternative (15%, 20% & own sales force).

(The data in the statements below are in thousands.)

15% 20%
Commission Commission Own Sales Force
$16,000.
Sales $16,000 100% $16,000 100% 0 100.0%
Variable expenses:
Manufacturing 7,200 7,200 7,200.0
Commissions (15%, 20% 1,200.
7.5%) 2,400 3,200 0
8,400.
Total variable expenses 9,600 60 10,400 65 0 52.5
7,600.
Contribution margin 6,400 40% 5,600 35% 0 47.5%
Fixed expenses:
Manufacturing overhead 2,340 2,340 2,340.0
Marketing 120 120 2,520.0 *
Administrative 1,800 1,800 1,725.0 **

Interest 540 540 540.0

7,125.
Total fixed expenses 4,800 4,800 0
Submitted by: The Gainers
Submitted to: Mr. Arsalan Hashmi 5
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 Income before income taxes 1,600 800 475.0
Less income taxes (30%) 480 240 142.5
Net income $ 1,120 $  560 $  332.5
*$120,000 + $2,400,000 = $2,520,000.
**$1,800,000 – $75,000 = $1,725,000.

Submitted by: The Gainers

Submitted to: Mr. Arsalan Hashmi 6
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 Case 6-32

QUESTION NO. 1
1. Break-even point in dollar sales:

a. Break-even point in dollar sales if the commission remains

15%.
Fixed costs $4,800,000
= =$12,000,000
CM ratio 0.40
b. Break-even point in dollar sales if the commission increases
to 20%.
Fixed costs $4,800,000
= =$13,714,286
CM ratio 0.35
c. Break-even point in dollar sales if the company employs its
own sales force.
Fixed costs $7,125,000
= =$15,000,000
CM ratio 0.475

Conclusion:
Estimated break even sales in dollar is less with 15% and
20% but relatively higher, if company hires own sales force.
Higher the break even means that more should be the sales in
order to generate profit. And lower the breakeven means that
company may generate more profit. (As compared to 20% or
having own sales force)
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Submitted to: Mr. Arsalan Hashmi
 QUESTION NO. 2
In order to generate a $1,120,000 net income, the company must
generate $1,600,000 in income before taxes. Therefore,
Dollar sales to= Fixed expenses + Target income before taxes
attain target CM ratio

$4,800,000 + $1,600,000 $6,400,000

= = = $18,285,714
0.35 0.35
If the company decides to continue selling through agents and
pays the 20% commission rate, 18,285,714 sales that would be
required to generate the same set income (1,120,000) as
continued in the budgeted income statement for the next year

QUESTION NO. 3
To determine the volume of sales at which net income would be
equal under either the 20% commission plan or the company
sales force plan, we find the volume of sales where costs
before income taxes under the two plans are equal.
X= Total sales revenue
0.65X + $4,800,000 = 0.525X +
$7,125,000
0.65X – 0.525X = $7,125,000 - $
4,800,000
0.125X = $2,325,000
X = $2,325,000
0.125
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X = $18,600,000
Submitted by: The Gainers 8
Submitted to: Mr. Arsalan Hashmi
 Thus, at a sales level of $18,600,000 either plan would yield
the same income before taxes and net income. Below this sales
level, the commission plan would yield the largest net income

QUESTION NO. 4
a) Degree of operating leverage, when commission rate remains
unchanged at 15%

= $6,400,000 = 4
$1,600,000

b) Degree of operating leverage, when commission rate is 20%

= $5,600,000 = 7
$ 800,000

c) Degree of operating leverage, when employs its own sales

force

= $7,600,000 = 16
$ 475,000
Conclusion:

As Operating leverage is a measure of how sensitive net

operating income is to a given percentage change in dollar
sales.
If operating leverage is high, a small percentage increase in
sales can produce a much larger percentage increase in net
operating income.
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Submitted by: The Gainers 9

Submitted to: Mr. Arsalan Hashmi
 QUESTION NO. 5
We would continue to use the sales agents for at least one more
year, and possibly for two more years. The reasons are as
follows:

If we analyze all of the three situations (15%, 20%, own sales

force). Contribution margin is higher when company has its
own sales force, as compared to other situations, which could
generate higher net income. But of course, company would
have to handle all promotion costs, too. So the fixed cost would
increase by $2,400,000, which would decrease the net income,
and increase the breakeven point.

It means that the company could generate higher profit by

increasing sales, as the operating leverage is higher (16). Use
of the sales agents for at least one more year would give the
company more time to hire competent people and get the sales
group organized.

Because sales agent have been selling Pittman’s products

for a number of years , so they are likely to have more field
experience than any sales force we hire. It may be more
difficult for the sales force to maintain the sales (it will probably
decrease).

For the moment, profits will be greater and risks will be less
by staying with the agents, even at the higher 20% commission
rate.

Conclusion:
For the long run should employ its own sales force, as it could
generate more income by having more sales
But if we talk about the next year plan, the company should
continue to use sales agents even at a 20% commission rate.
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Submitted to: Mr. Arsalan Hashmi