CVP Analysis
Jordan Company, a wholesale electrical supply company, uses independent sales agents to market the company’s products throughout the West Coast region. Currently these agents receive a commission of 19% of sales but are now demanding an increase to 26% of sales starting the next fiscal year, 2015. Jordan Company’s Controller prepared the 2015 financial budget before learning of the agents’ demand for an increase in commissions. The 2015 budgeted income statement is shown below.
Budgeted Income Statement
For the Year Ended December 31, 2015
Sales $ 13,500,000
Cost of goods sold 7,700,000
Gross margin $ 5,800,000
Selling and administrative costs:
Commissions $ 2,565,000
Other fixed costs 125,000
Total selling and administrative costs 2,690,000
Income before taxes $ 3,110,000
Income tax (35%) 1,088,500
Net income $ 2,021,500
In response to this demand, senior management has asked the Controller to consider replacing the independent agents with an in-house full-time sales force. The Controller is to budget for 3 sales people to be paid an annual salary of $38,000 each, plus commissions of 12% of sales. In addition, a sales manager will be hired at a fixed salary and benefits of $115,000. All other fixed costs remain the same. Of the budgeted Cost of Goods Sold (COGS), 60% is variable, the remainder is fixed over the relevant range. The variable COGS moves in proportion to total sales, increasing (decreasing) in proportion as sales increases (decreases)
Required:
a) Prepare a budgeted contribution margin income statement for the two alternatives
1. Accept the independent agents commission increase (alternative 1)
2. Replace the independent agents with an in-house sales force (alternative 2)
Show both operating income and income net of taxes for both alternatives.
b) Calculate the contribution margin % for each alternative and the break-even volume in sales dollars for each alternative.
c) What level of sales under alternative 1 will result in the same after-tax net income as alternative 2?
d) Prepare a memo to the Controller analyzing each of the alternatives with your recommended alternative and why. In the memo include your analysis of the best alternative given a recession that results in an 18% decrease in sales, as well as a business expansion resulting in an 18% increase in sales, using after tax net income under both scenarios to support your economic analysis. An 18% increase/decrease in sales is within the capacity relevant range for Jordan Company. You must show your calculations for all alternatives.