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Case 3-32 (75 minutes)
1. The contribution format income statements (in thousands of dollars) for the three alternatives are:
18% Commission
20% Commission
Own Sales Force
Sales .................................................
$30,000
100
%
$30,000
100
%
$30,000
100
%
Variable expenses:
Variable cost of goods sold ...............
17,400
17,400
17,400
Commissions ...................................
5,400
6,000
3,000
Total variable expense ........................
22,800
76
%
23,400
78
%
20,400
68
%
Contribution margin ............................
7,200
24
%
6,600
22
%
9,600
32
%
Fixed expenses:
Fixed cost of goods sold ...................
2,800
2,800
2,800
Fixed advertising expense .................
800
800
1,300
*
Fixed marketing staff expense ..........
1,300
**
Fixed administrative expense ............
3,200
3,200
3,200
Total fixed expenses ...........................
6,800
6,800
8,600
Net operating income .........................
$ 400
$ (200)
$ 1,000
*
$800,000 + $500,000 = $1,300,000
**
$700,000 + $400,000 + $200,000 = $1,300,000
Case 3-32 (continued)
2. Given the data above, the break-even points can be determined using
total fixed expenses and the CM ratios as follows:
a.
Fixed expenses $6,800,000
Dollar sales = = = $28,333,333
to break even CM ratio 0.24
b.
Fixed expenses $6,800,000
Dollar sales = = = $30,909,091
to break even CM ratio 0.22
c.
Fixed expenses $8,600,000
Dollar sales = = = $26,875,000
to break even CM ratio 0.32
3.
Target profit + Fixed expenses
Dollar sales to attain=
target profit CM ratio
-$200,000 + $8,600,000
= 0.32
= $26,250,000
4.
X = Total sales revenue
Net operating income = 0.32X - $8,600,000
with company sales force
Net operating income = 0.22X - $6,800,000
with the 20% commissions
The two net operating incomes are equal when:
0.32X – $8,600,000
=
0.22X – $6,800,000
0.10X
=
$1,800,000
X
=
$1,800,000 ÷ 0.10
X
=
$18,000,000
Case 3-32 (continued)
6.
To: President of Marston Corporation
Fm: Student’s name
Assuming that a competent sales force can be quickly hired and trained
and the new sales force is as effective as the sales agents, this is the
The major concern I have with this recommendation is the assumption
that the new sales force will be as effective as the sales agents. The
sales agents have been selling our product for a number of years, so
they are likely to have more field experience than any sales force we
hire. And, our own sales force would be selling just our product instead
number of salespersons each of whom sells only a single product. Even
so, we can afford some decrease in sales because of the lower cost of
maintaining our own sales force. For example, assuming that the sales
agents make the budgeted sales of $30,000,000, we would have a net
operating loss of $200,000 for the year. We would do better than this
force.
CASE 3-33 (60 minutes)
Note: This is a problem that will challenge the very best students’ conceptual
and analytical skills. However, working through this case will yield substantial
dividends in terms of a much deeper understanding of critical management
accounting concepts.
Frog
Minnow
Worm
Total
Sales .........................
$200,000
$280,000
$240,000
$720,000
Variable expenses .......
120,000
160,000
150,000
430,000
Contribution margin ....
$ 80,000
$120,000
$ 90,000
290,000
Fixed expenses ..........
282,000
Net operating income .
$ 8,000
Contribution margin $290,000
CM ratio= = =0.4028
Sales $720,000
Fixed expenses $282,000
Dollar sales = = =$700,100 (rounded)
to break even CM ratio 0.4028
2. The issue is what to do with the common fixed costs when computing
the break-evens for the individual products. The correct approach is to
ignore the common fixed costs. If the common fixed costs are included
in the computations, the break-even points will be overstated for
individual products and managers may drop products that in fact are
profitable.
Case 3-33 (continued)
b. If the company were to sell exactly the break-even quantities
computed above, the company would lose $108,000—the amount of
the common fixed cost. This occurs because the common fixed costs
have been ignored in the calculations of the break-evens.
Frog
Minnow
Worm
Total
Unit sales ................
22,500
160,000
200,000
Sales .......................
$45,000
$224,000
$160,000
$ 429,000
Variable expenses ....
27,000
128,000
100,000
255,000
Contribution margin .
$18,000
$ 96,000
$ 60,000
174,000
Fixed expenses ........
282,000
Net operating loss ....
$(108,000)
At this point, many students conclude that something is wrong with
their answer to part (a) because the company loses money operating
at the break-evens for the individual products. They also worry that
managers may be lulled into a false sense of security if they are given
the break-evens computed in part (a). Total sales at the individual
product break-evens is only $429,000 whereas the total sales at the
overall break-even computed in part (1) is $700,100.
Many students (and managers, for that matter) attempt to resolve
this apparent paradox by allocating the common fixed costs among
Case 3-33 (continued)
It would be natural to interpret a break-even for a product as the
level of sales below which the company would be financially better off
dropping the product. Therefore, we should not be surprised if
managers, based on the erroneous break-even calculation on the
Frog
Minnow
Worm
Total
Sales ..........................
$200,000
dropped
dropped
$200,000
Variable expenses .......
120,000
120,000
Contribution margin ....
$ 80,000
80,000
Fixed expenses* .........
126,000
Net operating loss .......
$(46,000)
*By dropping the two products, the company reduces its fixed
expenses by only $156,000 (= $96,000 + $60,000). Therefore, the
total fixed expenses would be $126,000 (= $282,000 − $156,000).
By dropping the two products, the company would have a loss of
$46,000 rather than a profit of $8,000. The reason is that the two
products dropped were contributing $54,000 toward covering
common fixed expenses and toward profits. This can be verified by
looking at a segmented income statement like the one that will be
introduced in a later chapter.
Frog
Minnow
Worm
Total
Sales ..............................
$200,000
$280,000
$240,000
$720,000
Variable expenses ...........
120,000
160,000
150,000
430,000
Contribution margin ........
80,000
120,000
90,000
290,000
Product fixed expenses ....
18,000
96,000
60,000
174,000
Product segment margin .
$ 62,000
$ 24,000
$ 30,000
116,000
Common fixed expenses ..
108,000
Net operating income ......
$ 8,000
$54,000
